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A Ponzi Scheme by Any Other Name

Posted by Larry Doyle on August 17, 2009 8:26 AM |

What investor does not want to allocate some portion of his portfolio to safe, liquid investments? Who hasn’t said to his broker or financial planner exactly what The Wall Street Journal reports this morning, ‘I Just Wanted to Play It Safe,’ in regard to the Wall Street Ponzi scheme designated as auction-rate securities?

The WSJ provides these conversations as evidence collected by New York Attorney General Andrew Cuomo in his case against Charles Schwab. As you read these conversations, I am sure it is easy to picture yourself as one of these customers:

Customer from Massapequa, New York

Customer: “You know, I’m not trying to make a ton of money. I just want to play it safe.”

Broker: “Understood.”

Broker: “When you go to get out of this, even though you tell the rep sell it that means you want to stop the auction. The hardest part of this auction is getting into it. That is the tough part. Getting out of it is easy as just selling.”

Customer from Seaford, New York

Customer: “I can just get out every 7 days?”

Broker: “That’s right.”

Customer: “I can just give you 7 days and don’t renew and you put the money back in my account?”

Broker: “That’s correct.”

Customer from Remsenburg, New York

Customer: “It is some kind of short term muni-based piece of paper used as an alternative to [a] money market.”


Customer: “So that is better than what I am getting?”

Broker: “Yeah, yeah. It is better than saving in the money market at the moment.”


Broker: “You pick up about 50 to 60 basis points over what you would get in a money market, and what you are giving up is next day liquidity.”


Customer: “OK. I can adjust it by $100k amounts every week?”

Broker: “In terms of if you wanna get out?”

Customer: “Yeah.”

Broker: “Yeah.”

Customer: “I’ll know a week ahead of time if I wanna make a big investment.”

Customer from New Hyde Park, New York

Broker: “…And it’ll roll over monthly unless you call me and say, ‘Hey [Broker], don’t roll it over anymore.'”

Customer: “Oh, I see. OK.”

Broker: “…And then next month I’ll stop the auction and all the cash will come back to your account.”

Customer: “OK, [Broker], thank you.”

Customer location unidentified

Customer: “Well I need the liquidity because I may buy a house soon.

Broker: “I see.”

Customer: “I sold my house and this is money that’s just there temporarily.”

Broker: “…instead of looking for the highest yield, I would personally look at the highest security. And that would be my second thing. And probably periodic auction rate securities. That would work better than any bond mutual funds for you. That’s my humble opinion.”

Customer: “OK. And it would be safer?”

Broker: “It would be much, much safer, for sure.”

These conversations are eerily similar to scenes in the cheap Wall Street flick The Boiler Room. Where were the SEC, NASD, and FINRA while these blatant misrepresentations were occurring? We know the NASD (FINRA’s parent) purchased ARS. We know FINRA sold these ARS in 2007 prior to the market’s failure.

We know the SEC has blessed a newly designed version of municipal auction-rate security known as x-Tenders. Are municipal money market funds loaded with these newly designed municipal auction-rate securities being marketed with full disclosure? Will we witness a replay of this nightmare?

Aside from a handful of attorneys general (Cuomo in NY, Galvin in MA), who is really trying to pursue justice in this space? Why hasn’t every bank, broker, or money manager involved in this scam been charged?

With upwards of $165 billion remaining frozen in ARS, there are lots of questions and lots of dollars still looking for answers.


Related Sense on Cents Commentary:

An Open Letter to the Board of FINRA Regarding Auction-Rate Securities (July 27, 2009)

An Auction-Rate Pig by Any Other Name is Still a Pig (June 19, 2009)

U.S. Attorney and SEC Investigating Lehman’s Auction Rate Securities Sales; They Should Also Investigate FINRA’s (May 21, 2009)

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