In the News: Recent Developments

January 26, 2010

States Planning to Review ARS Buy-Backs

By Andrew Ackerman

WASHINGTON — North Carolina securities regulators plan this week to begin work on a centralized auction-rate securities research center that will collect progress reports on how Wall Street and other dealer firms are fulfilling the “best effort” commitments they made to provide liquidity to institutional investors still holding illiquid ARS.

The initiative, launched on behalf of the North American Securities Administrators Association, comes as the liquidity provisions in ARS settlements reached during roughly the past 18 months have begun to expire. While firms generally are believed to have fulfilled their commitments to retail investors, it is not as clear what efforts, if any, they have made at restoring liquidity to institutional investors, generally defined as investors with $10 million or more in investments.

Most of the settlements required retail buy-backs by certain dates, but only asked firms to use their “best efforts” for institutional buy-backs. The firms had to file confidential monthly reports with regulators on their progress.

“We don’t have any reason to believe that they won’t honor their commitments, but it’s our responsibility to make sure that they do,” said Denise Voigt Crawford, president of NASAA and the commissioner of the Texas Securities Board. “We don’t want any of the buy-backs to slip through the cracks.”

David Massey, North Carolina’s deputy securities administrator, said the initiative is important because it will allow state regulators to review firms’ progress with institutional buy-backs in a consistent way. But he stressed that because several investigations are still ongoing, the information may not be readily available to the public. But it may be possible to release it in a “distilled” format in the future, he said.

Though regulators estimate that state and federal settlements have provided $60 billion in liquidity to retail investors that held ARS when the market collapsed in February 2008, there is no systemic information for institutional buy-backs and most firms have refused to comment on their efforts.

One group of publicly traded, non-bank corporations that still own billions of dollars of illiquid student loan auction-rate securities, or SLARS, are urging a federal liquidity backstop so they can finance the ARS at a value close to par and have money to invest in their businesses.

“The members of the coalition continue to hold a very substantial amount of SLARS securities that have not been resolved,” said Erik Klingenberg, a partner at Sonnenschein Nath & Rosenthal LLP who is representing the SLARS investors.

Joseph Fichera, senior managing director and chief executive officer of Saber Partners, who is an ARS expert, said NASAA’s initiative is “very important,” adding that firms do not appear to be doing much at providing liquidity at par to their institutional clients — offering loans less than 100% instead of full buy-backs or making a secondary market.

Fichera also questioned the settlements, reached during the height of the financial crisis when firms struggled to add the ARS to their balance sheets.

“The framework [of the settlements] done at the height of the economic crisis in which dealers successfully negotiated with regulators in settlement discussions that forcing them to buy back securities would set them under may have been true in August 2008, but is certainly not true now,” he said, noting the return to profits and pre-2008 compensation at Wall Street firms.

He said the ARS market remains largely opaque even with new information systems, and suggested that regulators pursue a “systemic” liquidity solution as well as enforcement actions against individuals.

Moreover, while each case is fact-specific, he said that if anyone suggested institutional investors that invested more than $10 million with Bernard Madoff should have “known better,” they likely would not have been
listened to.

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