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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)

  • AMEN Larry! Why hasn’t every single brokerage firm and financial planner in America who sold ARS been charged? Where was the SEC? Where is the SEC today? Why has the SEC been completely silent on this entire thing from day 1? Maybe because the current head of the SEC (Shapiro) was reviously the head of FINRA and therefore purchased ARS while she was head of FINRA. Those conversations noted in the Cuomo suit are exactly what I was told by my Certified Financial Planner. I was told ARS was exactly the same as a money market account, just with 7-day liquidity and with a much better interest rate. The 7-day liquidity time frame was repeated over and over again, and there also was never a prospectus for these things. Thank you as always for your relentless pursuit of the truth in this story Larry.


  • Sons of Vaval

    Great movie by the way.

  • Phil

    A little balance.

    “Up until the time the auction rate securities market collapsed, there was an uninterrupted 20-plus year period where there was no indication the market for these securities was at risk of collapse and that the underwriters would simply abandon them. We’re confident that we will prevail when we have the chance to expose the workings of this market completely rather than just through selective sound bites in the press,” she wrote.

    “We believe the NYAG ought to focus its efforts on the firms that underwrote these products, failed to disclose the key risks and then abandoned the products, rather than damaging the reputation and harming the shareholders of other companies that acted in good faith,” Ms. Bulgatz wrote.

  • Larry Doyle


    Not sure exactly what point you are trying to make but the fact is federal judges have weighed in and called the ARS market fraudulent in its sales and marketing practices.

    Just because fraudulent practices go on for a long time does not justify them.

    Do I need to remind you that there was another fraud that unwound over the last 9 months that also had a very long run.

    The KEY point is not that the market operated for a protracted period. The KEY point is that ARS were sold and marketed in a fraudulent fashion. ARS were not cash-like and never were cash-like instruments.

    If they were marketed appropriately the rates on them would have been much higher.

    Every bank, broker, or money manager involved in the sales and distribution of ARS should be held accountable. Additionally, FINRA’s involvement as an investor and regulator should be thoroughly detailed and exposed.

    Thanks for the opportunity to provide more balance to the equation.

    • Phil

      Larry, I think we all agree something was amiss here. However, maybe I’m not viewing this correctly and welcome further insight. I question:

      -Should money market funds not be sold because of what happened at the Reserve?
      -Should CDs not be sold because of what happened with Stanford?
      -Would we view the ARS situation differently if they were treated as a security, which required a prospectus.
      -Were they properly regulated and who was responsible for requiring such regulation?

      While every advisor should thoroughly understand any investment being recommended, I stop short of indicting every individual associated with sale and distribution of ARS without palpable evidence of an intent to deceive and defraud.

      However, I do agree that institutions or individuals selling these with an intent to deceive and defraud should be held accountable. Further, we need to better understand why ARS were not more thoroughly regulated.

      • Larry Doyle


        Thanks for responding. The fact is the regulatory authorities overseeing the sale and distribution of ARS were/are the SEC and NASD (now FINRA).

        My main beef has always been with the lack of proper oversight and regulation of ARS. In fact, the NASD purchased ARS for their own investment portfolio. However, the NASD knew ARS were not cash surrogates given the long maturities of the underlying loans. The NASD did not account for ARS as cash in their accounting statements. I wrote about this story and you can find it here at Sense on Cents, NASD Knew ARS Weren’t Cash.

        How about FINRA? FINRA assumed the ARS position (somewhere between $650-800+ million ARS) when FINRA was formed in 2007. FINRA spokesman Herb Perone said they used ARS for cash purposes but somehow or other FINRA knew enough and sold all their ARS in 2007 before the market totally failed.

        I have written extensively about this questionable activity by FINRA. If you care, all this info can be accessed by typing “FINRA ARS” in the search window in the upper right of each page.

        In regard to the individual brokers and brokerage entities, with all due respect a lack of understanding of a product does not excuse anybody or any firm for improperly selling and marketing the product. My personal feeling is that the individual brokers should not necessarily be singled out, but the brokerage house definitely should.

        Thanks for sharing your insights.

        • Phil

          Another viewpoint. See this morning’s WSJ article for Charles Schwab’s take (the individual not company). I think he makes a few valid points.

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