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Home > Cases > Auction-Rate Securities > Proposed Rule Change Has Brokers Up In Arms

Proposed Rule Change Has Brokers Up In Arms

Auction-rate securities were supposed to be like cash equivalents for individual and institutional investors. For years, the auctions in which the securities were bought and sold operated with relatively few glitches. Auction failures were rare, because the investment banks and securities firms running them stepped in with their own capital to buy the bonds.

Then, in 2008, it all came crashing down.

Much of the debt on auction-rate securities - which are long-term bonds sold by municipalities, student loan corporations and closed-end funds with interest rates that reset weekly or monthly - was guaranteed by bond issuers that also backed subprime mortgage-related securities. When the issuers' previously high ratings of AAA were downgraded because of their exposure to subprime-related guarantees, demand for auction-rate debt nose-dived.

With no bidders to purchase the bonds, auctions failed. The investment banks that once infused their own capital to support the securities pulled out entirely, and the market became frozen. As for investors, they quickly discovered that their cash-like investments were frozen, as well.

The recent troubles in the auction-rate securities market have ignited a wave of auction-rate lawsuits by investors against the investment banks and brokerage firms that sold them the instruments. The majority of allegations in the lawsuits focus on broker misrepresentation - and their failure to disclose material information about the securities and the fact that investments would become illiquid if an auction failed.

The rash of auction-rate litigation has prompted the Financial Industry Regulatory Authority (FINRA), which is the largest non-governmental regulator for all securities firms doing business in the United States, to become increasingly critical of its members. Now, the organization is proposing a new rule that would require registered firms - for the first time - to report allegations of sales practice violations against an individual broker made in arbitration claims or civil lawsuits that do not name the broker as a respondent or defendant.

The proposed ruling is making many on Wall Street nervous. Currently, if an arbitration claim doesn't name a broker - even if it refers to the broker's bad behavior - the complaint is never registered on a broker's record.

FINRA's amendment would change that, placing greater emphasis on the need for transparency and accountability.

In 2001, 25 percent of arbitration complaints didn't name brokers. Now, the number is closer to 50 percent.

Brokers, however, contend that FINRA's proposed rule change will make it extremely difficult to draw a line between investor claims that allege sales practices issues and those alleging product failures.

Regardless, given the fact that more and more investors are coming forth daily with tales of losing their life savings because they were marketed investments such as auction-rate securities as safe alternatives to money-market funds, a move to increase accountability and transparency on those responsible for selling the investments in the first place can only be a move in the right direction for the investing public.

Our affiliation of lawyers is actively involved in advising individual and institutional investors in evaluating their legal options when confronted with subprime and other mortgage-related investment losses.


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