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Did Hawaii Purchase ARS from FINRA through Citi?

Posted by Larry Doyle on March 4, 2010 7:29 AM |

The auction-rate securities market did not instantaneously freeze in early 2008. The fact is, the ARS market started to fail in mid-2007 on the heels of a variety of market segments repricing given the liquidity issues on Wall Street. Recall that mortgage hedge funds at Bear Stearns cratered in spring 2007. At that point, Wall Street was becoming much more risk averse while shepherding the use of its own capital and balance sheets. During this point in time, the ARS market started to fail and ultimately totally froze in early 2008.

Evidence is rampant that Wall Street worked feverishly from mid-2007 until early 2008 to offload auction-rate securities anywhere and everywhere without informing investors of the failing nature of the market.

Who was and is charged with protecting investors? The Financial Industry Regulatory Authority, FINRA. Did FINRA inform investors of the failing nature of the ARS market at that time? NO!!

What did FINRA do in regard to ARS? This regulator offloaded $647 million ARS in mid-2007. I would love to know where those ARS which had been owned by FINRA may have ultimately ended up. Today, we learn of an investor which owned upwards of $1 billion ARS and purchased half of them starting in mid-2007. Who is this investor? The state of Hawaii, which purchased all of their ARS holdings through a broker at Citigroup.

Was Citigroup strictly unloading its own ARS inventory, or was Citigroup acting as agent for another holder of ARS, perhaps FINRA?

Bloomberg provides chilling perspectives on what I deem to be the greatest fraud on Wall Street, the distribution of auction-rate securities. Bloomberg writes, Citigroup’s Auction-Rate Bonds Freeze $1 Billion in Hawaii Cash:

Two years after the auction-rate bond market froze, Hawaii has lost about $250 million in market value on $1 billion in student-loan securities sold by a single Citigroup Inc. broker as a cash substitute that the state has had difficulty unloading.

Hawaii purchased half of the securities for its short-term treasury account from Honolulu broker Pete Thompson, 60, in the eight months before the market collapsed, according to Scott Kami, an administrator at the state finance department.

Once again, the ARS market froze in February 2008. Hawaii purchased half of its ARS position in the eight months prior to that. Checking the calendar, that means Hawaii purchased approximately $500 million ARS from mid-2007 until the market totally froze. Who do we know sold $647 million ARS in mid-2007? By their own admission, FINRA, the regulator.  Oh boy!!

The chances are not zero that Hawaii purchased ARS which had been previously owned by FINRA. (The red ink is representative of money lost by Hawaii on these ARS!!)

The transactions came while Citigroup was increasing brokerage commissions and traders were being told to “make sure all hands are on deck” and “do whatever is necessary” to dispose of auction-rate bonds as the $330 billion market began to fail, according to a 2008 U.S. Securities and Exchange Commission complaint against the New York-based bank in a separate case related to sales of the debt.

Might we ever learn the full details of FINRA’s liquidation of ARS? Do you think the citizens of the cash strapped state of Hawaii may care to learn? Don’t you think they and every other ARS investor along with every investor in our markets are entitled to know that information? I do.

Will FINRA provide that information, or once again hide gutlessly behind the cloak of absolute immunity and claim the management of their finances is part of their overall regulatory function — even if the management of those finances encompasses what is generally described as front running and insider trading?

Explain that to the citizens of the state of Hawaii. As Bloomberg offers:

“I was shocked,” state Representative Karl Rhoads said of his reaction when a constituent informed him last year that Hawaii was stuck with the auction-rate securities. “I didn’t believe it. We’re a small state, only 1.3 million people,” Rhoads said in a telephone interview.

Hawaii’s frozen-cash crunch complicates efforts by Governor Linda Lingle, 56, to close a $1.2 billion budget deficit as tourism revenue has fallen during the worst recession since the 1930s. She has proposed eliminating 800 state jobs, with teachers being told to stay home without pay for 17 days from November 2009 to May of this year.

Would Mary Schapiro, current SEC Chair and then FINRA head, and Rick Ketchum, current FINRA head, like to say anything to these teachers and to Governor Lingle?

Or will America merely hear the fact that FINRA has absolute immunity in its regulatory function, even if it may encompass front running and insider trading?

Perhaps somebody within FINRA with knowledge of this ARS liquidation and with a conscience might want to conveniently leak the info.

Until those details are fully released, I think this entire situation truly smells.

LD

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  • Bill

    First I ever heard of ARS was in a 3/08 WSJ story about the Mayer family in NJ having been sold over $400 mil of the stuff by Lehman Bros. They got out of half or so of it before the market froze in Feb. They filed an arbitration claim–I guess through FINRA–for $250 mil or so they still had. I’m sure that went nowhere when LEH went belly up. Point I made to the SEC and other regulators I talked to was that, despite these brokers like TD Ameritrade claiming they were just order takers, that was a total and complete fabrication because someone like myself or 99%+ of other retail investors could not have called up and bought something they’d never before heard of.

  • Bill

    Another point is that still today the vast majority of investors and the public generally have never heard of the ARS scandal and do not have the foggiest idea what an ARS is. Why is that? Because the financial media have chosen to not report it. Why is that? Because almost every one of their advertisers were complicit in it. Just look at how many ads TD Ameritrade, for example, runs. You start trying to explain it to someone, and their eyes just glaze over.






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