MuniLand

Robert Khuzami: Master distracter

I blogged recently in support of Columbia Law professor John Coffee’s proposal for the SEC to hire outside expert attorneys to prosecute complex cases. He called the performance of the current SEC enforcement division lackluster, and wrote that it is “an overworked, underfunded agency that is subject to severe resource constraints.”

The soon to retire head of the SEC’s enforcement division, Robert Khuzami, blasted Professor Coffee’s idea in the National Law Journal last week with a piece titled “Unfair claims, untenable solution.” The New York Post nicknamed Khuzami the “master blaster” with a “poison pen” for going after Coffee.

In his rebuttal to Coffee, Khuzami lauds the number of settlements the SEC has achieved under his tenure. But the number of settlements under Khuzami and former SEC Chairman Mary Shapiro has actually declined from post-Sarbox-era SEC Chairmen William Donaldson and Chris Cox. NERA Economic Consulting shows this in its recently released SEC Settlement Trends: 2H12 Update (page 19):

Overall, the number of settlements per year declined from 751 in the pre-Schapiro era to 680 in the Schapiro era. The decline was both for settlements with companies and individuals.

However, using settlement data from the entire pre-Schapiro era obscures the fact that the Schapiro era average of 680 settlements per year is virtually unchanged from the average of 682 settlements per year observed in three years immediately prior to the Schapiro Chairmanship.

Should the SEC hire bounty-hunters?

The majority of pundits and market observers have only tuned into the effectiveness of the SEC as financial market regulator since 2008, when the financial system nearly collapsed. So far, criticism has been relatively shallow. But when one of the most influential securities attorneys in America, Columbia University’s John Coffee, weighs in on the effectiveness of the SEC’s enforcement actions, we should all take note. Coffee’s SEC biography gives some background on his preeminence:

According to a recent survey of law review citations, Professor Coffee is the most cited law professor in law reviews in the combined corporate, commercial, and business law field.

And what does Professor Coffee have to say about the efforts of the SEC to prosecute financial market lawbreakers? He wrote on the CLS Blue Sky Blog:

The SEC rounds up muniland’s bad guys

The SEC – the top law enforcer for muniland – has been riding the range. With 17 municipal securities enforcement actions in 2012, the SEC cops have come up with a nice collection of scalps.

The Bond Buyer held a webinar Wednesday on municipal disclosure with John Cross, who heads the SEC’s Office of Municipal Securities, Jay Goldstone, who heads the Municipal Securities Rulemaking Board and various municipal attorneys. It was an excellent summary of muniland disclosure laws, but what I found most interesting was John Cross’ discussion of the top SEC enforcement actions in muniland for 2012. Rounding up the bad guys. Here are the top four enforcement actions according to Cross:

1) The General Electric and Wells Fargo bid-rigging cases: In the case of General Electric, the U.S. Justice Department prosecuted criminal charges. Reuters reports:

Sallie Krawcheck should not run the SEC

The New York Times reported on Wednesday that Sallie Krawcheck, formerly of Citi and Bank of America, is the leading contender to be named chairman of the Securities and Exchange Commission. Let’s hope that President Obama comes to his senses and names someone more fit to the post. From the Times:

With Ms. [Mary] Miller withdrawing, Sallie L. Krawcheck, a long-time Wall Street executive, has emerged as a potential front-runner. Over the last year, she has become a familiar face in Washington, making the rounds with lawmakers to discuss consumer issues.

In my time working with the agency over a number of years I have been involved in multiple rounds of rule writing about the regulation of credit rating agencies. There are some particular kinds of personality traits that are necessary to herd and motivate an agency of over 1,000 lawyers. Based on my reading of her record, Ms Krawcheck is not qualified to take on this role.

Pay to play beyond Goldman Sachs

The SEC caught a big fish in muniland that was clearly breaking the “pay-to-play” rules. Pay-to-play is when municipal bond underwriters give contributions to politicians to win underwriting business. Reuters has the story:

Goldman Sachs Group Inc will pay more than $14 million to settle federal and state charges after it violated “pay-to-play” rules, in a case involving campaign contributions to former Massachusetts gubernatorial candidate Timothy Cahill.

