Auction Rate Securities Practices and Procedures

Since 2008, the market for auction rate securities has steadily declined in size.  In 2012, compared to an average of 34,568 daily trades in fixed rate securities, there were an average of 69 daily trades in auction rate securities. Many, many auctions failed in February of 2008, and the issuers of these securities often chose to remove their securities from the marketplace by buying them back.  In some cases, the securities remain outstanding but with rates so low that holders are unable to sell them at full value (par) through the auction process. Persons who want to buy (or sell) auction rate securities should be aware of these facts and consider them fully before making decisions to purchase (either in an auction or in a secondary trade—outside of the auction process) or to sell, potentially at a price well below par value.

Some auctions, though not many, have continued to "clear" successfully since the events of February 2008. However, there is no promise that they will continue to do so in the future.

This description of UBS´s current1 auction rate securities practices and procedures provides UBS clients and prospects with an overview of those practices and procedures, as well as the various risks investors should consider when participating in the auction rate securities market as a UBS client.

Before investing in an auction rate security, an investor should read the offering document for the particular auction rate security the investor is considering purchasing. The auction procedures applicable to that security will be described in the offering document. Those procedures will control the auction process for that particular security and may differ somewhat from the general description provided here.

Further information about auction rate securities may be obtained from a UBS representative.

There are two types of auction rate securities UBS clients may purchase. We may prohibit a client from buying securities whose auctions are failing. The first is auction rate certificates ("ARCs"),2  which are floating-rate debt securities with long-term maturities. The second is auction preferred stock ("APS"), which is preferred stock without a stated maturity. The yields on ARCs and dividend rates on APS are reset periodically through an auction process. See "How Rates are Established for Auction Rate Securities" below.

As reflected in the offering documents for the securities, there are risks in investing in auction rate securities, including:

  • the risk of a failed auction and its consequences, including how the rate to be paid following a failed auction is set
  • the potential existence of additional triggers or caps
  • the potential of holding the securities for an extended period of time

The features and risks of auction rate securities vary from issue to issue. Also, the practices and procedures of broker-dealers and auction agents conducting auction rate securities auctions may differ. For a complete discussion of the specific features and risks, ask your UBS representative for the specific offering documents for the security you wish to purchase.

ARC issuers include student loan revenue authorities, power authorities, states and municipalities. ARCs may be either taxable or tax-exempt, depending upon the issuer and other factors. APS are issued either by closed-end funds as a leverage vehicle for those funds or by corporate issuers. APS can be tax-exempt, taxable or tax-advantaged, depending upon the issuer and structure.

Short-term liquidity for investors in ARCs and APS largely depends upon the success of the auction process. As discussed above, at the current time very few auctions are successful. If an investor cannot sell these securities in a successful auction or in the secondary market,3  the investor will be required to hold ARCs until final maturity and APS indefinitely, unless the issuer redeems or restructures the security.

UBS formerly acted as an underwriter in the initial offering of ARCs and APS and thereafter served (and sometimes continues to serve) as broker-dealer in connection with the auctions for those securities. For its services as broker-dealer, UBS is compensated by the issuer of the securities or the underlying borrower in the case of a conduit financing. The amount of this compensation is based on an agreed-upon annual rate that is applied to the principal amount of securities sold or successfully placed through UBS in auctions. UBS may also place bids for its own (or "proprietary") accounts in auctions (see Bidding by UBS in Auctions) although it generally does not do so.

The initial interest rate for an ARC or dividend rate for an APS was affected by the credit quality of the issuer, general market conditions, current rates on comparable securities, supply and demand for a particular issue, the frequency with which rates are reset, and any relevant tax benefits. However, rates (dividends or interest) are reset periodically (typically daily or every 7, 28, 35 or 49 days) through an auction process, which is a bidding process in which orders are submitted through a broker-dealer. Some auction rate securities programs have a single broker-dealer. Auctions for these securities are known as "sole-managed" auctions. Other auction rate securities have multiple broker-dealers. Auctions for these securities are known as "competitive" auctions.

