Securities and Exchange Commission (SEC) Chief Christopher Cox is facing criticism for his lack of involvement in handling Bear Stearns’ financial crisis. The failure of Bear Stearns and alleged neglect from Cox has stimulated debate over who should be in charge of Wall Street, the SEC or the Fed.

Treasury secretary Henry Paulson suggested broadening the Fed’s responsibilities to include overseeing investment banks. 

Bear Stearns began having problems last July when two large hedge funds collapsed due to securities tied to subprime mortgages. The firm incurred $1 billion in write-downs by December. Some critics argue that Cox and the SEC should have pressured Bear Stearns to raise capital and increase the confidence in their investors.  

Cox was said to have been absent during crucial conferences with the Fed and the Treasury, who negotiated a bailout plan for Bear Stearns. One such call discussed J.P. Morgan Chase & Co. granting a loan to Bear Stearns, and the other meeting discussed J.P. Morgan potentially buying out Bear Stearns and the Fed’s role in lending money to investment banks.  

Many of Cox’s predecessors, such as Richard Breeden and Harvey Pitt, were seen as more proactive in taking charge over the securities market during times of financial turmoil.

According to reports, Mr. Cox claimed that the SEC acted appropriately during the Treasury and Fed bailout negotiations because the SEC’s responsibility was to regulate the industry—not arrange its deals.

Cox has encouraged constructive debate over the issue of shifting authority to the Fed, but his stance is primarily passive, saying that the outcome is up to lawmakers in Congress and not the SEC. He also says that if the Fed continues to loan money to investment banks, it will inevitably play a larger role in Wall Street.

Investors who put their money in two Bear Stearns hedge funds last spring are finding themselves uncertain, to say the least, about the value of these deteriorating funds. Former Bear Stearns’ hedge fund managers, Ralph R. Cioffi and Matthew M. Tannin, were charged this week with nine counts of securities, mail, and wire fraud.  

This case highlights the problems Wall Street is facing regarding how to value investments that have suffered from the subprime mortgage crisis. For example, Cioffi substantially undervalued one of the hedge funds, saying its loss was 6.5% in April, while colleagues at Bear Stearns said the loss was three times higher than what Cioffi valued.  

On a worldwide scale, banks and bank executives are writing down the value of their assets by as much as $380 billion. This year, Credit Suisse, Merrill Lynch, Morgan Stanley, and Lehman have had employees caught for overpricing the value of various assets, costing the firms and investors millions of dollars. 

Although executives are increasing their supervision over employees to prevent future dishonesty or over-optimism about valuations, the pricing process has become the bigger controversy. For example, rather than using only market prices, the chief financial officer of Citigroup said the company would use collateralized debt obligations as another determinant in pricing. Other investors have complained that Wachovia and Washington Mutual are using an over-optimistic housing index when modeling values.  

Write-downs occur usually when banks are selling in the market; although, banks such as Bank of America have refused to mark down the C.D.O.’s of a city in the Southeast because they did not want to be forced to mark down their other holdings, or cause a domino effect. 

Some steps have been suggested to remedy these problems, like expanding the evaluation period of traders to possibly prevent future valuation misconduct.  But the question for many investors remains: what are my investments worth?

The Securities and Exchange Commission is expected to propose today new requirements that will require bond-rating firms to disclose more information to the public. But will that be enough to restore confidence in the $5 billion-a-year industry?  

SEC officials found the old models used by the rating firms for complex structured products were underdeveloped. A majority of the new proposals will hold the firms more accountable and encourage them to change their practices. This proposal is the first step the SEC is taking against claims that bond-rating firms were ranking mortgage-related securities higher than necessary. 

The SEC is expected to mandate companies disclose historical ratings performance, including the dates of downgrades and upgrades. Rating firms, like Moody’s Corp., Standard & Poor’s and Fitch, will be required to publicize information used to determine ratings, the amount of research they acquired and how often they check the effectiveness of the ratings.  

The SEC will also suggest a new ratings scale to clear up confusion between complex structured debt from corporate debt. It will most likely propose rating firms identify the difference by using a notation “v” (for volatility), or explain how the methodology and risk of that bond differ from a similarly rated corporate bond.  

The hope is the new analysis and suggested rating system will give investors a better understanding of the accuracy of the rating.  

The SEC also hopes to demolish conflicts of interests in the proposal. According to The Wall Street Journal online, these issues range from bond issuers’ ability to influence which analysts are chosen to rate a particular bond, to expensive dinners, and to analysts being permitted to rate deals they helped structure. Analysts will also receive new boundaries dealing any type of bribes with the bond issuers or their bankers.  

This proposal comes just a week after the three largest rating companies settled with New York Attorney General Andrew Cuomo on how the firms collect fees in order to not rely on winning bond issuers business.

Many investors are feeling handcuffed to their auction-rate securities (ARS) as the struggle to get money back from the Wall Street banks continues. Bank of America, UBS AG and Wachovia Corp, (three of the firms that sold $330 billion worth of these securities) are now preventing efforts to create a second market. This market would provide investors access to their cash.

