Posted in: FINRA | SEC | Risky Investments | Auction Rate Securities |
FINRA issued a release last week announcing it had settled charges with HSBC Securities and U.S. Bancorp related to the sales of toxic auction rate securities. These broker dealers are among the 14 firms that have faced federal regulatory action for marketing auction rate securities as being safe as cash-when they certainly were not.
Auction rate securities (ARS) are long-term investments, a collection of municipal and corporate stocks which mature over 20 or 30 years. But prior to 2008 brokers commonly sold their clients on them being liquid and safe investments. Many investors believed auction rate securities to be lucrative, because of their inherent interest and tax benefits.
By 2008 nearly $330 billion in customer assets were tied up in these securities, which were to be bought and sold at periodic “Dutch” auctions throughout the year. After the credit crisis in 2007 these auctions began failing, which meant by February 2008 the majority of auction rate securities had become nearly impossible to sell.
HSBC Securities, which is a subsidiary of Hong Kong-based behemoth bank HSBC, was ordered to pay $1.5 million, and was ordered to purchase auction rate securities from customers who were not covered in earlier settlements.
From 2007 to early 2008, HSBC sold more than $1 billion worth of auction rate securities to a variety of customers. In FINRA’s release, the facts clearly indicate why HSBC have been fined multiple times and repeatedly ordered to repay purchasers of auction rate securities:
FINRA found up until February 2008 - when widespread auction failures froze ARS holdings - HSBC retail brokers recommended and sold ARS to customers, representing them as liquid and safe investments. But as of December 2007, it had become apparent to HSBC that credit markets were deteriorating and there were increased investment risks in ARS. In a December 2007 conference call, HSBC managers continued to suggest that brokers recommend ARS to retail customers, describing spikes in yields as “very advantageous” to customers. While noting “never say never” to the possibility of a failed auction, the managers indicated that they did not believe problems in the credit markets would affect ARS.
In an email after the conference call, a broker recommended to one of the managers that brokers should inform clients about the possibility and consequences of a failed auction for ARS: The next day, an ARS trading desk employee unsuccessfully sought the manager’s permission to send an email to the firm’s brokers concerning the heightened risk of owning ARS. The subsequent measures the firm took to notify its brokers of the risks associated with ARS were inadequate. The firm’s retail brokers continued to recommend ARS as safe and liquid investments while failing to adequately notify customers of these increased risks.
As for U.S. Bancorp, the investments arm of U.S. Bank, was also fined $275,000. Unlike HSBC, whose brokers directly solicited auction rate securities to customers, U.S. Bancorp relied on other securities firms’ marketing materials. According to FINRA’s release, these materials described ARS as a “great place for short-term money,” as well as a safe “cash alternative,” and U.S. Bancorp brokers did nothing to correct or clarify those bogus claims.
Investors of auction rate securities suffered badly in 2008 for a number of reasons.
First, the timing of auction rate securities auction failures could not have been any worse. Auctions began failing on the heels of the credit crisis, and as the recession worsened investors discovered they could not liquidate these assets.
Second, the minimum investment required is typically $25,000. While more than half of those who invested in auction rate securities were “institutional” investors - including corporations, non-profits organizations, and partnerships - the individual investor would have definitely suffered big losses.
Third, while many investors were reimbursed as early as 2008 for their auction rate securities investments, many investors have been left out because of loopholes in prior settlement agreements. While it is important for FINRA to continue holding firms like HSBC and U.S. Bancorp accountable, some investors have been waiting over two years to recover on their lost investments.
With regards to auction rate securities, in many cases the stockbroker misconduct involved was so egregious because brokers should have known better. Most people forget that the Securities and Exchange Commission ordered 15 broker-dealers to cease and desist their sales practices in the auction rate securities market, in part because they failed to set standard market rates and failed to protect the auctions for these investments. When the SEC issued this order, they were responding to firm activity dating back to 2003.
Federal regulators should not stop until every duped investor gets reimbursed for his or her auction rate security investment-and neither shall we. If you invested in auction rate securities prior from 2007 to 2008 and have not been compensated in a settlement, contact us for a free consultation of your case.
