FINRA To Broker/Dealers - Let The People Sell Their Auction Rate Securities
It is bad enough that broker-dealers sold auction-rate securities (ARS) to their customers as safe, liquid, cash alternatives with full knowledge that they were none of these things. Then, after the “auctions” failed and customer funds were frozen, many of these same firms continued to act against their customers’ best interests by forcing them to remain invested in these illiquid assets.
When the ARS market froze in February, investors were stuck – they could not sell their ARS at auctions, and there was no other mechanism to sell them. A rudimentary secondary market has sprung up in which third parties are willing to buy the ARS – at a discount from face value – from the investors. The discounts range from 5% to 30%.
It would seem to be a solution for investors, albeit an expensive one, but Bank of America, Wachovia, UBS, and other broker-dealers did not permit their customers to sell the ARS on this secondary market. The hypocritical investment banks claimed that they were “protecting” their customers from needless losses of principal on ARS that were sold as liquid, safe cash alternatives.
Fortunately, the Financial Industry Regulatory Authority (FINRA) has now stepped in to tell broker-dealers that they cannot refuse to transfer ARS when their customers want to sell them to third parties.
According to articles on Bloomberg.com by Darrell Preston and David Scheer, FINRA has said that it has no rule requiring a firm to deny unsolicited sales orders that it feels are not in a customer's best interest. Any investment bank that refuses to execute such a customer request may be violating FINRA rules.
According to Marc Menchel, executive vice president and general counsel of regulation at FINRA, the authority had heard anecdotal evidence that dealers were refusing to let customer sell ARS on the secondary market. “We want to make it clear that they can’t do that,” said Menchel. “At some point, it is time to step away and let the customer do the trade.”
The regulatory notice said that dealers are required to handle these sales under FINRA’s rule 2110, which requires firms to observe high standards of honor and just and equitable principles of trade. Three conditions must be met for the unsolicited sales of ARS: (1) customers on each side must understand that the dealer is not recommending the transaction or determining whether it is suitable, (2) customers must understand the firm cannot determine whether the price is sufficient or competitive, and (3) there are no “legitimate concerns” about the ability of both sides to settle the transaction.
The real reason the firms did not want to permit such sales was articulated by Bryan Lantagne, head of the securities division for the State of Massachusetts, who noted “[b]y allowing customer to sell at a discount, the banks allow customers to establish damages.” (Lantagne is the head of a task force for nine states examining whether brokers misrepresented the ARS as an alternative to money markets.)
The firms are obviously concerned that once customers establish damages they can bring arbitration claims. They would have continued to flout the rules in order to attempt to shield themselves from liability if FINRA had not come down squarely on the side of the investors.
Page Perry, LLC is an Atlanta-based law firm with over 125 years collective experience representing investors in securities-related litigation and arbitration. While past results are not indicative of future success, Page Perry’s attorneys have recovered over $1,000,000 for clients on more than 30 occasions. Page Perry’s attorneys are actively involved in counseling institutional and individual investors regarding their auction-rate securities investment problems. For further information, please contact us.
