Thursday, December 30, 2010

In the News: Auction Rate Securities

Forbes’ blogger Bill Singer narrates the story of Grand Circle LLC.

Grand Circle had brokerage accounts at the Royal Bank of Canada (RBC) and Wachovia. Through the recommendation of representatives at RBC and Wachovia, Grand Circle purchased auction rate securities (ARS). For business-related reasons, Grand Circle opened another brokerage account at CCO Investments Services Corp (CCO). Grand Circle’s Investment Policy stated that it wanted safe, liquid and AAA rated securities and that AAA rated ARS were in the list of acceptable securities. The assistant treasurer of Grand Circle believed that AAA rated ARS was safe and liquid and provided higher yields, so he, with the permission of CCO, directed the purchase of ARS.

ARS were first issued in the mid-1980s by corporations. Over the next two decades ARS were issued widely by institutions ranging from closed-end mutual funds, municipalities to student loan trusts. ARS were long-term floating rate securities whose coupon payments were determined at auctions that were typically held every 7 to 35 days. ARS were long-term securities with short-term floating rates. Broker dealers marketed ARS as liquid, short-term cash equivalents. However, ARS auctions failed en masse in February 2008 and proved to be illiquid and unsellable in the short-term.

SLCG has a written an in-depth paper on ARS, what they are, how their auctions worked and how they failed.

Wednesday, December 29, 2010

FINRA Press Release: Excessive Mark-Ups

FINRA Expels APS Financial, Bars Former President and Former Broker for Targeting an Elderly Investor with Fraudulently Excessive Mark-ups

The Financial Industry Regulatory Authority (FINRA) issued a press release today announcing that 
it has expelled APS Financial Corporation, located in Austin, Texas, barred the firm's former President, George Conwill, and barred Peter Aman, a former broker at the firm, in a scheme which overcharged an elderly investor by $1.2 million.
The settlement with APS Financial is detailed in the FINRA AWC No. 20050036446-02. Of the $1.2 million of total undisclosed mark-ups by Aman, $767,000 was considered fraudulently excessive mark-ups. Of the 45 transactions examined by FINRA, 43 transactions were related to the elderly investor and mark-ups ranged from 4.15 percent to 67 percent. FINRA has barred Conwill and expelled APS Financial Corporation for failing to provide proper supervision over the company’s transactions that would allow the company to detect fraudulent excessive mark-ups and for violating rules in trading in certain debt products.

A mark-up is the difference between what the selling price of the security and the market price, or cost price, of the security. A mark-up is not in itself fraudulent or excessive. To determine whether a mark-up is unfair, FINRA considers factors such as the type, availability and price of the security transacted and the content of the disclosure given by the broker to the customer prior to the transaction. Mark-ups are an obvious incentive for retail sales, investors should careful when being sold certain products whose complexity can often obscure and confuse the investors the extra costs attached to the products.

Tuesday, December 7, 2010

SEC Press Release: Banc of America Bid Rigging

 SEC Charges Banc of America Securities With Fraud in Connection With Improper Bidding Practices Involving Investment of Proceeds of Municipal Securities

The U.S. Securities and Exchange Commission (SEC) issued a press release today announcing that it had
charged Banc of America Securities, LLC (BAS) with securities fraud for its part in an effort to rig bids in connection with the investment of proceeds of municipal securities.
BAS has agreed to pay over $36 million, together with its affiliates, it has agreed to pay over $100 million to other federal and states. The SEC Order can be found here.
Proceeds in the sale of municipal securities are temporarily invested in reinvestment products before they can be used by the municipalities for their intended purpose. Reinvestment products are supposed to be chosen in a competitive bidding process. Under Internal Revenue Services (IRS) regulations, for municipal securities to be tax-exempt, the proceeds must be invested at fair value. The SEC found that BAS had rigged the competitive bidding process through secret agreements and deals and thereby affected the prices of the reinvestment products and “jeopardized the tax-exempt status of the underlying municipal securities”. According to the SEC, BAS had paid bidding agents so that it could win bids for 88 reinvestment products.

Municipal bonds are bonds issued by government entities at the city, county and state levels. Municipalities issue bonds to finance their projects for the public good. These bonds are called municipal bonds, and their rates may be fixed or floating. They are usually long term bonds. Municipalities usually use the proceeds of the bonds to purchase reinvestment products before using them for the municipalities’ intended purpose.

SLCG has written several papers relating to municipal bonds:
Investors may find in our dedicated website many other interesting papers and notes.