Auction Rate Securities Mess Continues

Some investments need a plain- language warning sticker that you find on a stepladder or a crib.

Caution was lacking for auction-rate securities, complex vehicles that were sold by brokers to institutions and individuals. They were bonds or preferred stocks that had interest rates periodically reset through auctions, which failed after the subprime-market meltdown.

Why did individual investors get the idea that these securities were liquid cash equivalents like money-market funds? The disclosure from brokers wasn't adequate.
The $330 billion auction market for these securities collapsed late last year and investors couldn't cash out.

What went wrong and how did these troubled investments end up in the hands of individuals? Which regulator neglected to check that folks like Dibbell were fully informed of the risks of these securities? Clearly there wasn't enough disclosure since retail investors bought about $165 billion of these vehicles.

"Based on the hundreds of complaints received, investors were not informed of the liquidity risks and received little disclosure," said Karen Tyler, president of the North American Securities Administrators Association, a state regulators group. "They were marketed as a safe, money-market cash equivalent."

Now regulators, led by de facto federal securities cops, New York Attorney General Andrew Cuomo and state agencies, are inspecting about 40 brokerage firms to see if they gave ample warning to their clients on auction-rate risks.

So far, state and federal regulators have reached settlements with eight major banks and broker-dealers to buy back more than $35 billion of the securities from investors.

The firms have been fined more than $522 million, paling in comparison with the $5 billion in penalties for the mutual-fund late-trading scandal in 2003.

Small investors seemed to be the last to find out about auction-rate pitfalls even though it was known that there were significant conflicts with these securities five years ago.

The Securities and Exchange Commission cited problems in this market going back to 2003. After a probe, the agency fined 15 firms more than $13 million combined in May 2006, and issued cease-and-desist orders, citing ``violative practices.''