General Description of Auction Rate Securities
Auction rate securities were first offered for sale in U.S. financial markets in the early 1980s. As of the end of 2005, there were approximately $263 billion of auction rate securities outstanding.
Many different types of issuers have issued auction rate securities ? for example, closed-end funds, corporations, municipal authorities and student loan organizations.
Auction rate securities have generally been issued as either bonds or preferred stock and are designed to serve as money market-type instruments. They are purchased and sold, at established intervals, through an auction-type mechanism, but have long-term maturities, or no maturity at all. In the auctions, auction rate securities are purchased and sold at par. Auction rate securities have also been called ?Auction Market Preferred Stock,? ?Variable Rate Preferred Securities,? ?Money Market Preferred Securities? and ?Periodic Auction Rate Securities.? The interest or dividend rate of an auction rate security is reset at these established intervals based on an auction in which investors who already hold the security (called ?holders?) and investors who seek to acquire the security (called ?prospective holders?)2 indicate their interest in continuing to hold, or in purchasing or selling, the security at rates that they specify to broker-dealers, such as Merrill Lynch, who have been appointed to participate in the auction. The dates on which the auctions take place (the ?auction dates?), and the interval between the auction dates (the ?auction period?), vary depending on the security. The auctions commonly are every seven days, twentyeight days, thirty-five days or forty-nine days, but there are also some securities for which the auctions occur daily and others for which the auctions occur at longer intervals ? for example, every six months or once over a multi-year period.
On May 31, 2006, the U.S. Securities and Exchange Commission (?SEC?) announced that it had settled its investigation of fifteen firms, including Merrill Lynch, that participate in the auction rate securities market regarding their respective practices and procedures in the market. The SEC alleged in the settlement that the firms had managed auctions for auction rate securities in which they participated in ways that were not adequately disclosed or that did not conform to disclosed auction procedures. As part of the settlement, Merrill Lynch agreed to pay a civil money penalty of $1,500,000. In addition, Merrill Lynch, without admitting or denying the SEC?s allegations, agreed to be censured, to cease and desist from violating certain provisions of the securities laws, to provide to customers written descriptions of its material auction practices and procedures, and to implement procedures reasonably designed to detect and prevent any failures by Merrill Lynch to conduct the auction process in accordance with disclosed procedures.