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In the News: Auction Rate Securities

Forbes' blogger Bill Singer narrates the story of Grand Circle LLC.

Grand Circle had brokerage accounts at the Royal Bank of Canada (RBC) and Wachovia. Through the recommendation of representatives at RBC and Wachovia, Grand Circle purchased auction rate securities (ARS). For business-related reasons, Grand Circle opened another brokerage account at CCO Investments Services Corp (CCO). Grand Circle's Investment Policy stated that it wanted safe, liquid and AAA rated securities and that AAA rated ARS were in the list of acceptable securities. The assistant treasurer of Grand Circle believed that AAA rated ARS was safe and liquid and provided higher yields, so he, with the permission of CCO, directed the purchase of ARS.

ARS were first issued in the mid-1980s by corporations. Over the next two decades ARS were issued widely by institutions ranging from closed-end mutual funds, municipalities to student loan trusts. ARS were long-term floating rate securities whose coupon payments were determined at auctions that were typically held every 7 to 35 days. ARS were 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.

SLCG has a written an in-depth paper on ARS, what they are, how their auctions worked and how they failed.