As broker-dealer, UBS4 accept bids from its investor clients5 and submits those bids to an auction agent, who tallies the result and declares the clearing rate. In such capacity, UBS strives to create an orderly auction process, but UBS does not submit bids (other than "hold at maximum rate" orders) for its proprietary accounts. It may place such proprietary bids after it knows what bids were made by its investor clients and generally may do so up to a submission deadline that is later than the submission deadline for investor clients to submit bids to UBS. (see Bidding by UBS in Auctions).

The "clearing rate" set in the auction process will be the lowest rate that "clears" the auction - that is, the rate for all holders will be equal to the lowest rate at which the cumulative total of securities demanded (buyers) is equal to the amount auctioned (sellers).

The following is an example of how the clearing rate is determined. The example assumes an ARCs issue with $250,000,000 principal amount outstanding. Each $25,000 minimum Authorized Denomination is referred to as a "Unit." Therefore, there are 10,000 Units. The following orders are received by the auction agent for an auction of the ARCs:

Bids - Existing Holders

Sell Orders

Bids - Potential Holders

200 Units at 2.95%

1,000 Units

400 Units at 3.00%

600 Units at 3.07%

1,000 Units

600 Units at 3.05%

1,200 Units at 3.10%

2,000 Units

1,000 Units at 3.10%

2,000 Units at 3.15%

Total = 4,000 Units

1,000 Units at 3.15%

2,000 Units at 3.17%

1,000 Units at 3.16%

Total = 6,000 Units


1,000 Units at 3.19%



2,000 Units at 3.20%



Total = 7,000 Units

In the above example, orders have been placed for the entire 10,000 Units outstanding as there are bids by existing holders for 6,000 Units and sell orders for 4,000 Units. Based on the orders above, the clearing rate would be determined as follows:

Units per Order

Bid Rate

Total Units

















































The bid that was placed by an existing holder for 2,000 Units at 3.17% cleared the auction for all 10,000 Units that were outstanding. Therefore, the rate of 3.17% is the clearing rate that will apply to all the ARCs until the next auction date.

If the demand for securities at or above the clearing rate exceeds available supply, the ARCs or APS will be allocated on a pro rata basis (that is, proportionate to order size) to those bidders whose rate is equal to the clearing rate, giving preference to "bids" by existing holders (see Types of Orders That May be Placed in an Auction) over "bids" by potential investors at the same rate. For this purpose, an existing holder who wants to purchase additional ARCs or APS is treated the same as a potential investor. The two types of investors are referred to in auction rate documents and this document as "potential holders."6

Potential holders who want to buy additional securities in an auction may submit a bid that specifies the par amount of the securities they want and the minimum rate they are willing to accept. Such orders are referred to as "bids."

Existing holders may submit the following kinds of orders with respect to securities they already own:

  • A "hold" order, which means they want to keep their securities at whatever rate is set in the auction.
  • A "bid,"7 which means they want to keep their securities, but only if the rate is set at or above their specified level.
  • A "sell" order, which means they wish to sell their securities, regardless of the rate set in the auction.
  • If a holder does not submit an order, UBS will treat the holder as having submitted a hold order—a "deemed hold" order.

Occasionally, issuers of auction rate securities change the period of time between auctions. If a holder has received notice that the issuer plans to convert the ARCs or APS to a longer auction period upon the next successful auction, but the holder has not submitted an order, UBS will treat the holder as having submitted a sell order—a "deemed sell" order. Investors should note that this is the OPPOSITE of the regular rule, where an investor who does nothing is treated as having submitted a "hold" order. Investors should pay attention to notices about changes in auction periods, because their securities will be sold automatically unless they affirmatively tell UBS not to do so—by submitting a "hold" order or a "bid."

