JPMorgan fails to disclose
Charlie Gasparino of Fox Business News seems to have scooped a muniland story yesterday when he reported that JPMorgan had failed to include material facts in a municipal bond offering on which it was the lead underwriter.
Lead underwriters have a special role in muniland. The Tower Amendment, passed in 1975, prohibited the federal government from requiring issuers of municipal debt to make specific disclosures to investors prior to offering securities for sale. Underwriters, however, do not enjoy the same protection, so the law has evolved to make them liable for the contents of the offering document for municipal debt. This requirement is administrated by the Municipal Rulemaking Board through Rule G-17, or the fair-dealing rule.
MSRB’s Rule G-17 is the Ten Commandments of muniland (emphasis mine):
Rule G-17 precludes a dealer, in the conduct of its municipal securities activities, from engaging in any deceptive, dishonest, or unfair practice with any person, including an issuer of municipal securities. The rule contains an anti-fraud prohibition. Thus, an underwriter must not misrepresent or omit the facts, risks, potential benefits, or other material information about municipal securities activities undertaken with a municipal issuer.
Gasparino’s reporting, which seems to be based on sources inside JPMorgan, nails the G-17 violation. He cites the omission of risks related to the Massachusetts state pension in a $469 million general obligation bond offering in May 2011. As the lead underwriter on the deal, JPMorgan carried out an internal study on pension risks but did not disclose those risks within the Massachusetts bond offering document:
Yet, J.P. Morgan didn’t include its pension fund analysis in bond deal disclosure materials that are made to investors, known as the deal’s “official statement,” according to current and former executives at the firm. Case in point: a $469 million bond issue by Massachusetts in May of last year, two months after the pension report was published.
J.P. Morgan was the lead underwriter of the deal, but the disclosure documents didn’t include the report’s dire findings, including the possibility that under one scenario the state must cut spending by 20.1% to fully fund its pensions over the next two decades, raise taxes dramatically or a combination of both.
[JPMorgan spokeswoman] Lemkau wouldn’t deny that the firm failed to include the report’s findings in its official statements, but said that the firm’s disclosures were proper.
From G-17 again:
(v) the underwriter will review the official statement for the issuer’s securities in accordance with, and as part of, its responsibilities to investors under the federal securities laws, as applied to the facts and circumstances of the transaction.
Gasparino goes on to say that the JPMorgan pension fund analysis was made available to 100 of the firm’s clients but not to other investors. According to John Coffee of the Columbia Law School, Regulation Fair Disclosure (Reg FD) specifically exempts municipal securities from equivalent disclosure. This means that investment banks are allowed, by law, to share material non-public information with certain classes of investors and not others. This Reg FD carve-out meant that JPMorgan would not have violated securities laws by sharing its pension study with a select group of clients.
Gasparino gets back to the main point as he closes his piece:
The bigger question may be if by keeping such analysis from investors, J.P. Morgan violated the law. “When it comes down to it it’s the issuer’s official statement,” said Bill Daly, director of government affairs for the National Association of Bond Lawyers.
“But for JPMorgan it’s a judgment call. If the firm knew the municipality had a problem and it wasn’t disclosed, you can make the case that it should be in the” official statement.
A bedrock principle of securities regulation is that underwriters have a duty to disclose material facts to investors. It feels as though JPMorgan is trying to get out ahead of this story, and we might see some regulatory action on this issue soon.
The Political Commentator: Will municipal bonds be the next headwind on the horizon for Jamie Dimon and JPMorgan?