The U.S. Securities and Exchange Commission has settled proceedings against 15 broker-dealer firms for practices that violate securities laws in the US$200 billion-plus auction rate securities market.

Auction rate securities are municipal bonds, corporate bonds or preferred stocks with interest rates or dividend yields that are periodically re-set through Dutch auctions. The SEC order finds that, between January 2003 and June 2004, each firm engaged in one or more practices that were not adequately disclosed to investors, which constituted violations of the securities laws.

These violations include: allowing customers to place open or market orders in auctions; intervening in auctions to prevent failed auctions, to set a “market” rate, or to prevent all-hold auctions; submitting or changing orders, or allowing customers to do so, after auction deadlines; not requiring certain customers to purchase partially-filled orders even though the orders were supposed to be irrevocable; having an express or tacit understanding to provide certain customers with higher returns than the auction clearing rate; and, providing certain customers with information that gave them an advantage over other customers in determining what rate to bid.

Some of these practices had the effect of favouring certain customers over others, and some had the effect of favouring the issuer of the securities over customers, or vice versa, the SEC said. In addition, since the firms were under no obligation to guarantee against a failed auction, investors may not have been aware of the liquidity and credit risks associated with certain securities.

The firms, which neither admit nor deny the findings in the order, consented to the entry of an SEC cease-and-desist order providing for censures, undertakings, and more than $13 million in penalties. The undertakings include providing disclosures of its material and current auction practices and procedures; and, requires them to have its CEO or general counsel certify that it has implemented procedures that are reasonably designed to prevent and detect violations in the auction rate securities area within six months.

The SEC reports that, in determining the structure of the settlement and the size of the penalties, it considered the amount of investor harm and the firms’ conduct in the investigation to be factors that mitigated the serious and widespread nature of the violations. In particular, the firms voluntarily disclosed the practices they engaged in to the SEC, upon the staff’s request for information, which allowed the SEC to conserve resources.

“This matter highlights both the industry-wide violations that existed in the auction rate securities market and the benefits to firms that cooperate with the SEC to quickly address problems,” said Linda Chatman Thomsen, director of the SEC’s division of enforcement. “This case signals that the commission is willing to take measured sanctions when broker-dealers are cooperative with the SEC in curing industry-wide violations and there is relatively modest investor harm.”

The order requires the respondents to pay the following penalties based upon their relative market share and conduct: Bear, Stearns & Co., Inc., Citigroup Global Markets, Inc., Goldman Sachs & Co., J.P. Morgan Securities, Inc., Lehman Brothers Inc., Merrill Lynch, Pierce, Fenner & Smith Incorporated, Morgan Stanley & Co. Incorporated/ Morgan Stanley DW Inc., and RBC Dain Rauscher Inc. must pay US$1.5 million each; and A.G. Edwards & Sons, Inc., Morgan Keegan & Company, Inc., Piper Jaffray & Co., SunTrust Capital Markets Inc., and Wachovia Capital Markets, LLC are to pay $US125,000 each. Banc of America Securities LLC is required to pay US$750,000 rather than US$1.5 million based on the quality of its self-monitoring capabilities in the auction rate securities area.

The commission’s investigation is continuing into entities that participate in the auction rate securities market.