AUCTION RATE SECURITIES
 
Questions & Answers
 
Q: What are “auction rate securities”?
 

A: According to Wikipedia (http://en.wikipedia.org/wiki/Auction_rate_security), an auction rate security is either a corporate or municipal bond with a long-term nominal maturity (usually 30 years) but whose preferred shares have no maturity date. The interest rate is reset at regular auctions which typically occur every 7, 28, 35 or 49 days. Existing holders and potential investors enter a competitive bidding process, commonly known as Dutch auctions, through broker/dealer(s). Buyers specify the number of shares they wish to purchase (usually in increments of $25,000) with the lowest interest rate they are willing to accept.


Each bid and order size is ranked from lowest to highest minimum bid rate. The lowest bid rate at which all the shares can be sold at par (the face value of the bond) establishes the interest rate, otherwise known as the "clearing rate". This rate is paid on the entire issue for the upcoming period. Investors who bid a minimum rate above the clearing rate receive no bonds, while those whose minimum bid rates were at or below the clearing rate receive the clearing rate for the next period.


Auction rate securities were first introduced during the late-1980’s. Initially only institutional or very high net-worth investors participated in this market because they were only available in minimum denominations of $250,000. However, banks dropped the minimum investment in auction rate securities to $25,000 a few years ago, making them more accessible to relatively individual retail investors. As a result, the market for auction rate securities mushroomed. In her 9 March 2008 article for the New York Times, Gretchen Morgenson reports that the market for auction rate securities grew to about $330 billion by February 2008 (see http://www.nytimes.com/2008/03/09/business/09gret.html).
 
Q: Why are regulators concerned?
 
A: As detailed in the articles cited above, the market for auction rate securities suddenly dried up in February 2008, when the major investment banks refused to act as the bidders of last resort, as they had in the past. As a result, sellers are learning that auction rate securities are not as readily redeemable as they had thought at the time of purchase. This poses liquidity problems for holders of auction rate securities. State regulators like the Securities Division of the North Carolina Department of the Secretary of State are concerned because many investors are reporting that they did not know that their money was being held in auction rate securities, and were not provided prospectuses or advised about the liquidity risks. State regulators from several states have formed a Task Force and are investigating this matter as part of an initiative for the North American Securities Administrators Association (NASAA). The North Carolina Department of the Secretary of State is a member of NASAA.
 
Q: If I have invested in auction rate securities, what should I do?
 
A: Any North Carolina resident who has had difficulty with his or her auction rate securities, or who is unable to access his or her investment funds, should contact the North Carolina Securities Division at (800) 688-4507 or by email at secdiv@sosnc.com. Complaint forms are available at http://www.secretary.state.nc.us/sec/complaint.aspx, and should be mailed to:
 
Securities Division
NC Dept. of the Secretary of State
PO Box 29622
Raleigh, NC 27626-0622
 
All complaints will be reviewed to determine if the state’s securities laws have been violated and, if so, whether further administrative, civil or criminal proceedings are warranted. All complaints will also be forwarded to NASAA’s Auction Rate Securities Task Force for further evaluation. All complaints will be treated as confidential, investigative information.

Whether or not any administrative, civil or criminal actions are taken, please understand that the Securities Division cannot:

  • Get your money back (only a court can order this);
  • Act as your attorney or provide legal advice to you (you must retain private counsel); or,
  • Provide advice with regard to your investments, including those involving auction rate securities (you should consult your registered investment adviser representative, CPA or tax attorney for guidance in these matters).
 
For further information about auction rate securities, please see the Auction Rate Securities Primer that the NASAA Auction Rate Securities Task Force has prepared.