While banks in Hong Kong are facing with the allegation of mis-selling of Lehman Minibonds, financial institutions in US are also being charged for mis-selling of "auction rate securities" (ARS).
According to Wikipedia, ARS typically refers to a debt instrument (corporate or municipal bonds) with a long-term nominal maturity for which the interest rate is regularly reset through a dutch auction, where broker-dealers submit bids on behalf of potential buyers and sellers of the bond. Based on the submitted bids, the auction agent will set the next interest rate as the lowest rate to match supply and demand. Since ARS holders do not have the right to put their securities back to the issuer, no bank liquidity facility is required. Auctions are typically held every 7, 28, or 35 days.
SEC charged two Wall Street brokers with defrauding their customers when making more than US$1 billion in unauthorized purchases of subprime-related auction rate securities. SEC alleges that Julian Tzolov and Eric Butler misled customers into believing that ARS being purchased in their accounts were backed by federally guaranteed student loans and were a safe and liquid alternative to bank deposits or money market funds. Instead, the securities that Tzolov and Butler purchased for their customers were backed by subprime mortgages, collateralized debt obligations (CDOs), and other non-student loan collateral.
Tzolov and Butler, while employed at Credit Suisse Securities (USA) LLC in New York, deceived foreign corporate customers in short-term cash management accounts by sending or directing their sales assistants to send e-mail confirmations in which the terms "St. Loan" or "Education" were added to the names of non-student loan securities purchased for the customers. They also routinely deleted references to "CDO" or "Mortgage" from the names of the securities in these e-mails. As a result, the complaint alleges that customers were stuck holding more than US$800 million in illiquid securities after auctions for ARS began to fail in Aug 2007. Those holdings have since significantly declined in value.
Recent Case 2
At early Oct 2008, SEC announced a preliminary settlement in principle with Banc of America Securities LLC and Banc of America Investment Services, Inc. (collectively, Bank of America) that would provide 5,500 individual investors, small businesses, and small charities the opportunity to sell back to Bank of America up to US$4.7 billion in ARS they purchased before the ARS market collapsed in Feb 2008.
The agreement also would require Bank of America to use its best efforts to provide up to US$5 billion in liquidity to other businesses, charities, and institutional investors. The proposed settlement would include charges alleging that Bank of America made misrepresentations to thousands of its customers when it told them that ARS were safe and highly liquid cash and money market alternative investments. The liquidity of these securities, however, was premised on Bank of America providing support bids for auctions when there was not enough customer demand, and Bank of America did not adequately disclose this support to customers. Bank of America continued to market ARS as cash and money market alternatives despite its awareness of the escalating liquidity risks in the weeks and months preceding the collapse of the ARS market. When Bank of America stopped supporting auctions in Feb 2008, there were widespread auction failures for Bank of America customers.
How could people restore confidence in the financial markets if there are so many scams?
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