Municipal securities

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Municipal securities (or munis) are exempt debt securities issued by state and local governments in the United States and its territories. They include securities issued by agencies or authorities established by those governments. Munis are used to fund items such as infrastructure, schools, libraries, general municipal expenditures or refundings of old debt.

When the United States introduced a federal income tax in 1913, the taxability of interest from municipal securities was challenged based on the constitutional principal of states' rights. That argument was upheld by the Supreme Court for much of the twentieth century but was finally rejected in a 1983 case. Today, congress has a right to tax interest income from municipal securities, but it currently chooses not to. Many states also exempt their securities from their own taxes, which makes those securities particularly attractive investments for their own residents. Of course, capital gains from buying or selling munis in the secondary market are fully taxed. Source: Riskglossary

See also Build America bond, municipal bankruptcy, muni swaps and Municipal Securities Rulemaking Board.

Contents

Congressional oversight

Wyden and Gregg defend call for shift to tax-credit bonds

Sens. Ron Wyden, (D.,Ore.) and Judd Gregg, (R., N.H.) are defending an proposal they have made to stop the issuance of tax-exempt bonds starting in 2011.

The senators maintain shifting toward the issuance of tax-credit bonds would make the U.S. tax code more equitable.

"Unlike a tax exemption, a tax credit allows tax payers at all income levels to realize the same tax benefits," the senators said in a statement.

Earlier this week, Wyden and Gregg unveiled a rewrite of the nation's tax code that would cut the number of individual income tax brackets to three -- 15%, 25% and 35% -- and create a single corporate income tax rate of 24%. The proposal, however, calls for what would effectively be the closure of the $2.8 trillion market for tax-exempt bonds, a suggestion state and local finance officials and market participants sharply criticize.

Tax-exempt bonds pay investors a coupon rate that is exempt from federal and most home-state taxes. Tax-credit bonds require investors to pay taxes on income but give a credit that would cover 25% of that income.

Tax-credit bonds have been around for more than a decade but have failed to attract a strong following. Tax-exempt bonds have been used by tens of thousands of municipalities working to raise capital.

The Regional Bond Dealers Association maintains it would be a serious mistake to curtail municipalities' ability to issue tax-exempt bonds. The tax-exempt municipal bond market dates to the 1920s and "is deep and liquid with ready investors who are fully accustomed to and comfortable with the products," Mike Nicholas, the association's chief executive said.

Wyden and Gregg included the shift to tax-credit bonds in their legislation as a way to raise revenue, and they accept that not everyone will be happy with the measure.

Still, they said they believe the change would be worthwhile.

"Overall, the significant reduction in tax rates made possible under [the legislation] will give a much-needed boost to individuals and businesses across the board," they said.

Grassley attempts to stop "tax stripping"

The Senate’s top Republican taxwriter has introduced legislation that would block the stripping and selling of tax credits from three kinds of tax-credit bonds. At the same time, Treasury Department and Internal Revenue Service attorneys are working to write stripping rules sought by muni market participants who contend they are needed to jump-start the programs.

Sen. Charles Grassley, the ranking minority member of the Senate Finance Committee, has introduced two bills that would extend programs for qualified zone academy bonds, qualified school construction bonds, and new clean renewable energy bonds. However, the Iowa Republican’s bills, which he introduced last month, also include provisions that would prevent the stripping of credits from the bonds.

The stripping bans were included in the bills because Grassley is concerned the IRS would be unable to properly trace ownership of the strips and prevent abuse, an aide said yesterday.

If passed, the legislation could stifle stripping before it has had a chance to begin.

Congress granted tax-credit bond issuers and investors the ability to strip credits in June 2008 as part of the farm bill, but market participants have been waiting for the Treasury to write rules that shine some light on a litany of questions. Treasury officials have said for months that while stripping guidance is a priority, the work has been bogged down by a number of complicated issues, including how to track the credits.

Grassley’s legislation has some market participants scratching their heads, as stripping was touted as a promising way to expand the current paltry market for tax-credit bonds by making the bonds and tax credits marketable to a broader base of investors.

“Allowing stripping for QSCBs would be hugely beneficial to the program and ultimately to the schools,” Scott Minerd, chief investment officer at Guggenheim Partners LLC, the biggest purchaser of QSCBs, said yesterday.

“Without stripping, there’s a limited appetite for these securities in the long run ... You’ve eliminated at least 85%-90% of all the buyers of bonds in the world, if not more,” he warned.

Guggenheim has purchased $1.2 billion of QSCBs, nearly half of the $2.5 billion that have been issued. The privately held financial services firm had planned by the end of last year to strip and sell the credits from bonds it purchased this fall from the Los Angeles Unified School District, with or without Treasury regulations. However, that attempt hit a wall when rating agencies refused to rate the stripped credits without the Treasury rules, Minerd said.

The viability of traditional tax-credit bonds also has come under question from lawmakers in the House, who last month approved a jobs bill that would allow state and local issuers of QZABs and QSCBs to receive direct Build America Bond-style payments from the Treasury instead of investors receiving tax credits.

Currently, Grassley’s bills have been referred to the Finance Committee, but if they are to gain any legislative momentum, they probably would need to be included in the so-called extenders package, annual legislation that Congress passes to extend expiring tax provisions.

Grassley and Finance Committee chairman Max Baucus, D-Mont., said before the Christmas break that extenders would be one of the first things they tackle in 2010, after spending much of December consumed with health-care reform legislation. The House passed its extenders bill last month, but it did not include any provisions blocking stripping. An aide declined to comment yesterday on whether Baucus supports Grassley’s legislation.

In addition to the proposed ban on stripping for the three kinds of tax-credit bonds, one of Grassley’s bills, S. 2851, would permanently extend the QZAB and QSCB program and authorize an additional $700 million annually for QZABs. The $700 million would be indexed to inflation. Under the bill, QZABs also would no longer have to comply with the Davis-Bacon Fair Labor Act. QSCBs would not be granted any additional authority beyond the current $22 billion authorization.

Grassley’s other bill, S. 2826, would authorize an additional $2.2 billion for CREBs.

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Senate plan changes MSRB and advisors


The U.S. municipal bond market may face tighter regulation including a new registration requirement for non-bank advisers to state and local governments, under legislation proposed by Senate Banking Committee Chairman Christopher Dodd.

The plan also would strip majority control of the Municipal Securities Rulemaking Board from investment banks and securities dealers, according to a draft released today by Dodd, a Connecticut Democrat. The change would provide seats on the board, which makes rules for the $2.8 trillion municipal bond market, to issuers, investors and financial advisers.

Such oversight is opposed by the National Association of Independent Public Finance Advisors, which doesn’t believe the MSRB is the right authority for its members, said Keith Curry, past president of the association.

“The MSRB isn’t the appropriate regulator because of the MSRB’s history of being controlled by brokers and dealers,” said Curry, managing director of Public Financial Management in Newport Beach, California, the market’s largest advisory firm.

The Alexandria, Virginia-based MSRB in February proposed being given authority over advisers, citing on-going state and federal investigations into their role in interest-rate swaps, guaranteed investment contracts and other municipal services. The advisers collect fees and influence the decisions of municipal bond issuers. They aren’t subject to the same rules on campaign contributions and other activities that govern investment banks and securities dealers.

CDR Investigation

On Oct. 30, CDR Financial Products Inc. founder David Rubin and two employees of the Beverly Hills, California-based company were indicted by a U.S. grand jury in New York City for allegedly taking kickbacks that allowed firms to excessively profit on investments sold to local governments.

The MSRB declined immediate comment on Dodd’s proposal, according to an e-mail from spokeswoman Jennifer Galloway.

In bringing advisers under MSRB rules, Dodd’s plan gives them a voice on the MSRB board. The proposal would change the MSRB so it is composed of eight public members and seven banks, including one financial adviser. The current board is made up of 10 banks and securities dealers and five public members. Dodd also requires issuers and investors to be represented among the public members.

Market Regulation

In the U.S. House, the Investor Protection Act of 2009, designed to improve regulation of financial markets was approved by the Financial Services Committee Nov. 4. It would also change the composition of the MSRB’s board to give more control to non- bank members and require regulation of non-bank financial advisers.

The House legislation would empower the SEC to regulate advisers rather than putting oversight in the hands of underwriters, said Robert Doty, a municipal finance adviser at American Governmental Services in Sacramento, California.

“The MSRB has a weak record when it comes to protecting issuer interests in receiving advice that is independent of the underwriters in municipal securities offerings,” Doty said in an e-mail. “This is a very dangerous proposal that would undo much of the effort to improve the municipal market.”

Former MSRB Executive Director Christopher “Kit” Taylor questioned whether issuers should have a voice on the MSRB board because their interests may be adverse to those of investors who the MSRB is supposed to protect.

Including Issuers

“Is this the Issuer Relief Act?” asked Taylor, now a consultant in Alexandria, Virginia, in a phone interview. “Issuers resist everything. If we’d have had more issuers on the board, we wouldn’t have gotten as far as we did in providing more information for investors.”

Dodd’s plan to overhaul regulation of U.S. securities markets also would require the Government Accountability Office to study municipal bond market disclosure and recommend changes, including possibly lifting the Tower Amendment that grants municipalities latitude on the timeliness of their disclosure and what they must tell investors.

“If you don’t lift the Tower Amendment, then you don’t improve disclosure,” said Taylor. “There is no way for investors to know what they’re buying.”

Dodd wants MSRB to have agent oversight

Senate Banking Committee chairman Christopher Dodd, who said Friday he plans to move forward with a massive financial regulatory reform bill without Republican support, told federal regulators that he wants the bill to include language that would give the Municipal Securities Rulemaking Board oversight of pension fund placement agents.

In a [Feb. 2 letter] to the Securities and Exchange Commission, the Connecticut Democrat urged the SEC not to impose a blanket ban on pension fund placement agents as called for in an August SEC proposal that aims to limit pay-to-play activities among investment advisers for states and localities.

Instead, Dodd recommended the SEC regulate pension fund placement agents the way a draft of his financial regulatory reform bill would regulate municipal market financial advisers and other market intermediaries: through mandatory SEC registration coupled with proscriptive rules of conduct set by the MSRB.

“This approach,” Dodd said in the two-page letter, “would enable the commission to monitor the activities of placement agents and of the municipal advisers. It would also increase transparency and disclosure in the marketplace, and prevent the abuse targeted by the commission’s proposed rule without prohibiting what many in the municipal securities market describe as useful and legitimate practices.”

Though the letter does not specifically mention the MSRB, market participants said that its reference to the municipal securities provisions in Section 975 of his draft Restoring American Financial Stability Act suggests he is talking about giving the MSRB authority pension fund placement agents.

The same section of the bill would also alter the board’s composition to ensure that a majority of its 15 members are public, and would give the MSRB authority over currently unregulated financial advisers, guaranteed investment contract brokers, third-party marketers, placement agents, solicitors, and swap advisers. A financial regulatory reform bill that passed the House in December would also make the MSRB a majority-public self-regulator, but would give the SEC regulatory authority over third-party intermediaries.

SEC seeks expanded authority over muni market

"A member of the Securities and Exchange Commission called on Wednesday for legislative changes to put municipal bond markets on a more even footing with the stock and corporate bond markets.

The municipal bond market, long a regulatory backwater, has become too prone to defaults and accounting irregularities, said Elisse B. Walter, one of the five S.E.C. commissioners.

In a speech in New York, Ms. Walter said the Depression-era laws that exempted municipal bonds from oversight by the S.E.C. had outlasted their usefulness.

She urged Congress to repeal the Tower Amendment, a 1975 law limiting federal authority over states and local government bodies that raise money on the bond markets.

Currently, municipal bonds do not have to be registered with the S.E.C., and governments generally report their financial condition with the type of accounting that can sometimes make them look much more solid than they would under the corporate accounting rules. The governmental rules are not enforceable by the S.E.C. in any case.

Ms. Walter, who is one of the commissioners appointed by President George W. Bush, said she was sharing her own opinions, not the commission’s. She acknowledged that her views would be unpopular. States and local governments have long resisted regulation by the S.E.C. as an infringement on their sovereignty. When the issue has come up in the past, Congress has shown sympathy for their concerns.

But Ms. Walter said that in her view, the issue should not be one of states’ rights, but one of balancing local interests with the national interest in sound financial markets.

“While we have to make proper allowances for the unique needs of municipal issuers,” she said, “we do not have to tolerate muni investors being treated like second-class citizens.”

She pointed out that local governments were engaging today in complex derivatives transactions “whose risks even sophisticated investors sometimes have trouble understanding.”

She said taxpayers and mom-and-pop investors alike would be increasingly exposed to those risks as older Americans retired and put their life’s savings into municipal bonds.

She said the S.E.C. currently had the legal authority to demand more timely and truthful financial information. But she also recommended changes that would take acts of Congress, like increasing regulatory authority over municipal bond issuers by putting it into a single body together with enforcement.

She proposed legislation that would require “conduit borrowers” — businesses that can issue tax-exempt bonds through their relationships with municipalities — to follow corporate registration and disclosure standards instead of governmental ones.

She also recommended bringing the shadowy financial intermediaries that serve governments into the regulatory framework."


"The Securities and Exchange Commission will likely seek ­legislation “sometime next year” to expand its authority over the municipal market, SEC chairman Mary Schapiro told reporters yesterday after speaking at the Securities Industry and Financial Markets Association’s annual conference in New York.

Legislation is needed to make the level of disclosure by corporate and municipal issuers more equivalent, she said, adding, “Not identical necessarily, but just more equivalent.”

Meanwhile, a California issuer known widely for embracing derivatives as an effective tool for lowering borrowing costs predicted that issuers will likely cease using derivatives in the future because the short-term market has collapsed.

Specifically, Brian Mayhew, chief financial officer of the Bay Area Toll Authority, speaking on a panel, said the market for variable-rate debt that issuers typically issue and then swap to a fixed rate has dried up as a result of the lack of affordable bank liquidity agreements and bond insurance for muni issuers.

“Absent insurance and liquidity, there’s nothing to back these things,” he said, referring to the underlying security on a synthetic fixed-rate swap. “I think you have a very, very limited world of derivatives going forward. At least from my standpoint, and I have $3 billion of [swaps].”

Not all issuers on the panel agreed with Mayhew, with Gene Saffold, chief financial officer of Chicago, saying he is “less pessimistic.”

