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Report Says Auction Rate Securities Concerns Raised in 2005

Aug 13, 2008 | Parker Waichman LLP

A prominent accounting firm raised questions about auction rate securities in 2005, years before the market went bust.  According to a report on thestreet.com, in May of that year, PricewaterhouseCoopers  issued an opinion that said  auction rate securities should not be considered a cash equivalent vehicle.

Auction rate securities are long-term corporate bonds, municipal bonds and preferred stock on which the interest rates are reset periodically based on bids submitted through securities firms. Generally, rates are reset every  seven, 14, 28 or 35 days. Because they can be sold during weekly or monthly auctions, banks and brokerages often touted auction rate securities as short-term investments or cash equivalents.  Unfortunately, because of the credit crises, the market for auction rate securities crashed.  Thousands of investors have been bewildered to find out that the investments they were sold as cash equivalents are now illiquid.

Various state and federal agencies have been investigating the auction rate securities crash, amid suspicions that investment banks misled their clients about both the liquidity of the vehicles and safety of the market.  In the past week, investment banks such as UBS, Citigroup, Merrill Lynch and Morgan Stanley have reached settlements with regulators or made offers to buy back billions of dollars worth of auction rate securities.  Probes are still ongoing, and other banks like Wachovia Corp., have revealed that they are facing investigations over their auction rate securities business.

While many investors were shocked when they learned that their auction rate securities were illiquid, PricewaterhouseCoopers was questioning the investment banks' claims that the vehicles were cash equivalents as early as 2005.  According to thestreet.com, a note from one of the firm's opinions said, "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."   The information was part of the accounting firm's reference materials available to clients on the firm's Web site.

Thestreet.com article said PricewaterhouseCoopers based its opinion on a  Financial Accounting Standards Board  (FASB) statement which says that an investment vehicle cannot be considered a cash equivalent unless it has a maturity less than three months. Many auction rate securities have maturities going out 20 to 30 years.

Unfortunately, neither the banks nor regulators did anything about the concerns raised by PricewaterhouseCoopers.  In fact, according to thestreet.com, the banks lobbied the FASB against the firm's opinion, and accused Pricewaterhouse of disrupting the market.


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