The turmoil in the $330 billion auction rate securities (ARS) market has spurred a series of investigations by the Securities and Exchange Commission, the Financial Industry Regulatory Authority (Finra), and Massachusetts securities regulators. Congressional leaders are calling for relief, allowing mutual funds to provide liquidity to retail investors holding the securities.
The mutual fund industry is working to come up with a solution for the closed-end fund segment of the ARS market. The Investment Company Institute has submitted a request to the SEC for exemptive relief that would allow closed-end funds to issue debt to buy back the preferred shares.
Charles Ladner, director of Boston-based John Hancock Funds, said the nature of auction rate securities has changed. "Auctions started fairly," he said. Then, "there were a lot of retail people who found themselves locked out of liquidity and need the money. The pressure is on to find some way to find liquidity. We have the obligation of duty and care to preferred shareholders."
The refinancing option is not without risks, cautioned Ladner, including legal and accounting costs. On the other hand, there is the "serious reputational risk suffered by fund companies, brokers who have sold them and their sponsoring firms," he said. "It is solvable, but it is not easy."
Bryan Lantagne, director of the Massachusetts securities division, announced an ARS task force last month and has already issued 15 subpoenas and requests for information to broker/dealers nationwide in an attempt to determine whether they committed any infractions in marketing the securities.
"Investors were not told about liquidity risks and not being able to access their funds," said Karen Tyler, president of the North American Securities Administrators Association, which is coordinating the effort. "There were representations made [that these were] equivalent to money market accounts. All the complaints say that these were money market account-like investments. Some were told it was like a checking account."
The products were sold, not bought, she added, and many small investors who purchased them are ill prepared to lose access to their money.
"What is happening to investors as a result? There are home purchasers who used this money as a down payment and are now losing it," she said. "There are small business owners who cannot make payroll, retirees and farmers. This is hitting mainstream America."