May 31, 2006
Citigroup, 14 Other Firms Settle Bond-Auction Probe
Published in Bloomberg News / BusinessWire
May 31 (Bloomberg) — Citigroup Inc., Goldman Sachs Group Inc. and 13 other banks agreed to pay a total of $13 million to settle claims they manipulated the $260 billion market for so called auction-rate bonds. The Securities and Exchange Commission’s two-year probe found that the firms, which also included Merrill Lynch & Co. and Morgan Stanley, gave some clients information on rival bids for the securities, whose yields are reset at periodic auctions. The attempt to curry favor backfired as sales of auction-rate bonds fell last year for the first time in seven years. “Virtually everyone was doing it and it became accepted practice, but it was not in accordance with what they were disclosing to investors,” Ken Lench, an SEC enforcement official in Washington overseeing the probe, said in an interview today. The 15 firms violated securities laws between January 2003 and June 2004 by letting customers change their orders in the supposedly blind auctions, the SEC said in a statement. They also stepped in to bid for their own accounts in order to dictate auction results, the SEC said. Auction-rate bond sales declined 22 percent in 2005 to $33.09 billion from a record $42.37 billion in 2004, according to Thomson Financial. Citigroup was the top manager of the securities in the municipal bond market last year, underwriting $10.46 billion in 69 issues.
“The market paused to assess what the impact of a major investigation would be,” said Joseph Fichera, chief executive officer of Saber Partners LLC, a New York firm that advises bond issuers. “These are serious issues that our industry needed to address to maintain the fundamental integrity of the auction process,” said Fichera, who was retained as an expert by the SEC in the case. The world’s four largest accounting firms told holders of auction-rate bonds last year that they had to reclassify the securities as investments rather than cash equivalents. The shift reflected the risk that buyers of the securities may not be able to sell them quickly if auctions fail to attract enough bidders, PricewaterhouseCoopers said in a report dated Feb. 16, 2005. Lench said brokers had intervened in the auctions to prevent that from happening, creating an illusion that the investments were almost as liquid as cash. The brokers, which earn fees based on the volume of auctions they conduct, had an incentive to minimize sharp increases or declines in the interest rates set by the actions, Lench said.
Don’t ‘Rock the Boat’
“Their whole goal was to not rock the boat,” Lench said. “These firms are earning 25 basis points on an annual basis for the auctions that they’re running, so profits in this industry are well up into the hundreds of millions of dollars.” A basis point is 1/100 of a point. The low penalties imposed on the firms — ranging from $125,000 to $1.5 million per firm — reflect their cooperation with the SEC and their willingness to improve disclosures and self-monitoring, Lench said. The SEC first asked about 25 brokerages two years ago to provide reports “detailing any potentially deceptive, dishonest or unfair practices,” according to a memo sent to members in May by the Bond Market Association, the Securities Industry Association and the American Bar Association. The other firms in today’s settlement were Bear Stearns Cos., Lehman Brothers Holdings Inc., JPMorgan Chase & Co., Morgan Stanley DW Inc., RBC Dain Rauscher Inc., A.G. Edwards & Sons Inc., Morgan Keegan & Co., Piper Jaffray & Co., SunTrust Capital Markets Inc., Wachovia Capital Markets LLC and Banc of America Securities LLC.
The settlement marks the second time the SEC has sanctioned Lehman for misconduct involving auction-rate securities. The firm agreed to pay $850,000 in 1995 to settle SEC claims that it manipulated auctions by improperly bidding for its own account. The firm didn’t admit or deny wrongdoing in the case. UBS AG, which has previously said it was a subject of the SEC’s probe, wasn’t included in the settlement. “We are not aware of any ongoing inquiries on this matter related to UBS,” said Mari Hope, a spokeswoman for the bank. The SEC’s settlement requires the firms to more fully disclose the way they conduct the auctions and gives each firm’s chief executive officer or general counsel six months to certify that they’ve implemented procedures to “prevent and detect” abuses, the SEC said. None of the firms admitted or denied wrongdoing.
“It’s an important signal that the SEC is paying attention to our debt markets,” said Arthur Levitt, a former chairman of the agency. “It protects the auction system and is a step toward making sure auctions are done fairly and no customer gets preferential treatment.” Levitt is a board member of Bloomberg LP, parent of Bloomberg News. The Bond Market Association, the New York-based industry trade group, today issued a draft of “best practices” for broker-dealers of auction-rate securities. The draft spells out the firms’ obligations to issuers and investors, and gives guidelines for bidding by the broker-dealer, and re-sales of auction securities, Marjorie Gross, senior vice president and regulatory counsel at the BMA, said in a statement. “We’re pleased to resolve the matter, and are committed to ensuring our auction practices meet the highest industry standards,” Citigroup spokesman Joseph Christinat said.
Morgan Stanley spokesman Mark Lake said the firm was “pleased to have reached an agreement with the SEC to settle this matter.” JPMorgan spokeswoman Kristin Lemkau, Bear Stearns spokesman Russell Sherman, and Goldman spokesman Lucas van Praag declined to comment. Other company officials didn’t immediately return calls for comment. There were $263 billion of auction-rate securities outstanding at the end of 2005, according to the five major auction agents. Of that amount, 46 percent was municipal debt, 27 percent financed student loans and 24 percent was closed-end-fund preferred securities, according to the BMA. About 92 percent of the total outstanding debt is rated triple-A by Standard & Poor’s and Moody’s Investors Service.
— With reporting by Walden Siew, Justin Baer and Eddie Baeb in New York. Editor: Dickson.