Auction-Rate Securities And Alcatraz

It is a good thing that "The Rock" is a national park now, and not a high-security prison. Some of the people who marketed auction-rate instruments may be going to jail. For the time being, Alcatraz is not an option.

According to The Wall Street Journal, "Federal prosecutors, ramping up criminal probes stemming from the credit crunch, are investigating whether two former Credit Suisse brokers lied to investors about how they placed their money into short-term securities, according to people familiar with the matter."

The auction-rate market, which had total investments of about $330 billion in it, stopped trading when banks and brokerage houses decided that supporting it was too risky.

In this case, the charges are not that auction-rate securities were less liquid than people believed. Rather, the government is saying that the form of the paper sold by the brokers in question to their clients was more risky other forms of the instruments.

The whole matter does open the door a bit more for broader litigation. There is the significant matter of what brokers and banks told their clients about how liquid these securities were. Since auction-rates had traded regularly since 1985, in some cases it was clearly represented that they were as liquid as cash but got slightly better yields.

Who said what to whom? That is what will be dragged through the courts for several years. Of course, clients could have read the fine print in the contracts. They would have seen that auction-rate paper was not a cash-equivalent. But, who cares about the details?

Douglas A. McIntyre