Alan Anders, deputy director of finance for New York City’s Office of Management and ­Budget, said that the city is considering entering into a derivative, known as a synthetic floater, under which it would issue fixed-rate debt and then swap fixed payments for variable ones.

Anders said the idea is “very appealing.”

Sam Gruer, managing director at Cityview Capital Solutions LLC, who was not at the SIFMA conference, said in an interview that he is aware of several issuers that are considering such arrangements, but does not know of any that have entered into one yet. Still, he said a synthetic floating-rate structure can provide issuers with “attractive” floating-rate funding levels without the relative risks tied to obtaining and renewing bank liquidity facilities.

“Additionally, given the steepness of the yield curve, shorter-dated, fixed-to-floating-rate swaps can still produce attractive floating-rate interest costs while significantly reducing the mark-to-market risk associated with longer dated swaps,” he said."


Source: House shoots for fall Bond Buyer, July 31,2009

"A congressional source said that the Financial Services Committee has no immediate plans to ­impose specific suitability requirements on small governments seeking to engage in derivatives, as was called for in an early blueprint of financial regulatory reform released by the Obama administration...

...The FA bill, which was introduced in May and seeks to place all muni advisers on a level regulatory playing field, would require FAs to register with the SEC and would impose a “fiduciary” standard on them. The congressional source said that lawmakers feel the FA bill, coupled with regulations to impose a fiduciary standard on dealers serving as investment advisers, would adequately ensure that unsophisticated municipalities do not engage in derivatives contracts that they do not understand.

The source said that the FA bill would be considered along with legislation to authorize the Federal Reserve to establish a temporary liquidity facility for variable-rate demand obligations, as well as a third bill to authorize the Treasury Department to run a temporary reinsurance program that would cover all insured municipal credits.

A fourth muni bill, which would require rating agencies to rate municipal bonds more similarly to corporate debt, is likely to be added to legislation designed to increase federal oversight of rating agencies, the congressional source said. A draft of that legislation was sent to lawmakers last week and seeks to mitigate conflicts on interest, increase the transparency of the rating process and reduce investor reliance on ratings."

Tower Amendment

  • Prevents SEC and MSRB from imposing corporate-style registration scheme for muni issuers
  • SEC Rule 15c2-12 does not violate Tower Amendment
  • Post-sale production of official statement
  • Post-sale material events notices and annual reports

Tower Amendment - Sec. 15B(d)(1)

  • Applies to both MSRB and SEC
  • Cannot require issuers, directly or indirectly, to file with either the SEC or MSRB “prior to sale” any application, report, or document in connection with issuance, sale or distribution of the securities

Tower Amendment - Sec. 15B(d)(2)

  • Applies to the MSRB, but NOT the SEC
  • Cannot require issuers, directly or indirectly, to furnish to the MSRB, purchasers, or prospective purchasers any application, report, documents, or information with respect to such issuers
  • Exception - if information available from source other than the issuer

State & local governments fiscal outlook, March 2010

term fiscal challenges which grow over time. Although the sector’s near-term operating balance remains negative, increases in federal grants-in-aid—largely from the Recovery Act—alleviated some near-term pressure. As shown in the insert to the figure below, the March 2010 operating balance measure (including 2009 Recovery Act funds) shows an improvement compared to the January 2009 simulation. In the near-term, the sector’s fiscal position can be attributed to several factors, including steep revenue declines.

GAO projects that the sector’s long-term fiscal position will steadily decline through 2060 absent any policy changes, as shown in figure 1. The decline in the sector’s operating balance is primarily driven by rising health care costs. The fiscal challenges confronting the state and local sector add to the nation’s overall fiscal difficulties. Because most state and local governments are required to balance their operating budgets, the declining fiscal conditions shown in GAO’s simulations suggest the fiscal pressures the sector faces and the extent to which these governments will need to make substantial policy changes to avoid growing imbalances.

GAO testimony on municipal fiscal stresses

This testimony is based largely on GAO’s July 8, 2009 report, in response to a mandate under the American Recovery and Reinvestment Act of 2009 (Recovery Act).

This testimony provides selected updates, including the status of federal Recovery Act outlays. The report addresses:

  1. selected states’ and localities’ uses of Recovery Act funds,
  2. the approaches taken by the selected states and localities to ensure accountability for Recovery Act funds, and
  3. states’ plans to evaluate the impact of Recovery Act funds.

GAO’s work for the report is focused on 16 states and certain localities in those jurisdictions as well as the District of Columbia—representing about 65 percent of the U.S. population and two-thirds of the intergovernmental federal assistance available. GAO collected documents and interviewed state and local officials. GAO analyzed federal agency guidance and spoke with Office of Management and Budget (OMB) officials and with program officials at the Centers for Medicare and Medicaid Services, and the Departments of Education, Energy, Housing and Urban Development, Justice, Labor, and Transportation.

What GAO Recommends

GAO makes recommendations and a matter for congressional consideration discussed on the next page. The report draft was discussed with federal and state officials who generally agreed with its contents. OMB officials generally agreed with GAO’s recommendations to OMB. DOT agreed to and has since addressed GAO’s recommendation.

Rating firms are standardizing rating scales

Municipal debt rankings by Moody’s Investors Service will shift to a global rating system next month that will put the 70,000 state and local bonds it assesses on a scale that’s comparable with corporate securities.

“We are responding to the evolving needs of the market for greater comparability between the ratings of these obligations and those issued by other entities,” Gail Sussman, group managing director at New York-based Moody’s, said in a press release today.

The new ratings don’t “represent a change in our opinion of the credit quality of affected issuers.” U.S. Representative Barney Frank, a Massachusetts Democrat who chairs the House Financial Services Committee, called the different rating scales “ridiculous” at a hearing on the $2.8 trillion market in May 2008.

The Moody’s announcement came a day after Senator Christopher Dodd proposed, as part of the biggest Wall Street regulatory overhaul since the 1930s, that municipalities be assessed in the same manner as companies. The same requirement was included in Frank’s financial-services legislation last year.

“This represents a transfer of money from wealthy investors back to municipalities,” Frank said in a telephone interview. “This recognizes what we have been saying all along.” Lockyer Letter

Municipal bond issuers led by California Treasurer Bill Lockyer began pressing companies that rate their debt two years ago to show investors how they would be assessed on a corporate scale. They said the existing system for ranking state and local obligations led to higher borrowing costs because government issuers default less frequently than higher-rated corporations. The dual rating system cost state taxpayers billions in higher interest rates and at the time forced them to buy bond insurance to obtain top rankings, according to a 2008 letter to rating-company heads from Lockyer and 10 other state treasurers and municipal officials.

California estimated the difference in ratings systems would cost the most-populous state an additional $5 billion on $61 billion of planned bond issues over 30 years.

“We’ll see how the market reacts and how much this move pays off for taxpayers in California and across the country, who have borne the financial burden of an unfair system,” said Tom Dresslar, spokesman for Lockyer, in an e-mailed statement today. “The Moody’s unified scales will produce ratings that more accurately reflect the tiny risk of default of tax-backed municipal bonds.”

Three Levels

Moody’s report on its rating methodology said the move to a global scale will raise long-term state and local government ratings by as much as three levels. The new rankings shouldn’t be viewed as upgrades, the company said. Most housing, health care and “enterprise” sectors of municipal bonds won’t change “because they are already well-calibrated with the global scale,” the report said.

“We’ll have to see what the actual changes are and re- evaluate default statistics and then compare it with similar corporate securities and then we will see whether we’ve achieved parity or not,” said Roger Anderson, executive director of the Princeton-based New Jersey Educational Facilities Authority and a signer of Lockyer’s letter.

“We’ll have to see what the actual increases are issuer by issuer,” he said in a telephone interview.

Moody’s in the past rated state and local bonds based on a separate scale that weighed credit risk within the municipal bond sector. The new municipal system will focus on credit risk based on average levels of default and loss in comparison to other similar debt securities, Moody’s said.

The company said it would phase in the move to the new ratings over four weeks. Dresslar said he hopes that the New York-based companies Standard & Poor’s and Fitch Ratings will also move municipal bonds to a global scale. S&P uses the same rating scale across all the sectors it rates, spokeswoman Ana Sandoval said in an e- mailed statement.

Fitch, which postponed a decision on moving to a global scale because of the collapse of credit markets in 2008 and 2009, may still take action, Richard Raphael, executive managing director of public finance, said in a statement released by spokeswoman Cindy Stoller.

The firm “expects to relay its updated perspectives to the market in the near future,” the statement said.

SEC oversight and rulemaking

The SEC Office of Municipal Securities, which is located in the Division of Trading and Markets, coordinates the SEC's municipal securities activities, advises the Commission on policy matters relating to the municipal bond market and provides technical assistance in the development and implementation of major SEC initiatives in the municipal securities area. In addition, the Office assists the division of Enforcement and other Offices and divisions on a wide array municipal securities matters. The Office works closely with the municipal securities industry to educate state and local officials and conduit borrowers about risk management issues and foster a thorough understanding of the Commission's policies. In addition, it reviews and processes rule filings of the Municipal Securities Rulemaking Board and acts as the Commission's liaison with the MSRB, FINRA and a variety of industry groups on municipal securities issues.

Andrew J. Donohue, Director, Division of Investment Management, U.S. Securities and Exchange Commission, Washington, D.C., May 7, 2010

SEC Approves Rule Changes to Enhance Municipal Securities Disclosure

Rule 15c2-12 prohibits brokers, dealers, and municipal securities dealers from purchasing or selling municipal securities unless they reasonably believe that the state or local government issuing the securities has agreed to disclose such things as annual financial statements and notices of certain events, such as payment defaults, rating changes and prepayments.

The Amended Rule will …

Expand the Rule to Cover Additional Municipal Securities – When it was first adopted, Rule 15c2-12 specifically did not apply to certain securities commonly known as variable rate demand obligations or VRDOs. Under the amendment, the rule will apply to new issuances of such securities. VRDOs bear interest at a rate that is reset periodically and investors are able to sell them back to the issuer at certain times for their full value.

Improve Disclosure of Tax Risk — The amended rule will specifically include disclosure of events that may adversely affect a bond’s tax exemption, including issuance by the IRS of proposed and final decisions about whether the bond can be taxed. Strengthen and Expand Disclosure of Important Events — Under the existing rule, an underwriter must have a reasonable belief that the state or local government that issued municipal bonds has agreed to provide ongoing, continuing disclosure of certain important events.

The existing rule presently provides that notice of all of the listed events need be made only “if material.” The amended rule will eliminate the need for a materiality determination for the following events:

  1. failure to pay principal and interest;
  2. unscheduled payments out of debt service reserves reflecting financial difficulties;
  3. unscheduled payments by parties backing the bonds, reflecting financial difficulties, or a change in the identity of parties backing the bonds or their failure to perform;
  4. defeasances, including situations where the issuer has provided for future payment of all obligations under a bond; and
  5. rating changes.

A materiality determination would be retained for some events, including, for example, bond calls.

The amendments also increase the number of events to include:

  1. tender offers;
  2. bankruptcy, insolvency, receivership or similar proceeding;
  3. mergers, consolidations, acquisitions, the sale of all or substantially all of the assets of the obligated person or their termination, if material; and
  4. appointment of a successor or additional trustee or the change of the name of a trustee, if material.

Establish a More Specific Filing Deadline — The amended rule will provide that notices of the events listed in the rule be disclosed in a timely manner not more than 10 business days after the event.

Currently, the rule simply provides for disclosure “in a timely manner.”

Additional Guidance — Over the years, the Commission has set forth interpretations under the antifraud provisions of the federal securities laws to require municipal securities underwriters to have a reasonable basis for recommending any municipal securities. The adopting release reaffirms that, to have a reasonable basis to recommend a security, a municipal underwriter must carefully evaluate the likelihood that a municipality will make the ongoing disclosure called for by the amended rule. The adopting release further states that it is doubtful that an underwriter could form a reasonable basis to recommend a security if the municipality had a history of persistent and material non-disclosure.

SEC and IRS to work more closely on municipal bond enforcement

The Securities and Exchange Commission and the Internal Revenue Service today announced that the two agencies agreed to work more closely to monitor and regulate the municipal bond market and industry.

SEC Chairman Mary Schapiro and IRS Commissioner Doug Shulman today signed a Memorandum of Understanding (MOU) designed to improve compliance with SEC and IRS rules and regulations related to municipal securities. The muni bond market currently totals about $2.8 trillion in outstanding securities and continues to grow in complexity and size.

"Through cooperative relationships like this, we are better positioned to protect investors and ensure they are getting the information they need when investing in municipal securities," Schapiro said.

"This memorandum reflects the commitment both agencies have in using all means possible to ensure the municipal bond market operates in accordance with all the laws that govern it," Shulman said.

The SEC and IRS will work cooperatively to identify issues and trends related to tax-exempt bonds in the municipal securities industry and to develop strategies to enhance performance of their respective regulatory responsibilities. To support this effort, the two agencies will work through a standing Tax Exempt Bond/Municipal Securities Committee to discuss policy, procedures and compliance issues.

The SEC and IRS will also share information as appropriate regarding market risks, practices and events related to municipal securities, among other things. In addition, the two agencies will collaborate on educational and other types of outreach efforts.

SEC muni office to seek outside experts

The Securities and Exchange Commission wants to hire outside municipal market experts, including traders and investment bankers, to work in its reconstituted municipal and public pension fund enforcement unit, Elaine Greenberg said Friday.

Greenberg, an associate regional director in the SEC’s Philadelphia office who is heading the new unit, said in an interview that the commission is just beginning the process of staffing up the unit, which was formally created in January along with four other specialized enforcement units. The new units will create a much more structured and rigorous for process SEC officials to pursue muni cases.

Greenberg could not say how large the unit will become, though its deputy chief is Mark Zehner, a regional municipal securities counsel who also works out of the Philadelphia office.

Greenberg told securities attorneys gathered here for the annual Practising Law Institute’s “SEC Speaks” conference that despite the size and importance of the muni market, it is “very thinly regulated,” and one of few methods of policing it is through an enhanced enforcement response using the SEC’s antifraud authority.

To that end, she said, the new enforcement unit will focus on developing strong cases about particular conduct, “cases that will have an impact on the behavior of market participants and will have a high deterrent effect.”

