SEC Settles Administrative Proceeding Regarding Broker Intervention in ARS Auction
June 2, 2008
The SEC recently settled an administrative proceeding instituted against First Southwest Company (FSC) for its role as an underwriter of, and agent for, auction rate securities. According to the SEC Order, FSC regularly intervened in the auctions that served to reset the interest rate on the securities by bidding for its own account in order to prevent failed auctions and to prevent all hold auctions (when a below-market rate is set because no securities are for sale in the auction). As a result of some of these interventions, the clearing rate (the rate that determines the interest rate or yield that the issuer must pay to investors until the next auction) was affected. Specifically, in those instances when these practices lowered the clearing rate, investors received a lower rate of return on their investments. Conversely, in those instances when the practices raised the clearing rate, issuers had to pay a higher interest rate or yield. Furthermore, to the extent that this practice artificially manipulated the auction process to prevent a failed auction, investors may not have been aware of the liquidity and credit risks associated with certain of the auction rate securities.
In the Order, the SEC alleged that FSC had failed to properly disclose in the relevant auction rate securities offering documents the role that it intended to play in the auction process and that this failure violated Section 17(a)(2) of the Securities Act which prohibits material misstatements and omissions in any offer or sale of securities. As a result of this violation, the SEC imposed a $150,000 penalty and ordered FSC to provide all customers who hold auction rate securities and the issuers of such securities with a written description of its material auction practices and procedures. In determining the penalty assessed on FSC, the SEC noted the firm’s cooperation, but also noted that FSC had not self-reported the potential violations to the SEC. The SEC also noted that it aims to promote voluntary disclosures in industry-wide investigations and to encourage firms to provide comprehensive information to the staff in such investigations.
http://www.sec.gov/litigation/admin/2008/33-8919.pdf