Recently, many investors have been trapped in auction rate securities when the auctions for such securities failed. The SEC is now proposing action that will permit local governments to buy their own debt at auction without being suspected of engaging in market manipulation. While the SEC’s aim is to assist local governments who have been paying higher interest rates because of the failure of the auctions, it may also permit investors in such securities to get out of an illiquid investment that had been sold as one that was as liquid as cash.
According to Kara Scannell’s article in the March 13, 2008 edition of The Wall Street Journal, during a congressional hearing on Wednesday, Erik Sirri, director of the SEC’s division of trading and markets, said the SEC is drafting guidance to “clarify that, with appropriate disclosures,” municipalities will be allowed to purchase their own debt at auction without triggering market-manipulation concerns.
The change in guidance comes in response to calls from Congress, Wall Street, and especially from the local governments that were faced with unusually high borrowing costs as auctions for their debt failed and the interest rates re-set to higher levels. More than $80 billion in securities have failed at auction resulting in interest rates as high as 20% for some municipal borrowers.
In addition to the guidance, the auction-rate market may be subject to additional disclosure requirements. The Municipal Securities Rulemaking Board, which writes rules governing the municipal bond market, is considering changes to increase price transparency. Sirri points to a lack of transparency for making the failed auction-rate market worse.
Auction-rate securities offer borrowers a way to finance for the long term at short-term interest rates, which reset every 7 to 35 days. Concerns about bond insurers and lack of liquidity caused investors to withdraw from the auction-rate market and the auctions to fail.
Investors in auction rate securities need to monitor these developments closely. Auction rate securities are simply not the cash, cash equivalents or money market type investments that many were sold as being. To the contrary, these investments can be very illiquid and can become impossible to convert to cash. Investors who bought auction rate securities based on the promise that they were the equivalent to cash or money market investments are well advised to consider liquidating these holdings as soon as a reasonable opportunity presents itself and consulting their legal advisers if any damages are sustained.