Mass. Sec. of State Galvin: SEC Missed Opportunity to Protect Investors From ARS

At least one state regulator is complaining that the SEC missed a chance to protect investors from the collapse of the $330 billion ARS market, when it failed in 2007 to police how banks sold the bonds to customers.  Massachusetts Secretary of State William Galvin is quoted by Bloomberg as stating “[i]t’s obvious they missed an opportunity.  They could have raised a red flag.”

Others such as James Cox, a professor at Duke University, add that the SEC didn’t improve sales practices fast enough to protect investors.  “In some areas the SEC remains in the clutches of the brokerage industry,” he told Bloomberg.

Bloomberg reports in the article that

the SEC didn’t stop brokers from selling the long-term securities ARS to individuals as alternatives to cash late last year when credit markets seized up, though they knew dealers routinely propped up the bonds. The SEC ended a probe of bid-rigging in May 2006 by permitting 15 banks to take part in auctions as long as they disclosed it on the Internet.

It was only after firms abandoned the market in February, leaving investors stranded with bonds they didn’t want and borrowers with interest rates as high as 20 percent, that state and U.S. regulators tackled Wall Street’s sales practices.

The SEC’s Linda Thomsen, Director of Enforcement, however, states that “the securities laws don’t permit us to bring enforcement actions for violations that haven’t yet occurred.”  She adds in the Bloomberg article that banks used their capital to keep auctions from failing for years, and that the risk of investors getting stuck with the securities “dramatically increased beginning in the latter part of 2007,” at which point “the firms were legally obligated to disclose the increased liquidity risks.”

The SEC may soon face questions from Congress about its role in the auction-rate market, as U.S. House Financial Services Committee Chairman Barney Frank will hold a hearing on Sept. 18 to examine regulators and firms.