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FINRA Fines HSBC Securities, US Bancorp Investments

Financial Industry Regulatory Authority (FINRA) has settled charges with two additional firms relating to the sale of auction rate securities (ARS) that became illiquid when auctions froze in February 2008: HSBC Securities USA and US Bancorp Investments.

HSBC, which was fined $1.5m, had by July 2008 repurchased more than 90% of its then current customers’ ARS holdings and, in October 2008, it offered to repurchase all of the remaining ARS held in those customers’ HSBC accounts. In total, HSBC repurchased more than $562m of ARS held by its customers. As part of the settlement, HSBC has agreed to offer to repurchase additional ARS sold to certain customers who transferred accounts before its previous buy-backs and to customers who chose not to participate in its prior offers.

US Bancorp Investments, which was fined $275,000, had already completed a repurchase of more than $150m of ARS held in customer accounts.

FINRA found that during the relevant period, HSBC sold in excess of $1bn worth of student loan, municipal and preferred ARS to its customers.

FINRA found up until February 2008 – when widespread auction failures froze ARS holdings – HSBC retail brokers recommended and sold ARS to customers, representing them as liquid and safe investments. But as of December 2007, it had become apparent to HSBC that credit markets were deteriorating and there were increased investment risks in ARS. Moreover, it found that HSBC failed to disclose the risk involved in ARS to the customers.

FINRA also found that HSBC’s advertising and marketing materials were not fair and balanced and that HSBC had sold certain unregistered ARS securities to customers who were not qualified to own them.

In the US Bancorp matter, FINRA found that the firm used internal marketing materials prepared by other securities firms that did not provide a balanced or adequate disclosure of risks of ARS. They described ARS as ‘a great place for short-term money’ and a ‘cash alternative’ but failed to disclose the liquidity risks of ARS. Other materials compared ARS yields to those of money market securities but failed to disclose the material differences between the investments, including differences in liquidity, safety and potential fluctuation of return.

FINRA also found that US Bancorp failed to maintain procedures reasonably designed to ensure that its registered representatives accurately described ARS to customers during sales presentations. FINRA further found that ARS were added to the firm’s approved product list without first being subjected to the usual due diligence process.

HSBC and US Bancorp agreed to a comprehensive settlement plan that has been applied in FINRA’s previous ARS settlements. In these settlements, FINRA took into account that both firms had initiated their own repurchase offers and that each had offered to buy back ARS that had not been purchased at their firms.

In addition to individual retail ARS investors, the buy-back offers include non-profit charitable organizations and religious corporations or entities, trusts, corporate trusts, corporations, pension plans, educational institutions, incorporated non-profit organizations, limited liability companies, limited partnerships, non-public companies, partnerships, personal holding companies and unincorporated associations that made individual ARS purchases and whose account value did not exceed $10m.

As part of the settlements, the firms also agreed to participate in a special FINRA-administered arbitration program for eligible investors to resolve investor claims for consequential damages – that is, damages investors may have suffered from their inability to access funds invested in ARS.

James Shorris, executive vice president and executive director of enforcement at FINRA, said: “The failure of each of these firms to adequately disclose the risks associated with auction rate securities left customers unprepared for the failure of the auction market. As with our previous ARS settlements, FINRA’s first priority has been to ensure investor access to the money frozen in their ARS investments. We are pleased that these firms have completed or agreed to complete offers to buy back frozen ARS from their customers.”