January 09 2007, 8:45pm EST

Auction Agents Pay SEC $1.6M

By Lynn Hume

WASHINGTON-Three auction agents in the $200 billion-plus auction-rate securities market have agreed to pay a total of $1.6 million to settle Securities and Exchange Commission charges that they accepted broker-dealer bids after deadlines and allowed dealers to intervene in auctions-actions that may have affected the rates paid on the securities.

The SEC announced the settlement yesterday against Deutsche Bank Trust Company Americas, the Bank of New York, and Wilmington Trust Co., saying they violated the securities laws by engaging in those practices from Jan. 1, 2003, through June 30, 2004, in the municipal, corporate, and preferred-stock auction-rate markets.

Deutsche Bank and the Bank of New York, which sources say typically account for more than 90% of auction-rate securities business, agreed to pay $750,000 each. Wilmington Trust, which is based in Delaware, will pay $100,000.

In addition, the firms committed to provide, within three months, written descriptions of their key auction-rate securities practices to broker-dealers and issuers, as well as notifications of any changes in those practices. Further, their chief executive officers or general counsels within six months will certify in writing that they have adopted procedures reasonably designed to prevent such violations in the future.

The SEC action against the auction agents follows a $13 million global settlement the commission reached with 15 broker-dealer firms in this market last June for violating the securities laws by engaging in undisclosed practices that either favored certain investors over others, issuers over investors, or manipulated clearing rates.

“This matter shows the commission’s intent to clear up the auction-rate securities market by going after market participants besides the broker-dealers, namely the auction agents,” Kenneth Lench, an SEC assistant director of enforcement, said yesterday. “While broker-dealers were primarily responsible for the widespread problems in this market, the auction agents enabled the broker-dealers to engage in certain illegal practices.”

SEC officials said yesterday that their investigation in the auction-rate securities market is continuing, suggesting that other broker-dealer firms or auction agents may be subject to enforcement action.

Some market participants questioned the size of the auction agent fines, but Lench said they were in keeping with the monetary penalties imposed on broker-dealers in the earlier global settlement. In that case, firms were each ordered to pay from $125,000 to $1.5 million.

The SEC said in its settlement order that the size of the payments were based partly on the amount of investor harm and the firms’ conduct in the investigation “mitigated the serious and widespread nature of the [violations].”

Joseph S. Fichera, chief executive officer of Saber Partners LLC in New York, who was hired as an expert adviser by the SEC on auction-rate securities, declined to comment on the settlement, but said in general: “Auction agents actually run the auction, but the way they are paid makes them more like clerks than managers.”

However, he added, “The auction agent’s first duty should be to the integrity of the auction process.”

Fichera said the auction-rate securities market needs to be much more open than it is today.

“If the Treasury administered auctions this way-with firms selectively sharing information and working both sides of the trades multiple times -people would be upset,” he said. “With all af the technological advances we’ve had, why can’t the auctions be opened up to all investors for bid? Why can’t all broker-dealers participate in them? That would make auctions what we all think they should be -broad-based and competitive with a level playing field.”

Spokesmen for Bank of New York, Deutsche Bank Trust, and Wilmington Trust said the banks were pleased to resolve the matter. The Securities Industry and Financial Markets Association declined to comment.

Auction-rate securities are bonds whose interest rates are periodically reset through auctions, typically every seven, 14, 28, or 35 days. Broker-dealers often market auction-rate securities to issuers as an alternative to variable-rate financing, and to investors as an alternative to money market funds.

Auction-rate securities are auctioned at par, so the return on the investment to the investor and the cost of the financing to the issuer between auction dates is determined by the interest rate (or dividend yield) set through the auctions.

The final rate at which all of the securities are sold is the “clearing rate,” which applies to all of the securities in the auction until the next auction. Bids with the lowest rate and then successively higher rates are accepted until all of the sell orders are filled. The clearing rate is the lowest rate bid sufficient to cover all the securities for sale in the auction.

If there are not enough bids to cover the securities for sale, then the auction fails, and the issuer pays an above-market rate set by a predetermined formula described in the disclosure documents. All the current holders continue to hold the securities, with some minor exceptions. If all the current holders of the securities elect to hold their positions without bidding, then the clearing rate is the all-hold rate, a below-market rate set by a formula, also described in the disclosure documents.

But the SEC found dealers intervening in auctions to prevent them from failing or resulting in “all-hold” auctions.

In this market, the issuer selects one or more broker-dealers to underwrite the offering and/or manage the auction process. A broker-dealer managing an auction is typically paid 25 basis points for the par value of the securities it manages. The issuer also selects an auction agent to receive the orders from the broker-dealer or dealers, and to calculate the clearing rate for the auction. The auction agent typically is paid one basis point for the principal outstanding amount of the securities on an annualized basis to administer an auction in accordance with an agreement.