Neil Morrison, a former vice president in Goldman’s Boston office, worked extensively on Cahill’s 2010 campaign while also soliciting underwriting business from the Massachusetts treasurer’s office, the Securities and Exchange Commission said. Cahill at the time was Massachusetts state treasurer.

Make way for new muniland disclosure and market structure

The SEC released its long-awaited report on muniland disclosure and price transparency yesterday. Ten years from now, every retail investor will want to say a word of thanks to Commissioner Elisse Walter, even if only half her recommendations on transparency and investor protection are implemented. Unfortunately, her term as SEC commissioner expires June 5, 2013, which leaves her less than a year to get the ball rolling on her proposals.

The report is composed of two primary areas: The first part concerns better disclosures by municipal bond issuers about their finances, and the second addresses the market structure for trading municipal bonds. It’s the second part that contains the really game-changing parts of the report.

On disclosure, the report recommends institutional changes, such as the requirement that muniland participants adopt the standards of the Government Accounting Standards Board and make timely and audited financial disclosures. The report recommends that conduit borrowers (think non-public entities like non-profit hospitals and private colleges) be subject to the same registration and disclosure standards as corporate securities and barred from using exemptions that municipal issuers rely on. Conduit issuers happen to have the highest incidence of defaults, and investors need the greatest level of disclosure for these securities.

Congress should protect municipalities from bad advice

Municipal advisers, those muniland professionals who are hired by public officials to evaluate their needs for financing and guide them through the underwriting process, don’t receive enough attention. Generally, they are paid by a government entity but also receive fees from the banks who underwrite the deals. Dodd-Frank set out to restrain potential conflicts in this space by requiring municipal advisers to register as such and imposing a fiduciary duty on their activities.

Now, however, some members of the House of Representatives are trying to roll back the portion of Dodd-Frank that would impose this fiduciary duty. A first-term congressman from Illinois, Robert J. Dold, whose prior professional experience was operating a pest-control business, has proposed legislation to strip the fiduciary duty requirement from Dodd-Frank. His bill currently has 35 co-sponsors.

Typically, municipal officials have little to no experience in financial markets. A financial adviser is on hand to untangle the complexities of different financing structures, guaranteed investment contracts (GICs) and derivatives. For public entities to get a fair deal, it’s critical that they get conflict-free advice from their financial advisers. The big Wall Street banks have for years sold highly complex and expensive products to poorly informed governments. See, for instance, these episodes from 2008:

Matt Taibbi and the muniland mafia


Matt Taibbi, a contributing editor at Rolling Stone, talks to radio personality Don Imus about municipal bid-rigging.

Cheers to Matt Taibbi for “The Scam Wall Street Learned from the Mafia,” his detailed Rolling Stone article about a municipal bid-rigging scandal that has already resulted in fines totaling nearly $700 million as well as 15 convictions for antitrust violations and wire fraud. A muniland bombshell that first became public over five years ago, the scheme reached its culmination in May when three former executives at GE Capital, General Electric’s finance arm, were convicted on charges of colluding to rig the public bids on muni bonds.

Taibbi laid out the larger picture of the scandal with his characteristic flair:

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.

Muniland’s huge Dodd-Frank win

A huge win for muniland was finalized last week when the SEC approved new rules that will shine light on the municipal bond underwriting process. This Bloomberg headline says it all: “Bond-Disclosure Rules Backed by SEC to Protect States From Banks”:

The rules were proposed by the Municipal Securities Rulemaking Board last year and are aimed at preventing Wall Street underwriters from steering public officials toward complicated debt financing without disclosing the risks. They were approved May 4 by the SEC, which will enforce them.

The disclosures are part of the effort to reshape financial regulations to prevent a repeat of the credit-market crisis of 2008, and stem from Congress’s decision to provide added protections for state and local governments. The economic crisis hit taxpayers with billions of dollars in unexpected costs when complex bond deals, once pitched as money savers, backfired as credit markets seized up.

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