The $13 million penalty assessed by the SEC in 2006 in a settlement against the 15 largest financial firms over the bidding process for auction-rate securities can now be seen as a portentous footnote to the current breakdown of the auction-rate business. Afterwards it was business as usual until the sub-prime liquidity crisis cast its long shadow across numerous markets including ARS.

Ordinary investors we’ve spoken to who are holding the municipal bonds, corporate bonds or preferred stocks issued by municipalities, other tax-exempt institutions and closed-end mutual funds are wondering how to extricate themselves from the situation. While they may now be collecting interest, it seems many investors who were unfamiliar with the auction-rate securities market were uniformly unaware that they wouldn’t be able to force the financial firms to give them an exit strategy.  Prompted by Congress, it was announced today that the SEC may permit issuers to bid on their own auction-rate securities.

Some individual investors, including seniors, retirees and students, were also told that the investments were better than money market funds or cash in the bank and “risk free.” To such investors, the risk averse and others for whom avoiding unsuitable investments is an economic necessity, liquidity is often a prerequisite to making an investment. Unfortunately, financial firms and their brokers don’t always put the investor’s objectives first.

Reporting on a contemporaneous development, the editor of InvestmentNews, Jim Pavia, published an opinion piece on March 10 about the importance of investor protection in promoting confidence in the markets, which can be applied equally in the ARS context:

“The recent push by the Financial Industry Regulatory Authority Inc. [Finra] to return money to harmed mutual fund investors was part of what should be a never-ending effort by the financial services industry to find ways to maintain consumer faith in the marketplace.

Finra recently settled cases against several firms that could result in the return of more than $25 million to fund investors who didn’t receive the benefit of net-asset-value transfer charge waivers to which they were entitled. According to Finra, certain customers eligible for NAV programs incurred front-end sales loads that they should not have paid, or purchased other share classes that unnecessarily subjected them to higher fees and the potential of contingent deferred sales charges.

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Making sure that markets are fair and that investors have confidence in equitable treatment should always be the top priority for the financial services industry. Making restitution to harmed investors certainly sends a great message.”

Investor protection: it’s a topic we have explored repeatedly over dozens of years in our practice representing the rights of investors.