Auction-Rate Danger Flagged in '05

The Association of Financial Professionals sent a letter in June 2005 to FASB complaining that auction-rate securities had been used as a cash tool since the 1980s and that the Pricewaterhouse opinion had introduced instability into the market.

"The change made it appear to the public that companies had done something improper, creating suspicion within the capital markets," James Kaitz, the organization's president, wrote in the letter. "Auction-rate securities represent an established, accepted and integral corporate cash management tool and should be accounted for as such."

SEC spokesman John Nester declines to comment on why the SEC remained silent on the issues raised by Pricewaterhouse in 2005. The commission continues to look at the failure of the auction-rate market, he notes.

"Among considerations for investigators is when banks knew the auctions were materially at risk for widespread failure and whether the risk was disclosed to customers," Nester says.

The SEC did censure many of the securities firms in 2006 and levied fines related to bids and prices of the products within the auction. The commission alleged some investors got better information than others on what rate to bid. Citigroup, Merrill, Goldman Sachs(GS Quote), Bear Stearns, JPMorgan Chase(JPM Quote), Lehman Brothers(LEH Quote) and Morgan Stanley were ordered to pay $1.5 million each.

Lance Pan of Capital Advisors says the SEC did not go far enough. He points out that no real auction existed and that the SEC recognized that the auctions were "managed" and not competitive at all. But the SEC allowed the dealers to manage the auctions because the numbers were so large -- roughly $200 billion in debt was brought to market every seven to eight days.