Closely mirroring comments she made last month when the new unit was formally announced, Greenberg said: “Through the unit we plan to build a comprehensive municipal securities and public pension enforcement program where we will develop the case law and legal precedent through the high-impact cases that we bring.”

She added that the SEC staff will “actively seek the market activities that pose the greatest risk of harm to investors and are indicative of potential violations.”

She said the unit will be focused on five areas of misconduct: offering and disclosure fraud; tax or arbitrage-driven misconduct; pay-to-play and public corruption violations; public pension accounting and disclosure violations; and valuation and pricing fraud.

SEC requires muni underwriters to reveal campaign aid

Municipal securities underwriters will have to disclose contributions to political campaigns in support of state and local government bond proposals under a rule approved by the U.S. Securities and Exchange Commission.

The requirement, intended to curb possible conflicts of interest, was proposed by the Alexandria, Virginia-based Municipal Securities Rulemaking Board, which sets policy for the $2.8 trillion U.S. municipal bond market. Bond elections allow local residents to approve or reject the issuance of debt.

The disclosures will allow “the public and regulators to monitor dealer contributions to bond ballot campaigns” with the aim of “reducing pay-to-play practices in the municipal securities market,” the SEC said in an order signed yesterday by Deputy Secretary Florence Harmon.

Underwriters in some states help school districts and other municipal borrowers win voter approval for bonds and then seek to be hired as underwriters. The new requirement will apply to so-called in-kind election services as well as to direct cash contributions. The MSRB already restricts campaign contributions by underwriters to elected officials who control their hiring.

MSRB notice

The Securities and Exchange Commission has approved amendments to Rules G-37 and G-8 to require the disclosure of certain contributions to bond ballot campaigns made by dealers, municipal finance professionals, their political action committees, and non-MFP executive officers on MSRB Form G-37, and to require dealers to create and maintain records of non-de minimis contributions to bond ballot campaigns. The amendments become effective on February 1, 2010.

SEC hearing on municipal underwriting

Open Meeting on Wednesday, July 15, 2009 at 10:00 a.m., in the Auditorium, Room L-002.

The subject matter of the Open Meeting will be:

The Commission will consider a recommendation regarding amendments to Rule 15c2-12 ("Rule") under the Securities Exchange Act of 1934 ("Act"), concerning the responsibilities of a broker, dealer, or municipal securities dealer acting as an underwriter in a primary offering of municipal securities and interpretive guidance intended to assist municipal securities issuers, brokers, dealers and municipal securities dealers in meeting their obligations under the antifraud provisions of the Act.

MSRB Files Disclosure Proposals Bond Buyer, July 14, 2009

SEC Rule 15c2-12

Background:

On July 15, 2009, the SEC approved proposed amendments to its Rule 15c2-12 (Rule). The SEC has proposed that these amendments, in their final form following public comment, will become effective the third month following the approval of the final changes to the Rule. These proposed amendments are the first significant overhaul of the Rule since the base version, which was adopted in 1989, was amended in 1994 to include secondary market disclosure requirements. These amendments will have significant implications for municipal issuers and borrowers of the proceeds of municipal bonds. The effects of these amendments are outlined in this alert.

Rule 15c2-12 provides the basic framework for secondary market disclosure by issuers and borrowers in the municipal bond market. The SEC lacks statutory jurisdiction over municipal issuers, other than limited, but significant, jurisdiction and oversight that derives from anti-fraud laws, including SEC Rule 10b-5. As a consequence, the SEC's approach to regulating secondary market disclosure by municipal issuers and the borrowers of the proceeds of municipal bonds is to impose mandates on broker-dealers, in their various roles as underwriters, placement agents, and remarketing agents, to conduct their business and discharge their general securities law obligations in a manner consistent with Rule 15c2-12.

The Rule has two basic requirements. First, it obligates underwriters to obtain and review offering documents for municipal securities (if available) and file them with the Municipal Securities Rulemaking Board (MSRB).1 Second, it obligates underwriters and remarketing agents to ensure that issuers and borrowers have in place contractual obligations for the benefit of bondholders to prepare and file annual reports and financial information, and notices of the occurrence of certain described events (referred to as “listed events”) with the MSRB, through its Electronic Municipal Market Access (EMMA) system. A few categories of issuers and types of securities are currently exempted from the application of the Rule.

The timing of the proposed amendments is notable. The announcement of the amendments occurred at substantially the same time that the SEC and MSRB have pending other regulatory actions that also would serve to increase the quality and quantity of disclosure, and as legislators and regulatory agency leaders are increasingly criticizing the lack of jurisdiction over disclosure by municipal issuers. The announcement of the amendments also follows on the heels of the MSRB's recent implementation of its EMMA system.

Public comments by organizations as diverse as the National Federation of Municipal Analysts, the Investment Company Institute, and the Government Finance Officers Association have increasingly questioned the existing quality of disclosure. At the same time, the public policies surrounding exemption versus registration also continue to fuel the debate. Moreover, SEC Commissioner Mary Schapiro has delivered testimony and offered public statements that recommend legislative action toward removing or modifying the exemption in order to improve transparency in the municipal securities market.

In addition, the SEC recently announced changes in its enforcement division, which include the creation of a national enforcement unit specializing in municipal securities and public pensions. All of these developments must be considered in the context of the recent global financial crisis and recession, both of which have predictably resulted in the current political environment. This environment has led to intensified discussion surrounding the transparency and adequacy of disclosure in the municipal marketplace, which may lead to more substantial regulatory and statutory protection for investors and consumers beyond the proposed changes to the Rule described in this alert.

Thus, while the amendments to Rule 15c2-12, if adopted, will clarify and increase disclosure obligations, the likely investor demand for more frequent and improved quantity and quality of disclosure, together with the increasing level of public debate on the subject, will impose more pressure upon issuers and borrowers to enhance their current secondary market disclosure practices.

U.S. probe lays out bid fixing

The Justice Department’s antitrust investigation has found dozens of firms and individuals conspired for at least six to eight years to secretly control the bidding for municipal bond investment and other contracts in more than 250 transactions, according to documents filed with a federal court in Manhattan.

The department has identified 25 entities and 30 individuals as co-conspirators in the scheme, Rebecca Meiklejohn, the department’s lead antitrust attorney in the case, told Judge Victor Marrero, of the U.S. District Court for the Southern District of New York, in a recent five-page letter that included several exhibits.

Meiklejohn did not name the individuals and firms, but included along with the Feb. 17 letter a list of transactions dating from July 20, 1998, through June 24, 2004, that she indicated were allegedly affected by the bid-rigging.

Bloomberg and other news organizations reported Friday that a document filed with the court Wednesday, but later sealed at the request of the firms, listed JPMorgan Chase & Co., Lehman Brothers Holdings Inc., and UBS AG among more than a dozen firms involved in the conspiracy.

The documents were filed in the Justice Department’s case against Beverly Hills-based investment broker CDR Financial Products Inc. and three of its current and former officials.

A federal grand jury indicted the firm, its founder David Rubin, its former financial officer Zevi Wolmark, and vice president Evan Andrew Zarefsky last October on criminal antitrust, wire fraud and other charges stemming from the alleged conspiracy to rig bids for municipal investment and derivatives contracts for undisclosed kickbacks disguised as fees. They pleaded not guilty in November. A trial has been scheduled for next year.

Documents filed earlier this year as part of plea agreements that the Justice Department reached with other former CDR officials cite transactions affected by bid-rigging schemes through November 2006, when the federal officials raided CDR and at least two other investment brokers.

In her Feb. 17 letter to Marrero, Meiklejohn said that, during its investigation, the federal government received recorded conversations from eight financial institutions, grouped by employee and identified by date and time of call. Some of the convervsations are for a period of only a few months, while others span several years.

In addition, the government has roughly 100 interview reports from seven current or former CDR employees as well as approximately 2,000 tape-recorded conversations from third parties, in which the government has identified a CDR employee as one of the speakers, she said. It also has data seized or otherwise obtained from CDR.

The testimony at the trial “will establish, in essence,” that CDR and its three current and former officials “secretly manipulated and controlled the bidding for contracts involving the proceeds of municipal bonds and other related contracts, to favor particular providers and that this conduct cheated the municipal issuers that were CDR’s clients and the Internal Revenue Service,” Meiklejohn told Marrero.

The trial has been scheduled for Feb. 7, 2011, but at a status conference held in the district court Friday, lawyers for the defendants pushed for a later trial date, complaining they will have difficulty examining the massive amount of data they were given by the Justice Department.

They said that “buckets” of information on the 250 deals contain 125 million pages and 670,000 audio recordings. They also pointed out the department itself has been reviewing the information for seven years and still is not finished.

Meiklejohn argued they do not need to read every page. In most cases, a word-search would be enough to find what they were looking for, she said.

Marrero said the defense’s concerns were “wrapped in a fair amount of hyperbole.” Still, he expressed sympathy, and suggested he might be willing to push back the February trial date by no more than a month or two. The next status conference is scheduled for May 14.

Meiklejohn described the contents of one of the “buckets” of information in her Feb. 17 letter to Marrero. It contained evidence related to some single-family mortgage revenue bonds, Series D, that were issued by the Utah Housing Corp. in 2001. The issuer had two investment agreements for which CDR handled the bidding on Aug. 7, 2001, Meiklejohn said.

The bucket, she said, contains evidence showing Zarefsky speaking to an investment provider, about the time the bids were due. Though Zarefsky was supposed to be brokering a competitive bid for the investment contract, he tells the provider, “I can actually probably save you a couple of bucks here.” He tells the provider he can lower the rates he initially quoted.

Bond documents for the transaction show that Lehman Brothers was the senior underwriter for the transaction and that Lehman Brothers Financial Products, Inc. was the “interest rate contract” provider.

4th guilty plea in bid-rigging case

NEW YORK -(Dow Jones)- A former financial services company employee pleaded guilty Wednesday to conspiracy and fraud charges in a bid-rigging and price- fixing scheme in the municipal finance market, prosecutors said.

In a statement, the U.S. Department of Justice's Antitrust Division said Mark Zaino pleaded guilty to two counts of conspiracy and one count of wire fraud.Zaino is the fourth person to plead guilty in the matter and has agreed to cooperate with prosecutors in the investigation.

In a charging document known as a criminal information filed Wednesday, prosecutors alleged Zaino engaged in a bid-rigging conspiracy from October 2001 to March 2006, in which Zaino and other co-conspirators agreed in advance on who would be the winning bidder for investment agreements sought by public entities issuing municipal bonds.

By the way, the company in question is most likely UBS:

The government contends that CDR Financial Products Inc. coordinated the bid-rigging scheme. In October, a grand jury indicted the firm, its founder David Rubin, former chief financial officer Zevi Wolmark, and vice president Evan Andrew Zarefsky. The firm and the three men deny they did anything illegal.

As part of the conspiracy, Zaino acted as a broker of investment agreements, and co-conspirator providers designated in advance which provider would be the winning bidder for certain GICs brokered by UBS.

The firm’s name was not identified in court filings or in October’s indictment, in which UBS is identified only as “Financial Institution A.”Market participants noted that Zaino worked as a vice president for CDR, then known as Chambers, Dunhill, Rubin & Co., prior to his job at UBS, which he began in spring 2001.

Three other former CDR employees have pleaded guilty to criminal charges and have agreed to cooperate with investigators. They are Matthew Adam Rothman and Douglas Alan Goldberg, former CDR vice presidents, and Daniel Naeh, who has not worked for the firm in years but was living in Israel and acting as a bidding agent on muni deals.A spokesman for UBS was not immediately available to comment.


"Several large financial institutions are in settlement talks with the Securities and Exchange Commission to resolve investigations into the awarding of municipal investment contracts, people familiar with the matter said.

UBS AG and Bank of America Corp. are among a few firms negotiating settlements with SEC staff, these people said.

A UBS spokesman declined to comment. A BofA spokeswoman said, "We don't comment on communications with regulators but continue to cooperate." The SEC didn't respond to a request for comment. Any settlement would need to be approved by the SEC commissioners.

The negotiations come as the three-year-old investigation culminated with federal indictments Thursday against three executives of CDR Holdings, a Beverly Hills, Calif., broker, as well as CDR itself. The company worked with municipalities to find managers to invest proceeds raised in debt offerings.

The indictment, filed in U.S. District Court in Manhattan, alleges the CDR executives rigged the auctions to select certain investment advisers and at times received kickbacks from those advisers. The cities, states and municipalities were paid inferior interest rates compared with what they would have earned if the bidding were fair, the government alleges.

Lawyers for the individuals and the company denied the allegations. The Justice Department's inquiry is continuing.

The SEC has been working side by side with the Justice Department in the investigation, which began in November 2006 with a raid on the offices of CDR and two other auction brokers.

Last year, a number of firms and individuals received Wells notices, in which the SEC informs targets of a probe that the staff intends to recommend filing charges. UBS and Bank of America previously disclosed they each received Wells notices.

In 2007, BofA reached a "leniency agreement" under which the government said it wouldn't file criminal antitrust charges against the bank in exchange for its cooperation with the probe. BofA also agreed to pay $14.7 million to the Internal Revenue Service over "the company's role in providing guaranteed investment contracts and other agreements."

GE Funding Capital Market Services Inc., a subsidiary of General Electric Co.'s GE Capital, also disclosed in SEC filings that it received a Wells notice in "connection with the bidding for various financial instruments associated with municipal securities by certain former employees of GE FCMS." In GE's 2008 annual report, the company said its unit disagreed with the SEC staff recommendation and was in discussions of a "potential resolution."

It isn't clear if GE is among the firms negotiating a settlement. GE declined to comment.

The indictment filed Thursday describes transactions between municipalities and CDR and unnamed participants. In at least two bid auctions coordinated by CDR, the government refers to Provider B, "which was a group of separate financial services entities that were controlled by or were part of a company headquartered in Connecticut," according to the complaint. Two people familiar with the matter said Provider B is a GE entity.

In one instance, involving bonds issued in 2005 by a state housing agency, the CDR executives allegedly provided information about competing bids to an official from Provider B, which emerged as the winning bidder, according to the indictment. Provider B gave the state agency an artificially low return because it reduced its rates based on knowing what other bidders were offering, according to the indictment.Several large financial institutions are in settlement talks with the Securities and Exchange Commission to resolve investigations into the awarding of municipal investment contracts, people familiar with the matter said.

UBS AG and Bank of America Corp. are among a few firms negotiating settlements with SEC staff, these people said.