All bids, whether by potential holders or existing holders, must specify a rate. If the clearing rate is below the rate an existing holder specifies in its order, the existing holder will be required to sell the ARCs or APS subject to its bid. So too, if the clearing rate is below the rate a potential holder specifies in its order, the potential holder will not acquire the ARCs or APS subject to its bid. UBS will not accept a bid where an existing holder or potential holder says "´Market rate´ is acceptable." A bid or a sell order may also not be "all or none" (that is, it may not be conditioned on being filled in whole). Under the terms of an auction, orders will typically be filled in part on a pro rata basis when there are not sufficient sell orders to fill all bids at the clearing rate.  If two orders have the same quantity and only one can be filled, then the first-in, first-out (FIFO) rule applies—in other words, the first bid made will be filled.

Orders may not specify rates that contain more than three figures to the right of the decimal point (e.g., 0.0301% would be invalid). The rates specified may not exceed the maximum rate or be less than the minimum rate, if any. All orders must be for the minimum denomination specified in offering documents or a multiple thereof (usually $25,000 or multiples of $25,000), unless the authorizing documents for a particular issue permit other authorized denominations. Orders that do not meet these criteria will be considered invalid.

The deadline for submitting orders to UBS is generally 12:00 p.m. (New York City time) on each auction date, unless there is an early municipal bond market close. If there is an early municipal bond market close, the deadline for submitting orders to UBS is 10:00 a.m. (New York City time). The deadline for submitting orders in daily auctions is 10:00 a.m. (New York City time). Orders may not be revoked after the UBS deadline. This deadline is subject to change in UBS´s sole discretion. UBS representatives will be advised of any changes at least two business days in advance. Generally, the deadline by which UBS must submit orders to the auction agent is 1:00 p.m. (New York City time), which gives UBS time to process and submit orders. UBS also has until 1:00 p.m. (New York City time) to submit proprietary bids, which means that at the time UBS submits proprietary bids, it will have knowledge of bids already submitted by UBS clients  (see Bidding by UBS in Auctions).

One possible outcome of an auction is that all holders remain holders regardless of the rate for the next succeeding interest (ARC) or dividend (APS) period. This may occur if holders affirmatively decide to remain holders and place hold orders or if holders simply do nothing on the day of an auction. This is referred to as an "all hold" auction. In an all hold auction, the interest or dividend rate will be set at the all hold rate as determined, according to the security´s offering documents. The all hold rate may adjust at each subsequent all hold auction. Although the all hold rate may be higher or lower than the prevailing market rate for similar securities at the time of the auction, the all hold rate generally is typically lower than all other rates (except a Minimum Rate). If UBS itself owns any ARCs or APS on the day of an auction, it is UBS´s practice to submit a "hold at the maximum rate" order for those securities into the auction. This will prevent that auction from being an all hold auction. However, UBS is not obligated to continue this practice, so holders should not assume that auctions will not be all hold auctions. Holders are encouraged to participate in auctions so that all hold auctions will not occur. UBS will not contact clients on auction dates to advise them that an all hold auction appears likely.

An auction can fail if the bid and hold orders are for less than all of the available securities.

The following is an example of how an auction can fail and the orders received by UBS would be handled. This example assumes an APS issue with 10,000 shares outstanding and a maximum rate of 3.75%:

Hold Orders

Bids - Existing Holders

Sell Orders


3,000 Shares at 3.12%



500 Shares at 3.25%


These facts would result in a failed auction, and the maximum rate of 3.75% would apply since the bids and hold orders are less than all the available securities, and there are no bids by potential holders. The sell orders for 300 and 1,200 shares for existing holders would not be executed, and these holders would hold until the next (if any) successful auction unless they were able to sell their shares in the secondary market as described under Secondary Market for Auction Rate Securities.

In the event of a failed auction, all holders, including those who submitted sell orders, must hold until the next (if any) successful auction. Neither UBS, nor any ARC or APS investor, has a right to require the issuer to buy back the security ("put the security back to the issuer"), including after a failed auction. During such a time, the interest or dividend rate is reset at a maximum rate, as determined, according to the security´s offering documents. The maximum rate may be above or below the prevailing market rate for similar securities at the time of the auction. If there are no subsequent successful auctions, the holder will be required to hold ARCs until final maturity and APS indefinitely, unless a secondary market exists or the issuer redeems or restructures the security.

