In the News: Recent Developments

July 10 2008, 1:00am EDT

Can ARS Issues Be Fixed?

By Andrew Ackerman

WASHINGTON – A Wall Street-based financial advisor is urging the Municipal Securities Rulemaking Board to increase the transparency of the auction-rate securities market by requiring broker-dealers to release auction results that are similar to the Treasury Department’s and by encouraging auction agents to open up the auctions to as many
broker-dealers as possible to increase liquidity.

Joseph Fichera, senior managing director and chief executive officer of Saber Partners LLC, stressed in a letter to the board yesterday that the MSRB should act decisively to fix the auction-rate market rather than let it languish.

MSRB executive director Lynnette Hotchkiss said yesterday that there is probably still time for the board to consider Fichera’s letter as a supplement to its slate of issues. At its board meeting next week in Denver, the MSRB is expected to discuss a plan unveiled in March to through the end of April.

“The market is looking for leadership now and not further litigation,” Fichera said in his letter, referencing the flurry of law suits brought recently by investors and securities regulators in light of the collapse of the ARS market in February. “The MSRB could help provide that leadership and help fix the course for the future.”

The board proposed establishing the ARS disclosure system as a way of increasing the amount of auction-rate information available to market participants. Currently, there is no source of comprehensive same-day information about auction-rate securities available to non-market professionals – even information as basic as the clearing rates set through the auction process.

In his letter, Fichera urged the MSRB to require broker-dealers to give “simple, accessible, and understandable” information to let investors judge the securities’ liquidity while warning that excessive disclosure requirements could lead to further “confusion and obfuscation”

The transparency model, he said, should be the disclosure provided by the Treasury Department for its auctions, in which the department releases an announcement ahead of the auction, followed by the auction results on a single page, both of which are accessible from a Treasury Web site.

In addition to replicating the information released by the Treasury Department, brokerdealers should be required to distinguish the amount of bonds the broker-dealer bid for its own account from other investors’ bids. Fichera emphasized that like the Treasury, the board should require broker-dealers to include a so-called bid-to-cover ratio, which he said would be a better alternative to requiring broker-dealers to disclose whether a given auction failed or was successful. Bid-to-cover ratios represent the amount of bonds that were bid compared to the total amount of securities in the particular auction. A bid-tocover ratio of 0.8 “clearly indicates an auction that did not succeed in clearing the entire issue,” Fichera said. A ratio of 1.1 would show marginal coverage but that all securities placed, while a ratio of 2.3 would show “robust demand:”

Turning to liquidity issues, Fichera claimed, that because a large part of the municipal ARS market involves auctions in which a single broker-dealer is permitted to bid on the securities, it is a misnomer to use to term “auction”, to describe the process of setting ARS clearing rates. “If the Treasury Department required all bids in their auctions to go through a single broker-dealer, most would question whether that was really an ‘auction’ by what we all consider that to mean,” he wrote.

Fichera added that the “sole broker-dealer system” creates confusion between variable-rate demand bonds that reprice through a remarketing agent in which it is clearly disclosed that the agents set the rate and are working on behalf of the issuer. But the term “auctions” suggest that the rates are set by investors through a true auction, not by the broker-dealer.

Remarketings should not be masked as auctions, and the board should consider limiting the use of the word “auction” to apply only to a competitive process where there are at least three independent broker-dealers through which investors could bid, mirroring new issue competitive auctions, he said.

“This means that the MSRB should encourage broker-dealers to give up the proprietary approach to auctions, which confuses the role of a broker-dealer in an auction with the completely different and independent role of a remarketing agent in variable rate demand obligations,” he said.

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