One investor, who has not had access to his invested money since February when the auction rate market began to freeze, is upset the bank is unwilling to release his bonds. Bank of America refuses to let him sell $100,000 of securities to Fieldstone Capital Group, claiming the deal is not in his interest. Brokers rejecting these transactions claim they are saving their customers from further unnecessary losses on the securities that they marked as cash-like instruments to begin with.

According to Vincent Dicarlo, formerly a lawyer at the SEC’s enforcement division, “if an investor finds a buyer, he should be able to move his securities to another dealer or take possession to complete the transaction.”

UBS has refused to find buyers for customer’s auction-rate securities because, in their opinion, the secondary market is “inefficient”. What could the secondary market be inefficient to if the primary market no longer exists?

“For someone needing their cash, the only choice is to go to the secondary market and sell them with a haircut,” said Steven Caruso, an attorney at Maddox Hargett & Caruso, who is representing investors in lawsuits against dealers.

According to Darrell Preston’s June 6, Boomberg.com article, since March at least 24 proposed class action suits have been filed over claims investors were told the securities were almost as liquid as cash. These investors have been caught for months with auction rate debt since the buyers that ran the bidding could no longer support the market due to losses linked to subprime mortgages. Before investors believed they could get their money back right away because dealers always bought the unsold securities.

Not only has Wall Street misrepresented these products to their customers, it appears some firms are now preventing these same customers from getting the relief and access to their money that many desperately need.

Preferred holders are fed up with waiting for Pacific Investment Management Co. (Pimco) to figure out a course of action to help those suffering after the collapse of $330 billion auction-rate securities market.  

Pimco is struggling to find a comfortable medium between their preferred holders and investors in the funds’ common shares, which trade on exchanges like stocks. The two groups have competing interests, therefore, making it difficult for the fund managers to refinance ARS without hurting the common holders by increasing costs.  

Municipal-bond issuers control a majority auction-rate market, so when the companies insuring these bonds were threatened by reduced credit-ratings, the market failed. The crisis left investors alarmed and with $63.4 billion of illiquid preferred shares.  

One holder told Bloomberg.com he bought “several hundreds of thousands of dollars” in the auction- rate preferred shares issued by Pimco’s closed-end funds before the freeze in February. Shareholders similarly situated are disappointed in Pimco’s lack of communication and failure to develop a solution. They have a just reason to be frustrated.  Pimco is the only top five manager of publicly traded closed-end funds without a plan for their investors to cash out.  

According to a company spokesman in Christopher Condon’s May 30, 2008 article, Pimco is “devoting considerable time, energy and attention to finding an approach that, consistent with our fiduciary obligation, reconciles the competing considerations facing common and preferred shareholders.”  Only time will tell how Pimco ultimately decides to treat investors.

Effective today, Fidelity Investments has been notified by Interactive Data, its third-party pricing vendor, that they will discontinue evaluating approximately 1,100 student loan auction rate securities (ARS) and 26 asset-backed securities. 

What this likely means for investors is that their next monthly statement will reflect “N/A” for the value of their action rate securities.  This will come as a tremendous shock to many investors who had been told by their brokers not to worry about the frozen auctions because the value of their positions was still there, it was only unavailable for a time.  Now many investors are going experience their greatest fears, the value will disappear from their statements (and possibly from their portfolio).

For investors already on edge due to the auction rate markets freeze, they now will have to deal with the realization that these products are in fact not as they were sold.  They are not cash equivalents.  They are in fact risky investments that can and will cause significant losses to their holders.

Media reports regarding auction rate securities have been widespread over the last several months.  And although many investors were not happy that their investments were tied up due to the failed auctions, many believed that things were only temporary.  Wall Street and its brokers perpetuated these feelings.  Now the truth is coming out.

It is not just Fidelity clients who are likely to witness N/A on their statements.  Investors with auction rate securities at other firms are likely to experience the same fate.  For investors waiting to see what is going to happen in this market, the shock of seeing the loss of value from these positions should move many to action.

The best course of action for an investor concerned with the performance of their ARS is to contact an attorney.  Many cases have already been filed on behalf of investors whose securities have lost all or part of their value.  Clearly these investments were misrepresented to investors.  Now, unfortunately, the losses are being recognized.  

Today’s Wall Street Journal reports that while the freeze in the auction-rate securities market struck many individual investors and their financial advisors as a surprise, Wall Street firms that marketed one type of auction security scrambled to prevent auction failures several months before the market collapsed.

Ian Salisbury writes that UBS AG, Citigroup Inc. and Bank of America requested at the end of last year that several student-loan authorities issue waivers that would make these securities easier to sell.

What this says is that Wall Street firms were aware of the potential for auction failures months before the failures began.  The question then becomes what were these firms telling their brokerage clients about risk during this time.

Investors were sold auction-rate securities as liquid, cash equivalents.  Once the auctions began failing, the market for these securities froze and investors have been left holding their investments ever since.     