The fact that any given auction clears successfully does not mean that an investment in ARCs or APS involves no significant liquidity or credit risk. UBS is not obligated to place such proprietary bids that will "clear" the auction. Investors should not assume that UBS will place proprietary bids or that failed auctions will not occur. UBS will not contact investors on auction dates to advise them that a failed auction appears likely.

The relative buying and selling interest of market participants in the auction rate securities market as a whole varies over time and may be adversely affected by, among other things, news relating to the issuer, the attractiveness of alternative investments, the perceived risk of owning the security (whether related to credit, liquidity or any other risk), general market conditions, the tax treatment accorded the securities, the accounting treatment accorded auction rate securities, including clarifications of U.S. generally accepted accounting principles relating to the treatment of the securities, reactions to regulatory actions or press reports, financial reporting cycles and market sentiment generally. Shifts of demand in response to any of the factors listed above cannot be predicted and may be short-lived or exist for longer periods.

UBS is permitted, but not obligated, to submit proprietary orders in auctions for ARCs or APS, either as a buyer or seller, and routinely does so. When UBS submits a proprietary order, it has an advantage over investors who are bidders because it knows about the orders placed by its clients. Therefore, UBS can determine the rate and size of its own order. This increases the likelihood that its order will be accepted in the auction and that the auction will clear at a particular rate. For this reason, and because UBS is compensated by the issuer or conduit borrower for its services as broker-dealer, UBS may have a conflict of interest with its clients. In a competitive auction (as defined above, one in which there is more than one broker-dealer accepting orders), UBS would not have knowledge of orders submitted to the auction agent by any other broker-dealer. In a sole-managed auction, UBS would be the only broker-dealer submitting orders to the Auction Agent. As a result, UBS could calculate the clearing rate before the orders are submitted to the auction agent and set the clearing rate with its order.

Although it is not obligated to do so, UBS may place proprietary bids in auctions to acquire ARCs or APS for its inventory, to prevent a failed auction or to prevent an outlier bid from skewing the auction results. UBS may place such proprietary bids even though it knows what orders its clients have submitted in the auction. Whenever UBS places proprietary bids, it must bid at a rate or within a range of rates that, in UBS´s good faith judgment, reflects a fair and reasonable rate for the security, taking into consideration such circumstances as prevailing market conditions with respect to the security at the time of the determination, general economic conditions and trends, current rates for comparable securities, and the financial condition and prospects of the issuer of the security. UBS may take into consideration such factors as the expense involved, the size of UBS´s inventory position, UBS´s capital requirements and UBS´s risk management needs. In placing proprietary bids, UBS may not take into consideration the interest of the issuer of the ARCs or APS in paying a low rate or the interest of clients in receiving a high rate.

Bids by UBS are likely to affect the auction rate, including preventing the auction rate from being set at the maximum rate or otherwise causing bidders to receive a lower rate than they might have received had UBS not bid. Bids by UBS are also likely to affect the allocation of the ARCs or APS being auctioned, including causing some bidders to have their bids rejected or receive fewer securities than they would have received had UBS not bid.

Under certain circumstances, a municipal issuer (or conduit borrower) may bid in an auction for its own securities. An issuer/borrower is required to disclose its intention to do this, and certain other information (including the size and rate of its bid), at least two business days prior to that auction. The issuer/borrower must also disclose the results of the prior auction and the results of the auction in which it participates. Disclosure is made to nationally recognized municipal securities information repositories (NRMSIRs), on the issuer´s/borrower´s public website if it has one, and on UBS´s public website. You can find out if the issuer/borrower of your securities is planning to bid in an auction by checking (two business days in advance) the following link: Information About Issuers/Conduct Borrowers in Their Own Auctions. You will also find the other information required to be diclosed.

Please take note that an issuer/borrower bidding in its own auction has different interests than all other investors in that auction. In particular, other investors are seeking to own securities at the highest possible interest rate, while the issuer/borrower may prefer the lowest interest rate.

