Auction rate securities are a type of long-term nominal maturity debt instrument where the interest rate is reset through a Dutch auction on a regular basis. However, since February 2008, most auctions have failed and the auction market is frozen. This has exacerbated the global financial crisis. Consequently, investors are hesitant to buy auction rate securities.
The issuer of ARS chooses one or more broker-dealers to administer the auction process. Investors can only buy and sell auction-rate securities through these brokers. These broker-dealers also select an auction agent to set the clearing rate for the auctions. Once all bids have been received, the auction agent sorts the securities into a rate-ordered list.
ARS are a type of fixed-rate bond or preferred stock that resets periodically. They can range anywhere from two to 30 years in duration. Usually, the minimum amount required to buy one of these securities is $25000. These securities are usually held by institutional investors or high-net-worth individuals. The Securities and Exchange Commission (SEC) has entered into an Order with Morgan Stanley, which regulates the market for ARS.
Auction rate securities were initially sold to investors as safe investments. Most were AAA-rated and promised investors liquidity similar to holding cash. However, in February 2008, this changed when banks began marking down their clients’ holdings at 3% to 5%. These lowered prices caused the largest investment banks to withdraw from the auction rate securities market. As a result, Merrill Lynch & Co. offered to buy back $10 billion of auction-rate securities starting in January 2009.
Historically, the auction rate market has been an attractive source of financing. However, it depends on the issuer’s preferences. In the past, auction rate securities were issued by companies like NUVEEN Investments. NUVEEN has since posted a disclosure on its website. The company issued a series C bond in 2007.
A number of lawsuits filed by investors have accused large banks and brokers of failing to disclose material facts about auction rates and the securities they sold. Unlike cash alternatives, the securities in the auction rate market had 30-year or longer maturity dates. These actions resulted in settlements for investors and large financial institutions. Although they are difficult to prove, investors may have lost a lot of money due to the deceptive marketing of these securities.
As with any securities transaction, Morgan Stanley may be able to influence the price at which the securities are auctioned. However, Morgan Stanley may not be obligated to participate in an auction and may decide to sell securities in the secondary market at any time. Morgan Stanley may also decide to sell auction rate securities on its own accord or share their fees with other brokers.
Auction rate securities have variable interest rates and are commonly issued by municipal, local, and corporate entities. These instruments are designed to minimize investment risks. They also offer tax-exempt or taxable rates. In addition to investors, these securities also benefit issuers because they can access lower cost financing.