[DEBATE] : Rigging the Riggers... Finance Capital Fines

[Riaz K Tayob]

Fines for market rigging are tiny fraction of its profits

Submitted by cpowell on 09:08PM ET Friday, March 16, 2007. Section: 
Daily Dispatches

SEC Allows Auction-Rate
Manipulation With Disclosure

By Darrell Preston
Bloomberg News Service
Friday, March 16, 2007

http://www.bloomberg.com/apps/news?pid=20601103&sid=amVIyWQRrnkI&refer=n...

The Securities and Exchange Commission, after sanctioning Wall Street's 
biggest financial institutions for misdeeds in the $260 billion 
auction-rate market, now lets the same firms manipulate investor 
purchases as long as they disclose their intentions.

Citigroup Inc., Bank of America Corp., and 13 more investment banks get 
inside knowledge of bids when they run auctions to set the interest 
rates on the securities. They can use the information to put in their 
own bids and influence the outcome, even after paying a $13 million fine 
to settle SEC claims about the practices last May.

The difference now is banks have to tell investors that they use inside 
information with a notice like this one by Goldman Sachs Group Inc.: 
"When we submit an order for our own account, we are likely to have an 
advantage over other bidders because we will have knowledge of some or 
all of the other orders placed through us."

The disclosures have safeguarded $650 million in fees that Thomson 
Financial data show the industry reaps each year from selling the 
securities, corporate or municipal debt with interest rates reset 
periodically through auctions. The control that dealers exercise over 
the market may force issuers to pay higher yields or leave investors 
with lower returns.

"You make your point, you collect your money, and everyone goes on as 
they were before," said Richard Lehmann, a registered investment adviser 
in Miami Lakes, Florida, and president of Income Securities Advisors 
Inc., regarding the SEC's action. "That's the way a lot of compliance is."

SEC Chairman Christopher Cox, a former Republican congressman from 
California appointed by President George W. Bush, declined to respond to 
several requests for comment.

Commissioner Paul Atkins, a Republican, had no comment, according to 
Hester Peirce, a member of his staff.

The three other commissioners -- Roel Campos and Annette Nazareth, both 
Democrats, and Kathleen Casey, a Republican -- didn't respond to 
telephone and e-mail messages seeking comment.

SEC spokesman John Nester said in an e-mail that the SEC's decision last 
year "speaks for itself."

Citigroup, Goldman, and the other brokerages settled claims they broke 
laws prohibiting omissions or misstatements in the sale of securities. 
The firms didn't admit or deny wrongdoing in the settlements.

The SEC's May 31 press release describing its cease-and-desist order 
says "each firm engaged in one or more practices that were not 
adequately disclosed to investors, which constituted violations of the 
securities laws," including "allowing customers to submit or change 
orders after auction deadlines"; "having an express or tacit 
understanding to provide certain customers with higher returns than the 
auction clearing rate," and "providing certain customers with 
information that gave them an advantage over other customers in 
determining what rate to bid."

Nester said in his e-mail that the order "did not find rigging, nor was 
rigging alleged."

Paul Kanjorski, a Pennsylvania Democrat who chairs the House 
Subcommittee on Capital Markets, Insurance and Government Sponsored 
Enterprises, said he plans to bring up the matter with House Financial 
Services Committee Chairman Barney Frank, a Massachusetts Democrat.

"I certainly will look at it, and where it's possible to have the 
regulator perform up to standards, I'd certainly rather do that then 
getting involved legislatively," Kanjorski said in an interview. "But 
certainly we have requirements of oversight and it's an issue that we 
should take up. We have to see if it constitutes some conflict of 
interest or violates some law."

Rates on auction-rate securities are reset every seven, 28, or 35 days 
via so-called Dutch auctions, at which investors submit the yield they 
are willing to accept to hold the debt. The lowest yield necessary to 
place all the bonds becomes the rate on the securities until the next 
auction.

SEC officials have said the auction-rate securities market is misnamed. 
"The method by which rates are set for auction- rate securities bears 
little resemblance to a pure Dutch auction process," said Martha Haines, 
the SEC's head of public finance regulation and the official in charge 
of market regulation for the municipal bond market. "There is nothing 
wrong with that so long as it is fully disclosed."

Haines, in a speech to a municipal bond industry conference in 
September, said auction-rate sales shouldn't be called auctions because 
of the dealers' ability to set rates. She suggested calling the bids a 
"managed auction process" or "bidding system." She said issuers and 
investors need to know not just that dealers may intervene to set rates 
but that dealers "commonly" intervene to control rates "with 
considerable frequency."

Investors don't know how many legitimate bids there were at an auction 
or what the range of offers was, so they can't know how much real demand 
there was for the securities, said Joseph Fichera, chief executive 
officer of Saber Partners LLC, a New York-based financial advisory firm.