A UBS spokesman declined to comment. A BofA spokeswoman said, "We don't comment on communications with regulators but continue to cooperate." The SEC didn't respond to a request for comment. Any settlement would need to be approved by the SEC commissioners.

The negotiations come as the three-year-old investigation culminated with federal indictments Thursday against three executives of CDR Holdings, a Beverly Hills, Calif., broker, as well as CDR itself. The company worked with municipalities to find managers to invest proceeds raised in debt offerings.

The indictment, filed in U.S. District Court in Manhattan, alleges the CDR executives rigged the auctions to select certain investment advisers and at times received kickbacks from those advisers. The cities, states and municipalities were paid inferior interest rates compared with what they would have earned if the bidding were fair, the government alleges.

Lawyers for the individuals and the company denied the allegations. The Justice Department's inquiry is continuing.

The SEC has been working side by side with the Justice Department in the investigation, which began in November 2006 with a raid on the offices of CDR and two other auction brokers.

Last year, a number of firms and individuals received Wells notices, in which the SEC informs targets of a probe that the staff intends to recommend filing charges. UBS and Bank of America previously disclosed they each received Wells notices.

In 2007, BofA reached a "leniency agreement" under which the government said it wouldn't file criminal antitrust charges against the bank in exchange for its cooperation with the probe. BofA also agreed to pay $14.7 million to the Internal Revenue Service over "the company's role in providing guaranteed investment contracts and other agreements."

GE Funding Capital Market Services Inc., a subsidiary of General Electric Co.'s GE Capital, also disclosed in SEC filings that it received a Wells notice in "connection with the bidding for various financial instruments associated with municipal securities by certain former employees of GE FCMS." In GE's 2008 annual report, the company said its unit disagreed with the SEC staff recommendation and was in discussions of a "potential resolution."

It isn't clear if GE is among the firms negotiating a settlement. GE declined to comment.

The indictment filed Thursday describes transactions between municipalities and CDR and unnamed participants. In at least two bid auctions coordinated by CDR, the government refers to Provider B, "which was a group of separate financial services entities that were controlled by or were part of a company headquartered in Connecticut," according to the complaint. Two people familiar with the matter said Provider B is a GE entity.

In one instance, involving bonds issued in 2005 by a state housing agency, the CDR executives allegedly provided information about competing bids to an official from Provider B, which emerged as the winning bidder, according to the indictment. Provider B gave the state agency an artificially low return because it reduced its rates based on knowing what other bidders were offering, according to the indictment.

Muni issuers say 120 days isn’t sufficient for disclosure

"State and local governments borrowing in the $2.72 trillion municipal bond market say they can’t file annual reports within 120 days of yearend.

The U.S. Securities and Exchange Commission, attempting to make municipal disclosure more like the corporate market, proposed in July that issuers voluntarily file audited financials within 120 days. Those making that deadline would be identified to investors on the Municipal Securities Rulemaking Board’s Electric Municipal Market Access Web site as taking steps to speed up disclosure.

More than 80 percent of the 21 responses borrowers and their associations filed with the SEC said a 120-day standard is unworkable because accountants are unavailable and the time is inadequate to assemble necessary information. Under current rules, issuers decide how long they have to report to investors, which means it often takes investors at least six months to get annual audited financials.

“The 120-day standard is simply unattainable,” wrote the Portland, Oregon, chief administrative officer, Kenneth Rust, and debt manager, Eric Johansen. “There are not a sufficient number of independent auditors available to conduct the auditing function within the 120-day period.”

Investors and SEC officials including Chairman Mary Schapiro have said investors need more information because of the risk tied to the rising volume of municipal bond defaults. They increased to $7.77 billion in 2008 from $349 million in 2007, according to the Distressed Debt Securities Newsletter, which monitors defaults. So far this year, $4.05 billion of municipal debt hasn’t met its terms...

...Under U.S. securities law, the federal government can’t require municipal bond issuers to disclose. The SEC requires banks that sell or underwrite municipal securities to contract with issuers to provide limited disclosure. The MSRB makes the rules, which are enforced by the SEC and Financial Industry Regulatory Authority, which oversees securities dealers.

There hasn’t been much enforcement of current disclosure rules, according to DPC Data. The firm found in a study last year that about one-fourth of issuers failed to file required disclosure for three or more years."

MSRB

See more information here Municipal Securities Rulemaking Board.

MSRB proposes rule to reduce "flipping"

At a meeting today and tomorrow in Philadelphia, the Municipal Securities Rulemaking Board plans to discuss proposed rule changes that would dictate the priority of retail and other customer orders in primary offerings, as well as where the board stands on its push to provide rating changes over its EMMA site.

MSRB executive director Lynnette Hotchkiss said there is “widespread agreement” by the 15-member board on the priority of orders proposal, which aims to ensure there is broad distribution of an issuer’s securities and that dealers honor an issuer’s definition of the retail order period.

At the same time, the proposal, which is pending before the Securities and Exchange Commission, would give dealers flexibility to get the best price for issuers while imposing record-keeping requirements “to allow an auditor to go in to reverse-engineer the deal and nail people if they didn’t abide by priority of orders or issuers’ desires or didn’t have appropriate disclosures,” Hotchkiss said in a brief interview this week.

“It’s a very complicated issue … but I don’t think the controversy is on the main substantive points,” she said. “Sometimes the board is simply arguing about the fact that this sentence doesn’t look quite right.”

Market participants who asked not to be identified contend that the proposed record-keeping requirements are crucial because the Financial Industry Regulatory Authority had to abandon an informal inquiry into abusive “flipping” last year when its investigators found there were no records to review.

Flipping generally occurs when dealers or institutional investors purchase bonds and then immediately resell them to retail investors at higher prices. Industry groups generally panned the proposal in comments filed with the SEC earlier this year, though some are seeking clarification of specific provisions.

"The municipal bond market’s regulator today proposed rule changes to curtail flipping of new bond issues, where the securities are sold to selected buyers during the underwriting and “shortly thereafter” reappear for sale at higher prices.

Some institutional investors claimed that underwriters and their related accounts “buy bonds in the primary offering for their own account even though other orders remain unfilled,” the Municipal Securities Rulemaking Board said in a statement today. The board is an industry self-regulatory group dominated by securities dealers.

The board proposal would require underwriters to “give priority to customer orders over orders for its own account” or from affiliates. It wouldn’t prohibit sales to related accounts, though underwriters “shall have the burden of justifying that such allocation was in the best interests of the syndicate” and in accord with principles of “fair dealing,” the board said in a draft interpretive notice.

Large increases in bond prices immediately after new issues go on sale has become common enough to raise objections from some banks, as well as institutional investors who spoke to the rulemaking board.

The board’s announcement doesn’t mention complaints by issuers, who incur extra costs if bonds are sold at lower prices and higher interest rates than needed.

“The proposed changes help make the case for competitive rather than negotiated bond sales,” said Robert Doty, president of American Government Financial Services, a Sacramento, California-based adviser to issuers."

Network of buyers "flipping" muni bonds

Source: Taxpayers Lose as Flippers Profit in Muni Bonds: Chart of Day Bloomberg, August 10, 2009

"Almost all secondary market sales of new municipal issues occur within the first 30 days of pricing, with a network of buyers reselling the bonds to make quick profits getting them into the hands of individual investors.

The CHART OF THE DAY, taken from the Municipal Securities Rulemaking Board’s 2008 Fact Book, depicts this pattern of new municipal bond trades.

Underwriters sell the bonds in large blocks or amounts to so-called favored institutional investors, such as mutual funds, who in turn sell them to other buyers, who sell them to individuals, the “retail” crowd. Traders, money managers, bond issuers and the former head of the Municipal Securities Rulemaking Board have all commented on how intermediate buyers profit by marking up bonds and reselling, or “flipping” them to individuals.

Municipal bonds are not well-placed to final investors by this system, said Christopher “Kit” Taylor, who for almost 30 years was executive director of the MSRB, the market’s self- regulatory organization.

“There is an unhealthy relationship between the bond funds and the dealer community,” said Taylor, now a consultant based in Alexandria, Virginia. “I have long suspected that dealers throw money at the funds by selling them new-issue securities in blocks and then slowly buying them back at up-prices for sale to retail.”

James C. Cusser, a former portfolio manager and municipal bond analyst for 30 years, who recently completed his masters degree in education at Harvard University, observed, “The biggest/best buyers take advantage of the nature of the illiquid muni market with the help of their best friends in the world.”

The same happens in the taxable bond market, Cusser, previously a fund manager at Waddell & Reed Inc., in Overland Park, Kansas, said. “But the price differences are slimmer and the potential profit is less certain.”

EMMA disclosure system

The Electronic Municipal Market Access system, or EMMA, is a comprehensive, centralized online source for free access to municipal disclosures, market transparency data and educational materials about the municipal securities market.

EMMA was established to increase the broad comprehensive access to vital disclosure and transparency information in the municipal securities market.

EMMA provides investors with key information about municipal securities, free of charge. The information on EMMA is presented in a manner specifically tailored for retail, non-professional investors who may not be experts in financial or investing matters. EMMA is the sister to the SEC's corporate disclosure system, EDGAR.

EMMA is maintained by the Municipal Securities Rulemaking Board (MRSB).

EMMA expanded July 1

EMMA’s continuing disclosure service will begin accepting such voluntary continuing disclosures effective July 1, 2009.

MRSB Notice of continuing disclosure launch

Such voluntary continuing disclosures will be in addition to continuing disclosure documents described in Exchange Act Rule 15c2-12 and other disclosure documents specified in continuing disclosure undertakings, but not specifically described in Rule 15c2-12, that are currently accepted by the pilot phase of the EMMA continuing disclosure service.

Thus, beginning on July 1, 2009, the continuing disclosure service of EMMA will accept submissions of, and make publicly available through the EMMA web portal, the following categories of continuing disclosure documents:

Financial/Operating Data

Rule 15c2-12-Based Financial/Operating Data

  • Annual financial information concerning obligated persons
  • Audited financial statements for obligated persons if available and if not included in the annual financial information
  • Notice of failure to provide annual financial information on or before the date specified in the continuing disclosure undertaking
  • Additional/Voluntary Financial/Operating Data
  • Quarterly/monthly financial information
  • Change in fiscal year/timing of annual disclosure
  • Change in accounting standard
  • Interim/additional financial information/operating data
  • Budget
  • Investment/debt/financial policy
  • Information provided to rating agency, credit/liquidity provider or other third parties

consultant reports

  • Other financial/operating data

Event-based disclosures

Rule 15c2-12 Material Event Notices

  • Principal and interest payment delinquencies
  • Non-payment related defaults
  • Unscheduled draws on debt service reserves reflecting financial difficulties
  • Unscheduled draws on credit enhancements reflecting financial difficulties
  • Substitution of credit or liquidity providers or their failure to perform
  • Adverse tax opinions or events affecting the tax-exempt status of the security

modifications to rights of security holders

  • Bond calls
  • Defeasances
  • Release, substitution or sale of property securing repayment of the securities
  • Rating changes

Additional/voluntary event-based disclosures

  • Amendment to continuing disclosure undertaking
  • Change in obligated person
  • Notice to investors pursuant to bond documents
  • Communication from the Internal Revenue Service
  • Tender offer/secondary market purchases
  • Bid for auction rate or other securities
  • Capital or other financing plan
  • Litigation/enforcement action
  • Merger/consolidation/reorganization/insolvency/bankruptcy
  • Change of trustee, tender agent, remarketing agent, or other on-going party
  • Derivative or other similar transaction
  • Other event-based disclosures

Voluntary Disclosure specifics

There is no obligation upon any issuer or obligated person to make a submission of any voluntary continuing disclosure document.

The categories of voluntary disclosure listed above are for the convenience of submitters and users of such documents and do not represent the MSRB’s opinion as to the appropriate items of disclosure with respect to any specific municipal security.

The availability of such categories does not imply or create an obligation to make any such disclosures, and it will not be uncommon for one or many of the categories to be inapplicable to any particular security.

Further, the nature of the specific documents submitted for a particular category may vary widely. The MSRB believes that various factors appropriate to the particular facts and circumstances of a municipal security transaction should be assessed by issuers, obligated persons and their agents in coming to a decision on whether to make a voluntary submission of continuing disclosure to EMMA, regardless of the categories listed above, to the extent such parties are not otherwise obligated to make such disclosures.

With respect to the submission process through EMMA, the various categories of continuing disclosure described herein will be organized to differentiate between categories of items specified under Rule 15c2-12 and additional or voluntary categories not specifically identified under Rule 15c2-12.

In most cases, submitters will be able to index a single submitted document into multiple applicable categories, including categories under both Rule 15c2-12 Disclosures and Additional/Voluntary Disclosures.

Only those categories for which submissions have been made for a particular security will be displayed on the EMMA web portal page for such security. Over time, the MSRB may combine two or more categories, may divide any category into two or more new categories or subcategories, or may form additional categories for purposes of indexing documents submitted in the “other financial/operating data” or “other event-based disclosures” general category, as appropriate, based on the types of documents received.

Municipal securities markets

2010 market size and ownership

"...The size of the municipal market reflects its significance to the economy. In 2009, there were approximately $2.8 trillion of municipal securities outstanding. Much of that amount is held directly or indirectly by retail investors. Individuals directly hold about 35 percent of the outstanding municipal securities, and another 34 percent is held by money market funds, mutual funds, and closed end funds on behalf of primarily retail investors.

But, the municipal market is not solely the province of buy-and-hold investors. Trading in this market has been substantial. In 2009, almost $3.8 trillion of long and short term municipal securities were traded in over 10 million transactions..."

2009 muni trade data from the MSRB

The Municipal Securities Rulemaking Board (MSRB) today released its 2009 Fact Book, an annual sourcebook that analyzes trading data and statistics for the $2.8 trillion municipal bond market. The Fact Book includes analysis on nearly every trade reported to the MSRB by municipal securities dealers in the last five years and provides key municipal market statistics unavailable elsewhere.

This year's Fact Book includes for the first time interest rate resets information and trading statistics for auction rate securities and variable rate demand obligations. The MSRB began collecting this data in 2009. Also new to this year's Fact Book are lists of the most actively traded municipal securities and trading volume for newly issued securities.

