The regulatory environment faced by both underwriters and issuers continues to become more complex, as enforcement actions and novel causes of action continued to be brought against both issuers and underwriters by various agencies in third quarter 2015.
The Securities and Exchange Commission (the “SEC”) announced a settlement on August 13, 2015 involving brokerage firm Edward Jones (the “Firm”) and the former head of its municipal underwriting desk, bringing to a close the SEC’s first ever enforcement action against an underwriter for pricing fraud in the primary market for municipal securities. The order entered by the SEC leveled $20 million in fines against the Firm and a penalty of $15,000 and a two-year ban from securities industry work against the head of the Firm’s municipal underwriting desk. The order included a determination that the Firm, rather than marketing new issue municipal bonds to customers at the initial offering price, in various instances (a) took such bonds into its inventory and then re-offered them to customers at higher prices than the initial pricing price or (b) failed to offer bonds for sale to its own customers until after trading had begun in the secondary market, and then offered such bonds at higher prices than the initial offering price. The net result of the misconduct was the overcharging of customers by more than $4 million and an adverse federal tax determination for one issuer of the bonds in question that resulted from the pricing markup issue.
Statements made by the SEC and its head officials about the pricing matter are worthy of consideration for market participants, particularly underwriters. Lee Ann Ghazil Gaunt, the chief of the SEC Enforcement Division’s Municipal Securities and Public Pensions Unit stated that, due to the fact that “investors receive very little information about their dealer’s compensation in municipal bond trades,” based on the fact that the current regulatory framework does not require dealers to disclose markups on municipal bonds, “it is important that firms have adequate supervisory systems to ensure that they are complying with their fair pricing obligations.” The lack of a supervisory system to monitor whether the markups it charged customers for certain trades were reasonable, in the SEC’s view, leads to a situation where there are no checks or controls on the markups that such bonds were then resold at to customers.
Not to be outdone, the Department of Justice (the “DOJ”) has also made an appearance in the world of municipal bond pricing. In late third quarter 2015, information came to light that a previously undisclosed DOJ investigation into possible collusion in the secondary market for municipal bonds was nearing its completion. While the results of the probe have not yet been released, Bloomberg reported in early September that the investigation was nearing completion. The probe targeted the use by certain inter-dealer brokers of a secondary market trading system operated by website MuniBroker.com. MuniBroker.com and similar platforms for inter-dealer brokers allow the sharing of pricing information among firms due to the fragmented nature of the municipal bond secondary market and the limited amount of pricing transparency available. The investigation purported to look into whether groups of inter-dealer brokers had agreed (or been forced to agree) to advertise their pricing rates only on the MuniBroker.com platform while boycotting competing services, thus limiting pricing transparency within the secondary market.
Credit: Garrett Churchill