Auction-Rate Danger Flagged in '05

Espen Robak, of Affiliate Pluris Valuation Advisors -- which helps banks and other financial institutions determine the value of these products -- says the banks were highly compromised.

"They were the sellers, the buyers and they were supporting the auction," he says of the firms. "They were in a unique position to know about the health of the market."

Barry Silbert, whose company Restricted Stock Partners handles a large secondary market in auction-rate securities, points out that the banks made all the proper disclosures about the inherent risk in investing in the products.

"Technically, they didn't do anything wrong," says Silbert.

Matter of Maturity

Pricewaterhouse justified its opinion based on Financial Accounting Standards Board Statement No. 95, which says that a product cannot be considered a cash management tool unless it has a maturity less than three months. Many auction-rate securities have maturities going out 20 to 30 years. It also refers to FAS 115, which allows for longer-term products to be listed as cash if purchased within three months of their maturity. So an auction-rate security should only be considered cash if purchased three months prior to maturity.

The opinion stirred up a great deal of trouble, and Wall Street quickly hired lawyers and fought back. It lobbied the FASB against Pricewaterhouse's opinion, shared by the other accounting firms who make up the Big Four, and charged them with disrupting the market. Wall Street also asked issuers to waive requirements in order to keep the rates artificially high.