The MSRB, which regulates municipal securities dealers, collects and disseminates official data about the municipal securities market as part of its mission to protect and educate investors. The MSRB makes municipal trade data available free of charge on its EMMA website. Daily and historical summaries of trade data based on security type, size, sector, maturity, source of repayment and coupon type are housed in EMMA's Market Statistics section. An electronic version of the MSRB 2009 Fact Book also is available free of charge on EMMA and at www.msrb.org.

Muni rating downgrades accelerate

Ratings for 279 state and local- government tax-backed bonds were reduced in 2009, up from 81 the previous year, as the recession cut tax collections and strained budgets, Moody’s Investors Service said.

Including bonds backed by revenue, such as those of hospitals and housing authorities, seven ratings were raised for every 10 that were reduced in the municipal market, the lowest ratio in at least 20 years. Ratings fell for 300 revenue debt issuers, up from 133 the prior year, Moody’s said.

The trend toward weaker credit quality was spread through the municipal market, and most ratings cuts were attributable to the worst economic recession since the 1930s, the rating company said.

“We expect negative trends to continue for the next 12-18 months” even though some economists report the recession is lifting, the report said.

Ratings reductions for three states -- California, Illinois and Arizona -- boosted the value of downgraded tax-backed bonds to $199.8 billion, the most in at least two decades. Including revenue-backed issues, $256.3 billion of debt was reduced, or about 9 percent of the $2.8 trillion municipal market.

The results aren’t part of Moody’s plan to overhaul its 27,000 municipal ratings to make them more comparable with corporate and sovereign bonds. That effort was postponed in 2008, and “Moody’s expects to provide guidance on the status” this quarter, said John Cline, a spokesman for the New York-based company.

Moody’s said ratings improved in 2009 for 320 tax-backed state and local-government issuers with $27.1 billion of debt, led by school districts in Texas. Revenue bond ratings rose for 64 issuers with $13.1 billion of bonds.

California’s $72 billion of general obligation and lease- backed bonds, the most of any state, were reduced to Baa1 from A1 during the year. Illinois, with $24 billion of debt, was cut to A2 from A1 with a negative outlook, and Arizona to A1 with a negative outlook from Aa3, affecting $1.8 billion.

Bond Buyer "Advance Refunding Calculator"

The Bond Buyer and Andrew Kalotay Associates are pleased to announce a new feature for our online users - a refunding calculator designed to help issuers make decisions related to advance refunding deals by factoring in the value of the call option embedded in their existing deals. Based on Kalotay's proprietary valuation algorithms and supported by data from Mergent Technologies, Municipal Market Advisors, and BondDesk Group, the calculator allows issuers or their professional advisors to retrieve real bonds, and evaluate the attractiveness of various refunding scenarios.

Munis prove resilient to fiscal pain

The $2,800bn municipal bond market, a key source of finance for US local governments, has had a banner year even as fiscal pressure mounts and lawmakers brace for more, painful belt tightening in 2010.

After multiple rounds of spending cuts, states are expected to face more than $350bn in deficits in the years 2010 and 2011, according to the Center on Budget and Policy Priorities. Yet municipal bonds this year are posting a totalreturn of nearly 15 per cent, which is the third best year in the past 20, according to a Merrill Lynch index.

"It is a testament to people's belief that munis are fundamentally safe," says Matt Fabian, managing director at Municipal Market Advisors, a research group.

Historically, the rate of default for "munis" has been a fraction of that for corporations for two main reasons: bond payments are high in the pecking order of bills for governments, typically ranking above vendors and even public assistance, and governments can raise taxes for debt service on general obligation bonds if revenues run short.

The market has benefited from lower supply this year thanks to federal subsidies for local governments to sell taxable debt, known as Build America Bonds, outside the traditional tax exempt muni market.

But demand has been strong, in spite of a steady flow of news about lay-offs, IOUs and shuttered schools, senior centres and prisons as governments struggle with falling tax revenues.

In the latest sign of growing trouble, on Tuesday, Moody's Investors Service cut its rating on $24bn in debt issued by the state of Illinois by one notch to A2, citing recurring deficits, concerns about cash and a chronically underfunded pension system.

Illinois is now the second-lowest rated state after California, which is rated Baa1. Its bonds fell, sending yields higher. Data from Thomson Reuters MMD put Illinois 10-year debt at 3.70 per cent from 3.55 per cent at the end of last week.

Also this week, New York Governor David Paterson said the state was withholding a percentage of payments to local school districts and governments to prevent it from ending December more than $1bn in the red. Its 10-year debt yields about 3 per cent.

Adding to the gloom, the UCLA Anderson School of Management forecast that unemployment in California will stay in the double digits to 2012. The state's 10-year debt yields roughly 4.30 per cent.

But yields in the broader municipal bond market have fallen even as public finances have steadily worsened across the country. Yields on top-rated 10-year debt are only about 2.70 per cent near a historical low hit earlier in the year, according to Thomson Reuters MMD.

In 2010, municipal bond issuance is expected to rise 8 per cent to a record $450.5bn, a survey by the Securities Industry and Financial Markets Association (Sifma) shows.

"Despite fiscal difficulties at the state and local levels, the strong issuance forecast underscores the market's appetite for municipal bonds," says Randy Snook, executive vice-president, business policy and practices at Sifma.

But investors' nerves - as well as long-standing assumptions on municipal finance - could be tested as governments are forced to make tough choices with less money.

"The key risk is that depleted cash due to sustained declines in revenue [taxes and other charges] won't be sufficient on a timely basis to cover high spending requirements that are politically difficult to cut as well as the growing burdens of fast rising liabilities like pensions," says Richard Ciccarone of McDonnell Investment Management.

"Yields that are too low won't cover the risk that market prices fall due to downgrades, as well as in more extreme cases, debt payments that are interrupted."


Citigroup leads muni underwriting

Citi experienced great difficulties throughout the financial crisis but in the municipal world it was business as usual. The firm took top honors for municipal underwriting in each year of the tumultuous decade, capturing 14.4% of the market overall, according to data from Thomson Reuters.

Click here to see 2009 Rankings

Annual rankings show that Citi ran the books on 399 issues totaling $58.1 billion in 2009, giving the New York-based bank a 14.3% share of the market. The number of deals Citi closed fell 22% compared to 2008 but overall issuance sizes were larger and that allowed Citi to increase volume by 4.3%.

A close second in the overall rankings was Bank of America Merrill Lynch, which captured 13.6% of the market on 513 issues totaling $55.4 billion.

Impressive as that is, it doesn’t match 2008 when — acting as separate units before announcing the merger in September of that year — B of A and Merrill controlled 15.7% of the market share on 695 issues totaling $60.6 billion. Together that outweighs Citi’s share in 2008, giving B of A Merrill the top spot in Thomson Reuters’ chart, but as the merger didn’t officially take effect until Jan. 1, 2009, Citi never actually got knocked from its high ground.

In any case, last year Citi was a top-10 player in each municipal sector, but it was three particular areas that helped the firm retain its title.

Citi was senior manager on 97 general purpose deals worth a total of $22.7 billion in the year — 115% more than in 2008 — accounting for 17.7% of the market. In transportation, the firm managed 50 deals worth $10.0 billion, accounting for 20.5% of the market. And in health care, it absorbed 20.2% of the issuance pie, leading 83 deals amounting to $9.0 billion.

JPMorgan remained in third place as it ran the books on 387 issues for a total of $46.9 billion. The firm improved its market share to 11.5% in 2009 from 9.8% in 2008.

The 2009 rankings show that the biggest firms continue to dominate the market, in largely the same order.

Outside the merger of Merrill and Bank of America, it can be seen that each of the top nine firms in 2009 was in the top 10 in 2008. The only top-10 player of 2008 not to make it into the ranks last year was UBS Securities LLC, which mostly exited the public finance business in 2008, and as a result sank from the seventh spot in 2008 to 15th last year.

Indeed, for all the talk of large firms scaling back their operations and giving room for smaller firms to climb the ranks, the top eight firms accounted for 71.1% of all underwriting in the year, in line with the decade’s average of 71.9%.

However, there were some notable climbers. The most obvious was Ramirez & Co., which jumped to 20th place as it managed $2.7 billion of issuances last year from the 60th spot in 2008 when it managed $307 million.

The trend of the dominant few extends to the Build America Bonds program, which hit the market in late March as part of the Obama administration’s stimulus package.

In Thomson Reuters’ new category tracking stimulus-related issuances — 95% of which are BABs, while 4% are qualified school construction bonds and 1% are recovery zone economic development zone bonds, qualified zone academy bonds, or clean renewable energy bonds — Goldman, Sachs & Co. took command. The firm controlled 14.7% of the stimulus market on 36 issues totaling $9.9 billion. More than a quarter of all Goldman underwriting was for BABs, placing it fifth in the overall senior manager ranks.

Looking at the 2009 municipal market by sector shows two dramatic movements. Issuance of general purpose bonds advanced a whopping 59.7% in the year as underwriters managed 3,548 deals worth $128.3 billion. In contrast, housing-related issuance fell 40.4% from $17.4 billion in 2008 to $10.4 billion last year.

Meanwhile, in terms of selecting an underwriter, competitive deals rose nearly 9% in 2009, but the clear choice for issuers remains negotiated underwriting, which increased by 4.3% and accounted for 85.7% of all transactions.

The number one underwriter of negotiated deals was Citi with 15.6% of the market share. In competitive deals, by contrast, Citi placed only fifth as rival B of A Merrill grabbed 17.2% of the deals.

The top spot for small-issue underwriters — $10 million or less — went to Milwaukee-based Robert W. Baird & Co., which climbed from seventh in 2008. On 436 separate deals totaling $1.773 billion, Baird seized 7.8% of the market, bumping Morgan Keegan & Co. to second place with 6.2% of the market.

RBC Capital Markets, which was the top underwriter for small deals for 16 consecutive years through 2006, fell one spot to third in 2009 with a 5.7% market share.

In the rankings of financial advisers, Public Financial Management Inc. ranked first for each year of the decade. In 2009 it advised on 829 deals worth a total of $51.5 billion and controlled 16.4% of the market.

Notable movements in the financial adviser category include NW Financial Group LLC, which climbed from 113th in 2008 to 13th last year. The New Jersey-based firm advised on 17 issues totaling $3.8 billion in 2009, compared with just $264 million in 2008. In the other direction, Morgan Keegan fell from the top 10 to number 20 — the firm advised on 83 deals totaling $2.47 billion, about half of the prior year’s total.

Among issuers, the largest by far in 2009 was California. The Golden State sold $23.2 billion of munis last year, almost three times more than in the previous year. With 24 separate issues, the state took up 5.7% of the total market, far more than the number-two participant, the Dormitory Authority of the State of New York, which captured 1.8% of the market with $7.5 billion of deals.

California’s largest sale was so big it eclipsed the cumulative issue amounts from every other issuer in the country except one. On April 22, the state came to market with a $6.86 billion taxable deal — the fourth-largest single issuance in history. The transaction was priced by a syndicate led by Goldman, JPMorgan, Barclays Capital, and Morgan Stanley.

In the decade as a whole, California issued $90.4 billion in 105 separate deals — almost double the $48.8 billion issued by New York City, which ranked as the second-largest issuer in the decade.

Muni underwriting fees at 8 year high

Source: Muni underwriting fees at 8 year high Bond Buyer, August 21, 2009

"The fees issuers pay to bankers to underwrite municipal bonds are higher then they’ve been for eight years, as the financial crisis heightened risk and decimated competition in the industry.

State and local governments this year are paying underwriters an average of $6.46 for every $1,000 borrowed, according to Thomson Reuters.

That payment, known as the underwriting spread, is up sharply from last year’s $4.83 average spread.

The last time issuers paid higher fees was 2001.

Underwriters and other market participants cite a number of factors for the fatter spreads, some on the supply side of the equation and some on the demand side."

...Created under the stimulus act, BABs (Build America bonds) allow municipalities to sell taxable munis and in lieu of the traditional tax exemption receive a subsidy from the federal government equal to 35% of the interest costs.

Issuers have sold $26.75 billion of BABs since the launch of the program in April, according to Bloomberg LP.

Bankers have charged more to underwrite BABs — an average of $8.04 per $1,000 face, compared with $6.27 for other munis, according to Thomson.

The crisis also knocked out a pillar of demand in municipals.

Earlier this decade, a group of hedge funds was buying munis to arbitrage what they perceived as irrationally high yields on long-term munis.

The arbitrage strategy required a complex hedging system using derivatives. The hedges assumed a stable relationship between tax-exempt yields and certain taxable yields, like the London Interbank Offered Rate or Treasury yields.

The flight to safety last year disrupted these relationships and many of the funds were forced to liquidate their positions after the hedges failed. As a result, a major contingent of buyers for munis vanished.

“They were really driving the demand side of the equation,” Yosca said of the municipal arbitrage funds. “That buy-side component seems to be a thing of the past now, so you’ve got to find alternative places to put the bonds.”

Large future strains seen

"The U.S. municipal bond market will become a "casualty" of massive deficits the 50 states likely will chalk up once the federal stimulus program ends, New York's lieutenant governor said on Wednesday.

"I believe that these States of the United States will face deficits the year after the stimulus ends of $300 to $500 billion a year," said Richard Ravitch, the financial guru who helped craft New York City's fiscal bailout in the mid-1970s.

Predicting this would be a major news story next spring, Ravitch added "and you may begin to see cracks in the municipal bond market well before that -- it's an inexorable casualty of unfundable state deficits."

"Banks are falling like autumn leaves around this country and nobody is projecting any significant growth for 2010," he said at New York University's Rudin Center for Transportation Policy & Management.

New York state gets one-fifth of its tax dollars from Wall Street and its meltdown has spawned budget gaps that Ravitch put at $3 billion to $4 billion this year, and $7 billion to $8 billion next year.

Congress enacted a two-year nearly $800 billion federal stimulus package, and when it ends, Ravitch said New York's state's deficit could shoot to $15 billion to $18 billion.

A total of 48 states already have deficits in their current fiscal years that add up to $179 billion, according to the Washington, D.C.-based think tank, the Center on Budget and Policy Priorities. For details, see: [ID:nNnN20445385].

The nearly $3 trillion U.S. municipal bond market, comprised of debt sold by states, counties, cities, hospitals, museums, turnpikes and the like, was pummeled during the height of last year's credit crisis but analysts investors have taken comfort from the historically note rate of defaults.

