MUNI BONDS | Rigged Markets

July 16, 2011–An outraged Republican friend sent me a link from Jesse's Café Américain, commenting on SEC and other actions announced on July 7. The related SEC actions, from their announcements, are summarized below. My friend was distressed at the inadequacy of the penalties.

SEC Actions and Related Other Government Actions

The SEC charged J.P. Morgan Securities LLC (JPMS) with fraudulently rigging at least 93 municipal bond reinvestment transactions in 31 states. JPMS agreed to settle SEC complaints of violations of Section 15(c)(1)(A) of the Securities Exchange Act of 1934 by paying approximately $51 million, to be passed on to municipalities that were cheated.

JPMS and its affiliates also agreed to pay $177 million to settle related claims by the IRS and other federal and state authorities.

JPMS improperly won bids by entering into secret arrangements with bidding agents to get an illegal 'last look' at competitors’ bids. Municipal issuers and investors didn't stand a chance against the fraudulent strategies JPMS and others used to guarantee profits.–Robert Khuzami, Director of the SEC's Division of Enforcement.

When municipalities sell securities, they usually invest the proceeds of the sales until the money is needed. As part of its oversight of the tax-exempt market, the IRS requires that such proceeds be invested at fair market value, which is commonly done by utilizing a competitive bidding process. But the SEC claims that during the period 1997-2005 JPMS's fraudulent practices undermined this process. Municipalities paid more for reinvestment products than they should have. JPMS thereby jeopardized the tax-exempt status of billions of dollars in municipal securities. 

When powerful financial institutions like JPMS conspire with each other to intentionally violate regulations designed to ensure fair investment prices, the integrity of the municipal marketplace becomes corrupted. Rather than playing by the rules, the rules got played. - Elaine C. Greenberg, Chief of the SEC's Municipal Securities and Public Pensions Unit.

The SEC complaint filed in U.S. District Court for New Jersey says that JPMS acted as agent for JPMorgan Chase Bank, N.A and on certain occasions:

• Won bids by obtaining information ("last looks") from bidding agents about competing bids. I
• Won bids that were wired in advance for JPMS to win (“set-ups”). The bidding agent deliberately set up non-winning bids from other providers, for whom other bids were wired for them to win. 

The employees involved are no longer with JPMS.

Comment

The SEC gets great credit for nailing this one. The penalties may be inadequate, but it's good to see the SEC taking action. The financial markets in the United States need to have their credibility restored and the SEC has a crucial role in making it happen.

MUNI BONDS | Bid-Rigging Investigation

The NY Times today has a prominent story on the "Nationwide Inquiry on Bids for Municipal Bonds" by Mary Williams Walsh. It starts:

The federal investigation that prompted Gov. Bill Richardson of New Mexico to withdraw his nomination as commerce secretary offers a rare glimpse into a long-simmering investigation of possible bid-rigging, tax evasion and other wrongdoing throughout the municipal bond business. Three federal agencies and a loose consortium of state attorneys general have for several years been gathering evidence of what appears to be collusion among the banks and other companies that have helped state and local governments take approximately $400 billion worth of municipal notes and bonds to market each year.

The background to this is that the Treasurer of New Mexico resigned in October 2005 facing 21 federal counts of extortion. The NY Times story continues:

E-mail messages, taped phone conversations and other court documents suggest that companies did not engage in open competition for this lucrative business, but secretly divided it among themselves, imposing layers of excess cost on local governments, violating the federal rules for tax-exempt bonds and making questionable payments and campaign contributions to local officials who could steer them business. In some cases, they created exotic financial structures that blew up.

After the NYC fiscal crisis in 1975 and concerns about the municipal securities market, the Municipal Securities Rulemaking Board was created. In 1978, the Council on Municipal Performance produced, with the assistance of the law firm of Chadbourne Parke, a ten-volume study of the municipal markets, the Municipal Securities Regulation series. Referencing this study, a NY Times editorial called for greater regulation of the municipal bond market. Twenty years later, SEC Chairman Arthur Levitt said in a
March 30, 1999 Speech:

Today, a new form of pressure exists on those who manage public funds. The pressure comes from the ever-escalating costs of political campaigns and the temptation to use control over public monies to raise funds to cover those costs. The pressure I'm talking about is "pay-to-play" – the selection of investment advisers to manage public funds based on their political contributions. I've been talking about pay-to-play since the very beginning of my tenure as SEC Chairman. Up until now, that discussion has focused on the municipal bond market. And, I'm proud to say that after a sustained period of cooperation between the private sector, self-regulatory organizations and the SEC, much has been done to address this insidious practice. Six years ago, the municipal securities business was rife with pay-to-play practices. Because of the importance of those markets, I placed banishing these practices at the forefront of our agenda, and in 1994, we approved the Municipal Securities Rulemaking Board's Rule G-37. It requires a two-year time out from doing business with a government client after a firm or its executives makes a contribution to an elected official. Some called the rule too strong a medicine. Well, when the patient is suffering and the fever is contagious, merely drinking a lot of liquids probably isn't the right or most effective solution. It's worth noting that a group of investment bankers were the first to confront the ethical implications of pay-to-play. They placed a voluntary ban on political contributions to officials with whom they did business. And just a few months ago, a group of financial advisors that help municipalities structure bond offerings met with me to announce a self-imposed ban on the same activity. Late last year, I asked the Division of Investment Management to look into the question of whether the Commission needed to address pay-to-play in the public pension area. After months of work on the issue, the Division has uncovered strong indications that pay-to-play can be a powerful force in the selection of money managers of public pension plans.
We found allegations of this activity in at least 17 states. Pay-to-play has affected both the largest of pension plans and the smallest of plans. The comptroller of a large state raised $1.8 million from pension fund contractors – many of whom are out-of-state. A former treasurer of a small state raised virtually all of his campaign contributions – $73,000 – from contractors for the state retirement system.

The SEC after Levitt doesn't seem to have dealt with the problem. Now we read in today's NY Times:

Pay-to-play in the municipal bond market is endemic,” according to a retired IRS manager in charge of overseeing the market.