Auction-Rate Danger Flagged in '05

Accounting firms raised questions about auction-rate securities' resemblance to cash almost three years before the market failed and before authorities cracked down on Wall Street's biggest firms for allegedly overstating the safety of the investments to investors.

In settlements with state authorities and the Securities and Exchange Commission last week, Citigroup(C Quote) and UBS(UBS Quote) agreed to buy back more than $26 billion in auction-rate securities and pay a cumulative $250 million in fines for allegedly marketing the investments to investors as an alternative to cash.

Regulators might have saved themselves the trouble years before the credit crisis set in, had they paid heed to accounting firm PricewaterhouseCoopers. In May 2005, the firm issued an opinion on auction-rate securities, arguing that the instruments should not be considered a cashlike product.

"The legal maturity of auction-rate securities is 20 to 30 years and, as such, the securities ordinarily should not be classified as cash equivalents, but rather as investments," said the note, part of Pricewaterhouse's reference materials available to clients on the firm's Web site.

The market for auction-rate securities -- debt instruments whose interest rates are reset in regular auctions -- became illiquid in February. The turmoil in the credit markets led banks to withdraw support for the auctions, which stalled, pressing state attorneys general and the SEC to action.

In addition to Citi and UBS, Morgan Stanley(MS Quote) on late Monday voluntarily agreed to buy back some $4.5 billion in auction-rate securities, and Merrill Lynch(MER Quote) last week voluntarily agreed to buy back some $26 billion.

Several other major banks, including Bank of America(BAC Quote) and Wachovia(WB Quote), have acknowledged subpoenas or investigations in connection with the probe.

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