Experts said defaults would only become a problem if the recession was lengthy though they saw warning signs. Detroit schools this year mulled a bankruptcy, a step already taken by California's Vallejo, partly because its public payroll was so costly. [ID:nN13577598] and [ID:nN28339331].

Ravitch underscored one of the big problems facing New York: generous health benefits granted public workers. "It's creating a political conflict of some significance," he said.

Another problem is Medicaid, the state-federal health plan for the poor, elderly or disabled. New York has had trouble clipping its escalating costs, partly because it lets middle-class families collect this benefit instead of requiring them to spend more of their assets the way other states do."

Short term market strained

Short-Term Municipal Market Continues to Show Strains, Fed Says Bloomberg, July 21, 2009

The market for municipal bonds whose interest rates reset daily, weekly or monthly exhibited “substantial strains” in the first half of 2009, in contrast with long-term municipal debt, according to a report to Congress by the Federal Reserve.

Local governments, nonprofits and hospitals that issued the debt, which offers borrowers short-term interest costs on longer-term bonds, are paying more for bank backstops that ensure bondholders can redeem their investment, the Fed’s Monetary Policy Report said. The cost to insure these variable- rate demand obligations, or VRDOs, is also increasing.

“Some municipalities were able to issue new VRDOs, but many lower-rated issuers appeared to be unwilling or unable to issue this type of debt at the prices that would be demanded of them,” the report said.

Even as U.S. states and local governments are facing the biggest declines in tax revenue since World War II, the Federal Reserve is opposing a U.S. House Financial Services Committee proposal to guarantee repayment of variable-rate bonds.

The Federal Reserve has “important misgivings” given “the potential for decisions about the provision of credit to states and municipalities to assume a political dimension,” said David Wilcox, deputy director of the Fed’s research and statistics division in May 21 testimony to the House Financial Services Committee."

Falling tax collections

State tax collections during the first quarter of 2009 showed the sharpest decline on record, dropping 11.7 percent overall, according to a new Rockefeller Institute report.

The decline in personal income tax was particularly sharp, with an unprecedented decline of 17.5 percent, as the weakened economy continued to hammer state budgets.

Forty-five of the 50 states experienced revenue drop-offs. Early figures for the second quarter reveal continued, broad worsening of fiscal conditions for states. Local tax revenue, meanwhile, remains relatively steady.

California municipal issues


"... Included in the bills he [Schwarzenegger] signed is a measure sought by investment banks to expand so-called “negotiated,” or no-bid, municipal bond sales and a bill requiring more disclosure by placement agents seeking to win pension fund business from state and local governments.

The no-bid bond bill, which supporters said was needed after the Wall Street credit crisis made competitive auctions more difficult, allows California’s 58 counties and 480 cities to sell general-obligation debt through negotiated offerings, in which the municipality decides in advance which banks will market it.

In competitive offerings, banks submit their lowest interest-cost bids on an advertised day. Current law allows negotiated sales by cities and counties for lease-backed and revenue bonds and by school districts.

The increasing use of no-bid deals in public finance has ignited debate over whether it saddles taxpayers with higher costs, since banks may set higher interest rates on bonds when they know they have a deal in advance. Banks have an incentive to raise interest rates on such securities, because it makes debt easier to sell, limiting the risk that underwriters will be left holding unsold bonds.

Bid sales saved issuers 17 to 48 basis points, “on average and all else equal,” according to a study published in the Winter 2008 issue of the Municipal Finance Journal. A basis point is 0.01 percentage point.

The no-bid measure passed by unanimous votes in both chambers of the Legislature. It was supported by the League of California Cities and California State Association of Counties. The California Association of County Treasurers and Tax Collectors opposed it.


Source: California Lawmakers Approve More No-Bid Bond Deals Bloomberg, August 28, 2009

"California lawmakers passed a bill sought by investment banks that would expand no-bid bond sales, which supporters say are needed after the Wall Street credit crisis made competitive auctions more difficult.

The bill allows California’s 58 counties and 480 cities to sell general obligation debt through negotiated offerings, in which the municipality decides in advance which banks will market it. In competitive offerings, banks submit their lowest interest-cost bid on an advertised day. Current law allows negotiated sales by cities and counties for lease-backed and revenue bonds and by school districts.

“With the way the economy and the bond markets were, it was difficult to get people to participate in the competitive bid process,” said Pedro Salcido, a legislative consultant to Assemblyman Ed Hernandez, a Los Angeles-area Democrat who carried the bill.

The municipal bond market has been upended by the two-year financial crisis, which caused the collapse of the largest bond insurance companies and the Wall Street arbitrage funds that once snapped up the local securities they guaranteed. Five of the largest 12 municipal underwriters have been bought or exited the market since 2007.

The measure passed by unanimous votes in both chambers of the Legislature. It now goes to Governor Arnold Schwarzenegger, a Republican. It was supported by the League of California Cities and California State Association of Counties. The California Association of County Treasurers and Tax Collectors opposed it.

Higher Costs

Schwarzenegger spokesman Mike Naple said the governor hasn’t yet taken a position on the legislation.

The increasing use of no-bid deals in public finance has ignited debate over whether it saddles taxpayers with higher costs, since banks may set higher interest rates on bonds when they know they have the deal in advance. Banks have an incentive to raise the interest rates on such securities, because it makes them easier to sell, limiting the risk that underwriters will be left holding unsold bonds.

More than a dozen academic studies show competitive bidding saves taxpayers money -- 17 to 48 basis points “on average and all else equal,” according to one study published in the Winter 2008 issue of the Municipal Finance Journal. A basis point is 0.01 percentage point. The savings mean $1.7 million to $4.8 million less in interest payments on the life of a 10-year bond.

“This is just another very clever scheme,” Lee Buffington, treasurer of San Mateo County, said in a telephone interview. “It’s the good ol’ taxpayers that are getting screwed here.”

Divergent Bids

Proponents of negotiated deals, including the underwriters and some of the financial advisers on whom municipalities rely, say these transactions allow more time to find investors and get the lowest cost.

James Cervantes, a banker with Stone & Youngberg in San Francisco and the vice chairman of the group that backed the legislation, said competitive sales have produced more widely divergent bids than in the past, which illustrates banks’ lack of confidence in their ability to resell bonds soon after buying them in an auction sale

“It tells you there’s less confidence in where the market is,” he said. “That’s a function of the disruption that hit our market, just like the broader capital markets, since September.”

Most Since 1977

That’s why AAA rated issuers have a better chance of selling bonds at competitive sales than do lower-rated issuers, Cervantes said. “Our thinking was it makes sense to acknowledge that and let local jurisdictions decide what made sense for them,” he said.

Local governments and not-for-profits have negotiated most sales since 1977. Last year, such issues accounted for 86 percent of the $391.3 billion of new municipal bonds, according to Thomson Reuters data. Nationally, $35.8 billion, or 15 percent, of the municipal bonds sold this year were sold by competitive auctions among underwriters, according to data compiled by Bloomberg.

Underwriting spreads for the first half of 2009, according to Thomson Reuters, show negotiated rose to $6.33 per $1,000 face value, the highest since full year 2001. Competitive rose to $6.91, the highest since 1996. All bonds rose to $6.38, the highest since 2001.

The California bill repeals an existing provision of a state law requiring annual interest and principal payments on debt issued by a municipality to be structured so that the maximum annual debt service payment does not exceed the minimum annual amount by more than 10 percent.

“This is just a rip off of taxpayers,” Buffington said."

Federal regulatory response

"The staff of the Securities and Exchange Commission has expressed its belief that California’s recently-issued IOUs are “securities” under federal securities law. As such, holders of these IOUs and those who may purchase them are protected by the provisions of the federal securities laws that prohibit fraud in the purchase or sale of securities."

The MSRB notes in particular its Rule G-30, which requires dealers to effect purchases and sales of municipal securities at fair and reasonable prices based on the dealer’s best judgment of their fair market value, and also requires dealers to charge fair and reasonable commissions in connection with brokered transactions. Dealers must deal fairly with customers and must not take advantage of a customer’s need for cash by offering to purchase registered warrants at deeply discounted prices that are below what could reasonably be viewed as their fair market value.

More details on a dealer’s fair pricing obligations are included in a January 26, 2004 MSRB notice.

Published quotations regarding offers to buy or sell registered warrants must be bona fide and must be based on the dealer’s best judgment of fair market value under MSRB Rule G-13, and advertisements regarding registered warrants are subject to MSRB Rule G-21.

MSRB Rule G-17 requires that, at or prior to the time of entering into a transaction, dealers must disclose to their customers material information about the transaction that is known to the dealer or is otherwise available from established industry sources. More details on this disclosure obligation are included in a March 20, 2002 MSRB notice.

Dealers buying, selling, or trading the registered warrants would be expected to know and to disclose to customers material information about the registered warrants available from, among other sources, the websites of the California State Controller and the California State Treasurer.

In particular, dealers selling registered warrants to customers must ensure that purchasing customers are aware of the terms on which the registered warrants are expected to become payable (including information about the contingent nature of the stated maturity date, the potential for early redemption, and any contingencies concerning tax exemption of interest on the warrants).

In addition to making the necessary disclosures to customers, dealers are required by MSRB Rule G-19 to consider such information when determining whether recommended purchases or sales of the registered warrants are suitable for their customers.

Dealers also would be expected to provide their customers with documentation of the transaction that may be necessary for customers to receive payment on the registered warrants upon presentment to the California State Treasurer’s Office. Further, dealers must provide confirmations of their transactions to customers in compliance with MSRB Rule G-15.

The MSRB understands that the registered warrants may not have CUSIP numbers, and, if so, transactions in the warrants need not be reported to the MSRB’s Real-Time Transaction Reporting System under MSRB Rule G-14.

Even so, dealers must maintain all appropriate records of their transactions with customers under MSRB Rule G-8, and such records are subject to examination by the appropriate regulatory agencies. Employees of dealers who engage in sales and trading of the registered warrants must have passed an examination qualifying them to engage in such activities -- either the Series 7 exam or a more specialized exam such as the Series 52."

WA state cuts bond offering size

Washington state will cut the size of its tax-exempt bond offering by 36 percent after borrowing costs rose from a 42-year low.

The state that is home to Microsoft Corp. will shrink a planned $875.7 million offering tomorrow to $563.9 million, said Chris McGann, a spokesman for the treasurer’s office in Olympia. Washington is rated AA+ by Standard & Poor’s, Aa1 by Moody’s Investors Service and AA by Fitch Ratings.

State and local government bonds extended their declines today, pushing higher benchmark yields tracked in a daily survey by Municipal Market Advisors of Concord, Massachusetts. Yields on 10-year debt rose 6 basis points, the most since June 10, to 3.16 percent. A basis point is 0.01 percentage point.

Morgan Stanley Smith Barney said dealers are becoming less willing to take on inventory that may undermine a profitable year. Issuers plan to sell about $8.5 billion of fixed-rate bonds, down from the eight-week high of $11 billion last week, based on data compiled by Bloomberg.

Washington originally planned to sell $1.38 billion of general obligation securities this week. In addition to the tax- exempt debt tomorrow, Goldman Sachs Group Inc. and JPMorgan Chase & Co. are to market $500 million in taxable Build America Bonds Oct. 15, according to data compiled by Bloomberg. The issues will fund capital improvements and refinance debt.

Rebounding yields may reduce the savings states including Hawaii and Mississippi get from refinancing taxpayer-supported debt. Investors balked at low payouts while anticipating a Federal Reserve rate increase. The Bond Buyer 20 index of 20- year general obligation securities climbed to a three-week high of 4.06 percent after reaching 3.79 percent, the lowest since 1967, on Oct. 1.

“It’s pretty obvious, interest rates are not going to stay at zero in any kind of economic recovery,” said Joseph Deane, who oversees the $4.9 billion Legg Mason Western Asset Managed Municipals Fund at Western Asset Management in New York. The fund’s five-year average return of 5.7 percent is best among its peers, according to Bloomberg data....

...The municipal market “got overstretched,” Deane said. “Everybody was just grabbing every bond they could get.”

The gains were driven by investors pouring a record $65.5 billion into municipal bond mutual funds, according to data cited in an Oct. 9 report by George Friedlander, municipal strategist at Morgan Stanley Smith Barney in New York, a joint venture of Citigroup Inc. and Morgan Stanley. The previous full- year record was $42.9 billion in 1993.

Size of municipal securities market

"A glimpse at the Bond Buyer's summary of Thomson Reuters data from the first half of the year shows how much the market has changed (highlights only):

Comparing January to June, 2008 and 2009 (Percent Change)

New Issuance

  • Total new issuance -16.2%
  • First quarter -0.1%
  • Second quarter -25.6%
  • Tax-exempt -15.8%
  • Taxable +56.8%
  • New money +1.6%
  • Refunding -36.9%
  • Combined -32.6%

Method of Sale

Negotiated -15.8% Competitive -16.6% Private placements -60.5%

Security

Revenue -28.3% General obligation +12.0%

Structure

Fixed-rate +15.3% Variable rate (short put) -79.6% Variable rate (long/no put) -9.8%

Bank-qualified +90.6%

With bond insurance -62.1% With letters of credit -73.8% With standby purchase agreements -94.5%

General statistics

Outstanding par value: $1.8 trillion

  • Market cap of Wilshire 5000 – about $10 trillion
  • Number of securities outstanding – 1.3 million
  • Total NYSE, NASDAQ, AMEX securities - about 8,500
  • Number of muni issuers – 51,000
  • Number of corporate issuers – about 7,300

--Volume of new issues

Long-term issuance

  • 2002 - $359 billion (14,400 offerings)
  • 2003 - $384 billion (15,039 offerings)
  • 2004 - $360 billion (13,601 offerings)
  • 2005 - $408 billion (13,939 offerings)

Short-term issuance

  • 2002 - $72.4 billion (3,545 offerings)
  • 2003 - $69.8 billion (3,425 offerings)
  • 2004 - $56.6 billion (3,276 offerings)
  • 2005 - $50.5 billion (3,270 offerings)

Daily trading activity

  • Issues traded (CUSIPs) - 11,000
  • Less than 1% of outstanding
  • Par traded - about $10 billion
  • $81 billion traded in major US equity markets
  • Number of trades - about 30,000
  • About 4 billion shares traded on major equity markets


Risks of muni bonds

Source: MRSB Notice 2009-38 (JUNE 30, 2009)

As some state and local jurisdictions struggle with the fall-out from current economic conditions, investors should be aware that:

  • Defaults, while quite rare, do occur.
  • Information about financial problems that affect the bond’s issuer has not always been readily available to investors.
  • The current market value of a municipal bond may be hard to determine because many municipal bonds trade infrequently.
  • A bond’s market value may change for reasons having nothing to do with the financial condition of the issuer, such as a change in interest rates.
  • In cases where an issuer has purchased bond insurance or some other protection feature, the higher overall credit rating of a bond may be more reflective of that protection than of the financial condition of the issuer.