While the firms highlighted in the WSJ piece refused comment, it is likely that they  will have to answer questions soon as investors who suffered losses start litigating their claims.

New York Attorney General Andrew Cuomo has launched an investigation into auction rate securities.  Just last week, the Attorney General’s office issued subpoenas to 18 Wall Street institutions.  It has been reported that more subpoenas are expected. 

The investigation is looking into the way these securities were marketed and sold to both municipalities for financing and to individuals as investments.  As has been reported by a number of media outlets, the auction rate securities markets have been largely frozen since February.  The lack of liquidity in a product sold as a cash alternative has raised red flags with regulators.  

In addition to the NY Attorney General, a task force of other state securities regulators has been created to investigate the actions of Wall Street firms relative to the auction rate market.    

In SmartMoney’s May 2008 issue, James B. Stewart writes an insightful article regarding auction rate preferred shares (ARPS).  Mr. Stewart calls on Wall Street to “do the right thing” and redeem investors positions.

ARPS are shares in closed-end mutual funds that own various kinds of triple A-rated bonds.  These shares were sold as “cash equivalents” to investors concerned with liquidity and preservation of capital.  Brokers told investors that these investments offered little or no risk because rates were set at regualr auctions, often every seven days.  However, due to the ongoing credit crisis, these auctions began failing in February.

At that time, Goldman Sachs and Citigroup stopped bidding in these auctions.  Other Wall Street firms soon followed suit.  The result was an evaporation of liquidity.

Now thousands of investors in the $330 billion auction rate securities market are left holding investments that were sold as safe, cash equivalents.  Three months into this crisis and many auctions remain frozen.

Mr. Stewart asks that Wall Street step up and take care of its customers.  But to date, Wall Street has refused to do so.  Many firms have offered their valued clients loans to cover any liquidity concerns, but none are redeeming these shares at par.  As Mr. Stewart points out, there is somehting wrong with the way Wall Street has chosen to handle this issue.

Clearly brokerage firms did not appropriately represent these products.  Although historically ARPS have performed similar to money markets, they are not money markets.  There are risks with auction rate securities (as many investors have now become aware).  Wall Street knew these risks existed. 

Should these auctions remain frozen and Wall Street not step up and redeem investors’ shares, the only recourse for aggreived investors will be filing claims for their losses.  If past actions of Wall Street are any indication, it appears that many investors will have no choice but file claims to recover their funds.  Funds that were supposed to be safe and liquid.  

Quoting Mr. Stewart, leave it to Wall Street to “turn a plain-vanilla product into a nightmare for investors.”          

Bear Stearns, the fifth largest investment bank on Wall Street, has fallen.  The end was exacerbated by Bears’ exposure to the subprime markets and the ongoing credit crisis. 

Just days before the Fed and JP Morgan stepped in to rescue Bear, most on Wall Street would have said that it was unthinkable that a major investment firm would fall.  In fact, even as rumors of Bears’ liquidity problems surfaced, no one was speaking of total collapse.  However, within days of the rumors, the Fed and the Treasury Department were working to put a deal together to bail out Bear Stearns.  

On a long Sunday, government officials met with officers and directors of Bear and JP Morgan in an attempt to broker a deal that would prevent the bankruptcy of a major Wall Street player.  At the end of the day, a deal had been reached.  JP Morgan would buy Bear Stearns for $2 a share. 

In the aftermath of the announcement, Bear shareholders were crying foul.  Bear was, afterall, trading for over $150 a share a year ago.  As a result of shareholder discontent, JP Morgan has recently raised its offer to $10.02 a share-still a far cry from what Bear was trading at just two weeks ago.

The question for many investors is ‘how could this happen?’  How could such a prominent Wall Street firm simply fail?  The answer is partly due to the complexities of the products that Bear (and other investment banks) create to sell to investors.

As babyboomers retire and the amounts of investable monies grow, Wall Street is looking for new ways to generate profits (for both themselves and clients).  As a result, investment firms are constantly creating products that supplement the usual stocks, bonds and mutual funds.  One of those newly created investments, collaterized debt obligations (CDOs), is generating quite an impact on the markets today.   

CDOs are investment products that pool mortages and other debt together and are sold to investors.  Much has been written about how mortgages, often of the subprime variety, were packaged by investment banks and sold.  As the housing market burst, many homeowners were left unable to meet their mortgage payments.  The result has been an increase in defaults and therefore a decline in the value of the investments.

It seems to many that a perfect storm came together and that Bear Stearns was a victim of the unforseeable.  However, the problems in the current market were created by Wall Street.  Bear Stearns, and others like them, are not victims of the credit crunch.  They  are responsible for it.  The real victims are the investors who were sold products that were unsuitable, whose risks were not properly disclosed and who have lost millions as a result.

Although the collapse of Bear Stearns is a historic event, the collapse of many investors’ portfolios is the true tragedy.  The government has stepped in to help the investment banks, who is going to help the real victims?