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FINRA Investor Alert: Auction Rate Securities

Auction Rate Securities: What Happens When Auctions Fail

The Financial Industry Regulatory Authority (FINRA) published an Investor Alert on auction rate securities (ARS). This provides quite a thorough background on ARS, their auction mechanism and risks of failure, alternatives to ARS, and redemption and liquidity issues.

ARS are issued widely by institutions ranging from closed-end mutual funds, municipalities to student loan trusts. ARS are long-term floating rate securities whose coupon payments are determined at auctions that are typically held every 7 to 35 days. ARS are long-term securities with short-term floating rates. Broker dealers marketed ARS as liquid, short-term cash equivalents. However, ARS auctions failed en masse in February 2008 and proved to be illiquid and unsellable in the short-term. In light of recent history, ARS are not liquid short-term cash equivalents and investors ought to be careful when faced with the prospect of owning an ARS.

SLCG has written a paper on Auction Rate Securities. Other papers can be found at our dedicated website.