Investors considering an investment in municipal bonds should bear in mind that no two municipal bonds are created equal—and they should carefully evaluate each investment, being sure to obtain up-to-date information about both the bond and its issuer.

Default rates of muni bonds

The primary concern of all bond investors is whether they will ultimately get their money back. This is especially the case with municipal bond investors: Municipal bond investors willingly accept lower yields compared to other fixed income investments primarily due to the safety record of municipal bonds.

When an issuer fails to live up to the payment obligations of a particular bond issue, the bond is considered to be in default. If an issuer misses an interest payment or fails to pay back the principal on the scheduled date, this does not necessarily mean that the investor will not get their money back. With municipal bond defaults, investors many times get most of their money back. The amount of money that the investor receives from a bond investment that has defaulted is known as the recovery rate.

The 3 largest ratings agencies, Standard & Poor’s, Moody’s, and Fitch Ratings, have each produced a case study examining default risk and recovery rates of municipal bonds. We will summarize the findings from each of these studies below. Investors may also click on the following links to directly access the three studies.

Fitch Ratings:

Standard & Poor’s:


Moody’s

Summary:

Each of the 3 ratings agencies assigns ratings to various municipal bond issues as a part of their business; the ratings classify credit risk just as an individual’s credit score is used to assess credit risk. Generally, a municipal issuer such as a school district or a state pays the rating agency to have an upcoming bond issue rated. Just as with individuals, the better the credit rating, the cheaper it is for the issuer to borrow money. The ratings agency analyzes the various risk factors associated with a particular bond issue and the issuer. Based on the rating agencies assessment of the risk factor, the issuer is assigned a credit rating (Aaa, AAA, Baa, etc…).

In its 2003 study, Fitch Ratings concluded the following:

Based on two studies released in 1999 and 2003, Fitch reviewed all municipal bond defaults between 1987-2002. Based on the results of its findings, Fitch Ratings came to conclusion that the different types of municipal bonds fit into three categories of default risk….Class 1, Class 2, and Class 3.

Class 1, the safest category, is comprised of most local and state general obligation bonds. Class 1 also includes general obligation and revenue bonds issued by established authorities with no competition or natural monopolies in essential public services. Altogether, Class 1 includes the following types of bond issues:

  • State general obligation bonds
  • Local general obligation bonds
  • Local school districts
  • Appropriation-backed and tax-backed debt of local and state governments
  • Public power distribution
  • Water and Sewer Authorities
  • Public higher education
  • Single family housing

In this category of issuers, the cumulative default rate between 1987-2002 was .24%; the comparative default rate during this same period for AAA-rated global corporate debt was .43%.

Class 2 from a default perspective is comprised of public service enterprises providing essential services, but where the enterprise is subject to competition or fluctuation in demand. The bonds issued in Class 2 are generally revenue bonds providing services such as:

  • Public power generation (as opposed to distribution which is in category 1)
  • hospitals
  • waste disposal
  • private colleges and universities
  • military and state multifamily housing
  • museums and stadiums
  • airports and seaports
  • toll roads with established traffic patterns

In Class 2, the five-to-fifteen year cumulative default rate between 1987-2002 was .70%; the comparative default rate during this period for AA-rated corporate bonds was .73%. The types of bonds in Class 2 have a similar default rate to AA-rated corporate bonds according to the Fitch Ratings study.

In Class 3, the issuers are comprised of entities that compete with private enterprises and have highly unpredictable or volatile revenue streams. These types of issuers include:

  • Nursing homes and continuing care retirement facilities
  • Industrial development bonds
  • Local Multifamily housing
  • Toll roads without established traffic patterns
  • Tobacco bonds
  • Tribal gaming

In Class 3, the five-to-fifteen year default rates of 3.65% are comparable to 3.97% for ‘BBB+’ rated corporate bonds.

An interesting assessment made by the Fitch study is that Fitch expects that even if the ratings are similar, a single A-rated airport bond will have a higher expected default rate than a state or school district also rated single A. This should lead an investor to place an emphasis on the type of bond issue being considered in addition to the bond’s rating. Municipal bonds rated similarly can have vastly different characteristics. According to this Fitch study, the type of issuer and issue is as important as the credit rating when evaluating the likelihood of future default.

Recovery Rates:

When a municipal bond defaults, the investor generally will still receive some money back from their investment; this is known as the recovery rate. In some cases and with certain types of issuers, the recovery rate can be as high as 100% or 100 cents on the dollar. In some cases, a temporary default on interest payments can be cured with some late payments from the issuer and the issuer can resume servicing the debt once again according to schedule.

Comparing different categories of municipal bonds to corporate bonds maybe accurate in terms default rates, but the recovery rates are another matter according to Fitch. Corporate bonds have an average recovery rate of about 40% or 40 cents on the dollar.

Fitch in this study creates 6 classes of recovery rates. The first 3 classes are assumed to have recovery rates of 100% of the principal.

Class 1:

  • State GO debt
  • State sales tax backed debt

In the event of default in this class, Fitch assumes a recovery rate of 100% of the principal amount with an assumed loss of 1-years interest.

Class 2:

  • Local general obligations
  • Local tax-backed debt
  • Transit authorities
  • Water, sewer, gas
  • Public colleges and universities, GO and tuition-revenue backed
  • Single family housing

For Class 2, Fitch assumes a recovery rate of 100% of the principal with 2-years of missed interest payments.

Class 3:

  • local and state leases, certificates of participation, and appropriation-backed
  • Airports and seaports
  • Power distribution

For Class 3, Fitch’s model assumes a recovery rate of 100% with 5-years of missed interest payments.

Class 4:

  • Waste disposal
  • Nursing homes and retirement facilities
  • Private colleges and universities
  • Established Bridges and roads
  • Museums and stadiums
  • Public power generating facilities
  • State and local multifamily housing

For class 4, Fitch’s model assumes a recovery rate of 90%.

Class 5

  • military housing
  • start-up and new bridges and toll roads

For Class 5, Fitch’s model assumes a recovery rate of 70%.

Class 6:

  • private prison
  • stadiums
  • student housing
  • private university bonds backed by auxiliary revenues
  • hospitals
  • tribal gaming

For Class 6, Fitch assumes 40% recovery rates.

Fitch doesn’t explicitly address where many other types of bonds such as industrial development bonds, tobacco securitizations, etc..

Conclusion:

The way an investor would use this information is by being aware of the default risk and recovery rates of various categories of municipal bonds. Rather than simply relying on a rating or a recommendation, information such as this historical analysis from Fitch Ratings should provide you an additional set of data points in helping you understand the risks of investing in municipal bonds.

Investors should be aware that this is simply one analysis done by Fitch Ratings in 2003 and the information should be considered as an educated opinion based on a historical analysis of municipal bond defaults.

Municipal securities prosecutions

See also muni swaps.

Third guilty plea in muni bond bid rigging national scheme

United States Attorney's Office, Southern District of New York, Contact: (212) 637-2600

WASHINGTON — A third former employee of Rubin/Chambers, Dunhill Insurance Services Inc., also known as CDR Financial Products (CDR), pleaded guilty today to his participation in bid-rigging and fraud conspiracies related to contracts for the investment of municipal bond proceeds and other related municipal finance contracts, the Department of Justice announced. CDR is a Beverly Hills, Calif.-based financial products and services firm.

According to the charges filed today in the U.S. District Court in Manhattan, Douglas Alan Goldberg of Chatsworth, Calif., engaged in separate bid-rigging and fraud conspiracies with companies that provide a type of contract, known as an investment agreement, to state, county, and local governments and agencies throughout the United States. The public entities were seeking to invest money from a variety of sources, primarily the proceeds of municipal bonds that they had issued to raise money for, among other things, public projects. Goldberg also pleaded guilty to one count of wire fraud. According to the plea agreement, Goldberg has agreed to cooperate with the ongoing investigation.

The department said in court documents that CDR was hired by public entities that issue municipal bonds to act as their broker and conduct what was supposed to be a competitive bidding process primarily for contracts for the investment of municipal bonds proceeds. Competitive bidding for those contracts is the subject of regulations issued by the U.S. Department of the Treasury and is related to the tax-exempt status of the bonds.

Goldberg admitted that, as a part of the bid-rigging conspiracy, from at least as early as 1998 until at least November 2006, he and other co-conspirators designated in advance which co-conspirator providers would be the winning bidder for certain investment agreements and submitted or caused to be submitted to CDR intentionally losing bids. According to the court documents, kickbacks in the form of fees that were inflated or unearned were paid to CDR in exchange for assistance from Goldberg and other CDR co-conspirators in controlling the bidding process and ensuring that certain co-conspirator providers won the bids they were allocated.

As a part of the fraud conspiracy, from as early as August 2001 until at least November 2006, Goldberg and others gave a co-conspirator provider information about the prices, price levels or conditions in competitors’ bids, a practice known as a “last look,” which is explicitly prohibited by U.S. Treasury regulations. As a result of the information, the co-conspirator provider won contracts at artificially determined price levels. In exchange for giving the provider information, CDR requested and received kickbacks from the provider and relied on the provider to submit intentionally losing bids when requested on other contracts.

This is the third guilty plea to arise from an ongoing investigation into the municipal bonds industry, which is being conducted by the Antitrust Division’s New York Field Office, the FBI and Internal Revenue Service Criminal Investigation. On Feb. 23, 2010, Daniel Moshe Naeh, also known as Dani Naeh, a former CDR employee, pleaded guilty to bid-rigging and fraud conspiracies and to one count of wire fraud. On March 11, 2010, Matthew Adam Rothman, also a former CDR employee, pleaded guilty to bid-rigging and fraud conspiracies and to one count of wire fraud. The department is coordinating its investigation with the Securities and Exchange Commission, the Office of the Comptroller of the Currency and the Federal Reserve Bank of New York.

On Oct. 29, 2009, CDR along with its owner and president, David Rubin; its former chief financial officer and managing director, Zevi Wolmark, also known as Stewart Wolmark; and its vice president Evan Andrew Zarefsky, were indicted and charged with participating in bid-rigging and fraud conspiracies. The trial for CDR, Rubin, Wolmark, and Zarefsky is scheduled to begin on Feb. 7, 2011.

The bid-rigging conspiracy with which Goldberg is charged carries a maximum penalty of 10 years in prison and a $1 million fine. The fraud conspiracy with which Goldberg is charged carries a maximum penalty of five years in prison and a $250,000 fine. The wire fraud charge with which Goldberg is charged carries a maximum penalty of 20 years in prison and a $250,000 fine. The maximum fines for each of these offenses may be increased to twice the gain derived from the crime or twice the loss suffered by the victims of the crime, if either of those amounts is greater than the statutory maximum fine.

Anyone with information concerning bid rigging and related offenses in any financial markets should contact the Antitrust Division’s New York Field Office at 212-264-0390 or visit http://www.justice.gov/atr/contact/newcase.htm, or the FBI at 212-384-5000.

An ex-CDR Financial Products Inc. worker pleaded guilty to conspiring to rig bidding on investment contracts sold to local governments, prosecutors said.

Daniel Naeh pleaded guilty on Feb 23 in federal court in Manhattan, admitting he engaged in fraud schemes with companies that provide instruments municipalities use to invest the proceeds of bond issues. Naeh, who lives in Israel, agreed to cooperate in the federal probe, the U.S. Justice Department said yesterday in a statement.

CDR, founder David Rubin and two other employees of the advisory firm were indicted in October by a federal grand jury for conspiring to rig bids on investment contracts sold to states, cities and other government agencies. Naeh is first person to plead guilty in the probe, which lasted more than three years and has drawn in dozens of banks including JPMorgan Chase & Co. and Bank of America Corp.

“If I were Rubin and the other guys, I’d be sweating it,” said Christopher “Kit” Taylor, who was the executive director of the Municipal Securities Rulemaking Board, the national regulator of the municipal bond market, from 1978 to 2007. “They get CDR, they get everybody else in the industry.”

CDR and its employees, who ran the auctions for the investment work, awarded deals to favored firms in exchange for kickbacks, according to the indictment. The government alleges that the conspiracy cost taxpayers by allowing the banks to pay below-market rates.

Rubin, former CDR Chief Financial Officer Z. Stewart Wolmark and Evan Zarefsky, a former vice president, have pleaded not guilty.

‘Without Merit’

CDR faces a fine of as much as $100 million, the U.S. has said. The charges are “without merit and in fact, a total fiction based on a lack of understanding of the municipal reinvestment market,” CDR said in a statement on its Web site. Susan Hoffinger, a lawyer for Naeh, didn’t immediately return a call seeking comment yesterday.

Trinity Funding Co., a unit of General Electric Co. and Financial Security Assurance Holdings Ltd., a former subsidiary of Belgian bank Dexia SA, were two unnamed companies that allegedly conspired with CDR to rig auctions, people familiar with the matter said on Nov. 18.

CDR was hired by local governments to conduct auctions for investments purchased with bond proceeds until the money was needed to pay for construction projects or used to retire old bonds as they come due.

From as early as August 2001 until at least November 2006, Naeh gave an unnamed co-conspirator at a bank information about competitors’ bids, the Justice Department said.

Last Look

The practice, known as a “last look,” is prohibited by U.S. Treasury regulations that require states and local governments to get bids from at least three “reasonably competitive providers,” of investment agreements.

According to an antitrust lawsuit filed last year, Naeh shared information about a bid in July 2002 for the Tampa Port Authority in Florida with Dean Pinard, a Bank of America employee. That civil complaint by the Sacramento Municipal Utility District named Bank of America, JPMorgan, UBS AG and other banks as defendants, as well as CDR.

“It’s nice to have friends,” Naeh wrote in an e-mail to Pinard. “We’ll call you in a little bit.” Bank of America won the bid.