The auction process for auction rate securities is designed so the holder will sell securities primarily through the auction process. An investor who wants to sell between auctions (or before maturity) is at market risk and may not be able to sell readily or at a favorable price. If UBS purchases ARCs or APS in the secondary market, it does so at a price that is fair and reasonable fair market value, which may be lower, equal to, or greater than, the par value of the security. This differs from a successful auction, in which all sellers receive par. On the day of an auction, until the auction results have been announced by the auction agent, UBS will not conduct secondary market trades in the auctioned securities or even commit in advance to enter into a secondary market trade in the auctioned securities. Investors are encouraged to participate in the auction process for the purchase or sale of ARCs or APS.

UBS (Wealth Management) is under no obligation to purchase ARCs or APS from its own customers, but may be able to assist a customer in selling ARCs or APS in the secondary market. Prices received are very unlikely to be at par, and it may not be possible to sell the securities at all. UBS acts as an agent, not a principal, in such sales.

Nothing in this document constitutes a solicitation or recommendation of a particular investment for a specific client. UBS Financial Advisors are solely responsible for making any recommendations or suitability determinations with respect to their clients´ accounts. 

Liquidity Risk: An existing holder may sell its ARCs or APS in only one of two ways. The investor may sell them in an auction through a broker-dealer designated by the issuer by placing a sell order (see Types of Orders That May Be Placed in an Auction). The investor may sell them outside of an auction through a broker-dealer designated by the issuer if that broker-dealer chooses to maintain a secondary market for the ARCs or APS.

Existing holders will be able to sell all of the ARCs or APS for which they place sell orders only if there are sufficient bidders in the auction. If there are not sufficient bidders, existing holders will not be able to sell all of the ARCs and APS for which they have placed sell orders and, in fact, may not be able to sell any. While UBS may submit a proprietary bid to avoid a failed auction, it is not obligated to do so and has not done so since February 2008. There may not always be enough bidders to prevent a failed auction if UBS does not submit a proprietary bid. Failed auctions are possible, especially if the issuer´s/conduit borrower´s/guarantor´s credit were to deteriorate, if a market disruption were to occur, or if UBS was unable or unwilling to submit a proprietary bid.

Under certain circumstances, the auction agent and broker-dealers (such as UBS) for an auction rate security are entitled to resign. If they do so and are not immediately replaced, it will not be possible to hold auctions for the securities. The rate on the auction rate securities during a period when there are no auctions will be described in the offering document for those securities. Investors should be aware that it may not be a market rate.

Suitability: ARCs and APS are suitable for some investors. However, the minimum denomination is usually $25,000, and purchases in excess of $25,000 must be in $25,000 multiples. Money market funds are generally precluded from investing in ARCs and APS, because there is no guaranteed put feature on the bond. These securities are unlikely to be suitable for investors seeking high returns or a high assurance of liquidity; it is likely that there are fixed rate investments that will provide a higher rate of return with a similar credit exposure, which, as a general matter, may be more suitable for such investors. Please contact your tax advisor regarding the suitability of tax-exempt investments in your portfolio. These securities may also not be suitable for investors who are seeking to fund a specific liquidity need in the near future; there are short duration products, such as money market funds, and variable-rate demand obligations and Treasury bills, which, as a general matter, may be more suitable in that scenario.

Early Call Risk: An issuer may have the option to redeem the ARC/APS at any time or on set dates prior to maturity, typically at par plus accrued interest through the redemption date. An investor will then have to consider how to reinvest the proceeds, and may be unable to find desirable yields or credit quality.
Interest Rate Risk: When market interest rates rise, the market value of fixed income instruments generally will decrease. ARCs/APS are structured to reduce—but do not necessarily eliminate—the risk related to rising market interest rates.

Reinvestment Risk: In a declining rate environment, investors with adjustable rate or variable rate securities may generally find lower yields at which to reinvest interest or principal. Investments in ARC/APS entail certain other risks, which are described in the relevant prospectus or offering memorandum. Such offering documents are available upon request. For additional information, please contact a UBS Financial Advisor.