"There are still serious disclosure issues out there," said Fichera. "If 
they're going to call it an auction, you need a level playing field."

The other firms that settled charges brought by the SEC are Bear Stearns 
Cos., JPMorgan Chase & Co., Lehman Brothers Holdings Inc., Merrill Lynch 
& Co., and two units of Morgan Stanley, all based in New York; 
Toronto-based Royal Bank of Canada; Wachovia Corp., based in Charlotte, 
North Carolina; A.G. Edwards Inc. of St. Louis; Morgan Keegan Inc., 
based in Memphis, Tennessee; Piper Jaffray Cos. of Minneapolis; and 
Suntrust Banks Inc. of Atlanta.

The SEC settlement estimated that brokerages charge 0.25 of a percentage 
point on average to manage the auctions. Based on Thomson's estimate 
that there are $260 billion of such securities outstanding, the firms 
generate fees of $650 million a year. The $13 million fine the group 
paid amounts to 2 percent of the fees.

"We are basically helpless," said Sarah J. Hussey, principal of Weston 
Financial Group in Bridgewater, New Jersey, who sometimes buys the 
securities and sells them when rates are reset too low. "We have to take 
whatever rate is set."

Auction-rate securities, which also include some preferred stock, 
accounted for 8.6 percent of the municipal bond market in 2006, or about 
$32.6 billion of bond sales, according to Thomson. Sellers are attracted 
to the market because it offers an alternative to variable-rate debt, 
while buyers purchase them instead of a money-market account.

States and local governments sell auction-rate debt, as do corporations. 
Borrowers include Washington, D.C., New Jersey's Economic Development 
Authority, and the Brazos Higher Education Authority, a student loan 
provider in Texas.

The Bond Market Association, a New York-based trade group for bond 
underwriters, proposed guidelines last May that would allow banks to use 
information on bids before putting in their own offers. The so-called 
best practices for auction-rate securities "are being worked on," said 
Katrina Keller, spokeswoman for the group, now known as the Securities 
Industry and Financial Markets Association.

Dealers don't have an advantage in auctions because their bids must be 
at the so-called estimated market rate, judged by a broker-dealer to be 
"fair and reasonable," according to the proposed practices, said Mary 
Kuan, vice president and assistant general counsel at the Securities 
Industry and Financial Markets Association, in a written statement.

The SEC appears most interested in preventing failed auctions and 
ensuring there are adequate buyers, said James D. Cox, the Brainerd 
Currie Professor of Law at Duke University in Durham, North Carolina, 
and a securities law specialist.

"The SEC got a victory and the other side got off with limited 
sanctions, so both sides think they're better off," said Cox, who isn't 
related to the SEC chairman.

Brian Steel, a spokesman for New York-based Citigroup, said the bank has 
adhered to the settlement agreement.

"We've complied with the order," he said.

Goldman spokesman Michael DuVally in New York; Merrill spokesman Mark 
Herr; Lehman spokeswoman Kerrie Cohen; JPMorgan spokeswoman Brooke 
Harlow; and Wachovia spokeswoman Christy Phillips declined to comment. 
Shirley Norton, a spokeswoman for Charlotte-based Bank of America, also 
declined to comment. Spokesmen for Bear Stearns, Morgan Stanley, RBC, 
A.G. Edwards, Morgan Keegan, Piper Jaffray and SunTrust didn't respond 
to phone calls seeking comment.

"The lack of transparency is a little off-putting," said Dominick 
Vetrano, who manages $125 million at Clune & Associates in Chicago. "You 
have to get a better yield to make up for the opaqueness."

Vetrano said typical buyers of auction-rate securities are wealthy 
individuals living in states with high income taxes such as California 
or New York. They buy the securities for periods such as three months 
rather than certificates of deposit or individual municipal bonds, which 
can be difficult to find.

For example, Vetrano said a current New York City auction- rate bond 
pays 3.15 percent, compared with 2.90 percent on a standard New York 
municipal money market fund. "Therefore, I am getting the client more 
yield on a very similar product," he said.

The guidelines being worked on by the bond industry group don't specify 
the fiduciary duties of dealers hired by underwriters to handle auctions 
and don't give issuers any way to review the bids to see how the price 
is determined, according to Frank Hoadley, bond finance chief for Wisconsin.

"While there must be a level playing field for all investors to assure 
investors fair treatment, the duty of the broker-dealer is to the issuer 
to achieve the lowest cost of funds," Hoadley, a member of the 
Chicago-based Government Finance Officers Association, wrote in a letter 
last July to the industry group.

Investors also said the proposals don't go far enough in requiring 
securities dealers to separate their dual roles as overseers of auctions 
and buyers of the debt.

"We would like to have more transparency," said Lance Pan, whose Capital 
Advisors Group in Newton, Massachusetts, manages $7.5 billion in cash 
and follows the auction-rate market. "There are not enough hard and fast 
rules."

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