University of Tampa

On another deal for the University of Tampa in March 2002, Naeh and Pinard exchanged e-mails about their plans to rig a bid for an investment agreement, according to the utility’s lawsuit, which was moved from federal court in Sacramento, California, to New York.

“Call me on my cell below when you get a Tampa number,” Pinard wrote, according to the lawsuit. The Sacramento utility received the e-mails and descriptions of tape-recorded conversations and other evidence from Bank of America. Pinard didn’t immediately return a phone call seeking comment yesterday.

In February 2007, Bank of America disclosed that it was cooperating with Justice Department’s investigation in exchange for leniency. Shirley Norton, a Bank of America spokeswoman, declined to comment yesterday.

On August 16, 2002, Naeh caused the Missouri Health and Educational Facilities Authority to award an investment agreement to an unnamed firm, according to a court filing. The firm, identified only as ‘Provider A’, was awarded the bid after allegedly agreeing to pay CDR a kickback of $475,000, according to the October indictment.

Kickback

The Missouri agency, which issues tax-exempt bonds for nonprofit hospitals and universities in the state, received an “artificially determined” interest payment on May 31, 2006, because of the kickback, the government said.

Bank of America won the bidding and then made a side deal under which it agreed to make periodic payments to CDR in exchange for an upfront payment from CDR, according to a letter from the U.S. Internal Revenue Service that was disclosed by the city in 2005.

Earnings Diverted

The IRS in 2005 told Atlanta officials that the payment swap may have been used to hide the diversion of investment earnings from the tax-exempt bond proceeds that should have been rebated to the government.

Federal prosecutors have alleged that the firms conspiring with CDR disguised their kickbacks by paying his company to broker swaps with other financial institutions.

The case is U.S. v. Rubin/Chambers, Dunhill Insurance Services Inc., 09-CR-01058, U.S. District Court, Southern District of New York (Manhattan).

Justice Department alleges bid rigging

"A California financial products firm, two of its current executives and a former executive were indicted on Thursday for bid rigging and fraud related to municipal bond contracts, the Justice Department said.The indictments against CDR Financial Products Inc, also known as Dunhill Insurance Services Inc, and the executives come after a three-year investigation that touched some of the biggest names in the nearly $3 trillion municipal bond industry.

A number of California municipal governments have sued CDR Financial alleging bid rigging, said Nanci Nishimura, an attorney at Cotchett, Pitre & McCarthy. The firm is representing Los Angeles and Stockton, Calif., as well as San Diego, San Mateo and Contra Costa counties in lawsuits against CDR Financial."

JPMorgan, Lehman, UBS Named as conspirators in muni bid-rigging

JPMorgan Chase & Co., Lehman Brothers Holdings Inc. and UBS AG were among more than a dozen Wall Street firms involved in a conspiracy to pay below-market interest rates to U.S. state and local governments on investments, according to documents filed in a U.S. Justice Department criminal antitrust case.

A government list of previously unidentified “co- conspirators” contains more than two dozen bankers at firms also including Bank of America Corp., Bear Stearns Cos., Societe Generale, two of General Electric Co.’s financial businesses and Salomon Smith Barney, the former unit of Citigroup Inc., according to documents filed in U.S. District Court in Manhattan on March 24. The papers were filed by attorneys for a former employee of CDR Financial Products Inc., an advisory firm indicted in October. The attorneys, as part of their legal filing, identified the roster as being provided by the government. The document is labeled “list of co-conspirators.”

None of the firms or individuals named on the list has been charged with wrongdoing. The court records mark the first time these companies have been identified as co-conspirators. They provide the broadest look yet at alleged collusion in the $2.8 trillion municipal securities market that the government says delivered profits to Wall Street at taxpayers’ expense.

‘Sufficient Evidence’

“If the government is saying they are co-conspirators, the government believes they have sufficient evidence that they can show they were part of the conspiracy,” said Richard Donovan, a partner at New York-based law firm Kelley Drye & Warren LLP and co-chair of its antitrust practice. Donovan isn’t involved in the case.

The government’s case centers on investments known as guaranteed investment contracts that cities, states and school districts buy with the money they receive through municipal bond sales. Some $400 billion of municipal bonds are issued each year, and localities use the contracts to earn a return on some of the money until they need it for construction or other projects.

Muni pension systems

California group pushes for pension reforms

A group of California taxpayer advocates is aiming to turn a bad run of news for public retirement plans into a pension reform movement in the nation’s biggest state.

They’re pushing a ballot measure that would scale back defined-benefit pension plans for new public workers at both the state and local level. They say their plan would save California governments $500 billion over 30 years.

“You’ve got public safety workers retiring with 24 years of service, retired in six-figure pensions for 35 to 40 years. We can’t sustain it,” said Marcia Fritz, president of the California Foundation for Fiscal Responsibility, a group that’s writing the pension reform ballot measure. “It’s not affordable.”

The group, which was founded by former California Assemblyman Keith Richman, has the support of taxpayer groups and has taken the first steps to put the measure before voters in November 2010. It has requested a title and summary from the California attorney general, which are needed before it could petition to put the measure on the ballot.

The group’s leaders met with Republican Gov. Arnold Schwarzenegger last month in hopes of garnering his endorsement. He hasn’t endorsed the effort yet, though he’s been pushing for pension reform for a while. He unsuccessfully tried to force a less far-reaching set of reforms through the Legislature with a budget package in June.

There’s no denying the run of bad news over the past year. Pension fund investment portfolios have withered even faster than the public budgets that would replenish them. Major local governments like Los Angeles, San Diego and San Francisco are facing sharp increases in their pension contributions to make up for investment losses, just as they are cutting public services to taxpayers.

Fitch Ratings cited Los Angeles’ rising pension obligations as it downgraded the state’s biggest city last month.

The California Public Employees’ Retirement System, the state and the nation’s biggest fund with 1.6 million members, lost $56 billion in the fiscal year that ended June 30. Its assets fell 23% to $181 billion from $237 billion. Fund values have rebounded to $197.6 billion at the end of September.

The fund’s chief actuary, Ron Seeling, made waves in August when he called current benefits “unsustainable.”

Even Democrats like Treasurer Bill Lockyer are warning that the state can’t afford to keep offering pensions and retiree health care benefits that increase endlessly.

“It’s impossible for this Legislature to reform the pension system, and if we don’t, we bankrupt the state,” Lockyer told Democratic state lawmakers on Oct. 22. “And I don’t think we can do it here because of who elected you. You’re just captive of the current environment.”

For the record, Lockyer doesn’t think the state is going to go bankrupt and constantly reminds the municipal bond market that the state’s general obligation bonds get paid first, before other obligations. Spokesman Joe DeAnda says the treasurer was trying to make it clear to lawmakers that current benefits, particularly for retiree health care, are not sustainable.

While Lockyer hasn’t endorsed the pension reform referendum, his spokesman said he’s looking at the measure.

Public employees’ groups say they’re willing to talk about cutting back pension abuses, such as pension spiking, whereby public workers compensation is boosted in the final year of work to make pensions larger. But they have pledged to stop the ballot measure at all costs.

“We’re very, very strongly opposed to it,” said David Low, chairman of Californians for Healthcare and Retirement Security, a labor coalition formed to oppose the measure. “It’s draconian. If you look at the numbers in the initiative, it doesn’t just reform pensions. It dramatically cuts pensions for every new public employee.”

Low said the measure would cut police and firefighter pensions by 35%, teachers by 45% and other employees by 50% or more. Fritz said the measure would offer a uniform, “modest, adequate, fair” defined-benefit pension for all state and local government workers in California.

She said the measure’s main benefit would be forcing pension decisions into the open. Fritz said current benefits are negotiated in closed-door collective bargaining sessions, with unions playing local governments off of each other to secure ever-higher pension benefits.

Her group would reduce benefit levels, increase retirement ages, limit pension benefit calculations to base pay alone, and require that any pension sweeteners be put to a public vote. Under the plan, a police officer or firefighter would get retirement benefits equal to 2.3% of pay for every year of service at age 58. That’s down from 3% at age 50.

Fritz admits her group faces an uphill battle, but she says voters are more likely to scale back benefits than elected officials who are beholden to public workers’ unions.

“In some ways, believe it or not, it’s just easier to go to the voters,” she said. “When we show them what people get and the little amount of work they have to do to get it, as far as the number of years, people tend to be very shocked.”

Low said that the $100,000 pensions publicized on conservative Web sites are rare, going to less than 1% of workers, primarily managers. He said the school bus drivers and cafeteria workers he represents are more likely to get pensions of $10,000 to $20,000 a year.

A Field Poll published in October showed some public support for pension reform. Some 60% of California voters supported capping the amount of pension benefits, while 56% favored replacing pensions with 401(k)-like defined contribution plans that have become common in the private sector.

Low said his group’s polling and focus groups show voters won’t go for the sort of deep pension cuts Fritz is proposing.

“It’s a nonstarter,” he said. “If this thing receives any support at all, we will oppose it with everything in our arsenal.”

GASB multiyear review of pension rules

Source: An Overhaul or a Tweak for Pensions New York Times, August 26, 2009

"After more than three years of deliberations, the board that sets the accounting rules for state and city governments is still far away from issuing a new standard for public pension funds.

What may seem like tedious labors over technical matters can have a large impact on public employees, taxpayers and investors. Many municipalities around the country are grappling with serious shortfalls in their pension funds caused by the recession and other woes.

Since the deliberations began, San Diego’s finances have been rocked by a pension scandal; Vallejo, Calif., has filed for bankruptcy after promising costly benefits; and New Jersey has warned that it lacks the cash to comply with its actuary’s instructions.

The panel, the Governmental Accounting Standards Board, heard impassioned testimony on Wednesday on the need to make public pension numbers more straightforward, more closely mirroring the pension accounting for corporations. But proponents of an overhaul were countered at every step by state officials and others who testified that broad changes were unnecessary and would disrupt budgets by introducing market volatility.

The board, an independent nonprofit organization that sets the accounting standards for governments, has said that the next step will be the publication, by next May, of a “due process document” to offer possible changes in the rules. That will engender a new round of public comment and revisions, and eventually a new pension accounting standard. The process is expected to take several more years.

“I have concerns that these efforts may, in fact, be too late,” one speaker, Diann Shipione, told the board. She said that the existing accounting rules were too loose, allowing “pension mischief” to go on for many years.

“As a result of the fuzziness and imprecision,” she said, “we now have many large systems that are essentially insolvent.”

Ms. Shipione, a former trustee of the San Diego city pension fund, eventually became a whistle-blower, insisting that the fund’s financial reporting was false, constituting securities fraud. After a long legal battle, the Securities and Exchange Commission agreed with her. She is now earning a master’s degree in public administration at the Kennedy School of Government at Harvard.

Ms. Shipione told the accounting board that she thought revisions were needed to make it easier to see when states and cities were falling behind on their pension contributions, which she hoped would prompt them to pump more money into the plans.

But some members of the board took issue with her goals. William W. Holder, one member of the accounting board, told Ms. Shipione that the board’s duty was to write rules that produced accurate and informative financial reports — not to promote desirable activities like funding pension plans more robustly.

“We try to avoid bias in setting accounting standards,” he said. “What we don’t try to do is develop some preconceived notion of what that behavior would be, and then write a standard that would encourage it.”

In the corporate world, the Financial Accounting Standards Board writes the rules for pension disclosures. It also seeks to avoid bias, and also works at a slow, deliberative pace.

But FASB has a great deal more power and independence than its governmental cousin. Its rules are enforced by the S.E.C., and it was given an independent funding source in the post-Enron accounting reforms. The corporate pension accounting rules came under harsh criticism at the beginning of this decade, and the FASB has already issued some revisions. Others are still in the works.

The governmental board, by contrast, must still raise its own money. And because no government agency enforces its policies, it must issue rules that states and municipalities will adopt voluntarily. Six of its seven members work on a part-time basis.

Others who spoke on Wednesday sought to assure the accounting board that its existing rules were sound. They acknowledged that some governments had had pension debacles in the last few years but said that was because they did not follow the rules.

Robert A. Wylie, executive director of the South Dakota Retirement System, said that pension woes were largely absent in his state and that his plan had a well-established funding policy.

Mr. Wylie said South Dakota had the ability to reduce promised benefits when times were tight, something forbidden by statute or constitution in many other states. Because of this flexibility, he said, South Dakota had always been able to keep its contributions in line with its benefits. For a state like South Dakota, he said, the existing pension rules were “very workable.”

“Major changes may add to what would be, in our mind, confusion,” he said.

Questions posed by the board members suggested they were leaning toward making narrow changes in the existing rules, like shortening amortization schedules or reducing the number of actuarial methods that plans may use. They did not seem eager to grapple with the question of which discount rate to use to measure public pension obligations — the biggest issue in the minds of critics of the current rules.

A recent study published by the National Bureau of Economic Research found that the discount rates now in use were masking a pension shortfall of $1.2 trillion at the state level.

The questions from the board members also suggested that they were interested in making public pension funds more comparable to each other. The current accounting rules allow so much flexibility that comparisons can be unfair.

Jeremy Gold, an actuary and economist who testified at Wednesday’s meeting, said he expected that when the new standard was finally issued, it would improve the comparability of pension plans.

“The center of gravity is still in favor of sharper pencils, rather than a whole new way of doing things,” said Mr. Gold, who called for radical changes. “This will make Texas, California and New Jersey all comparable while they go to hell in a handbasket.”

The accounting board will reconvene in Washington on Friday for additional testimony.

Municipal predation

"With the unraveling of the deal for the shadowy American Private Police Force to take over and populate an empty jail in Hardin, Montana, it's pretty clear that the small city got played by an ex-con and his (supposed) private security firm.

But an investigation by TPMmuckraker into how Hardin ended up with the 92,000 square foot facility in the first place suggests that, long before "low-level card shark" Michael Hilton ever came to town, Hardin officials had already been taken for a ride by a far more powerful set of players: a well-organized consortium of private companies headquartered around the country, which specializes in pitching speculative and risky prison projects to local governments desperate for jobs.

The projects have generated multi-million dollar profits for the companies involved, but often haven't created the anticipated payoff for the communities, and have left a string of failed or failing prisons in their wake.

"They look for an impoverished town that's desperate," says Frank Smith of the Private Corrections Institute, a Florida-based group that opposes prison privatization. "They come in looking very impressive, saying, 'We'll make money rain from the skies.' In fact, they don't care whether it works or not."

References


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