Municipal Bonds

Muni Bond Funds Hit by Puerto Rico’s Debt Problems

Published on: October 9, 2013 | by Shepherd Smith Edwards & Kantas, LLP

The SSEK Partners Group is investigating claims by investors who bought Puerto Rico municipal bonds from UBS (UBS), Banco Santander (SAN.MC), Banco Popular and other brokerage firms. We are also looking into claims involving other muni funds that have been exposed to Puerto Rico, including the:

• Franklin Double Tax-Free Income A (ticker: FPRTX): 65% of its holdings involve Puerto Rico obligations.

• Oppenheimer Rochester VA Municipal A (ORVAX): 33% of its holdings in Puerto Rico bonds.

UBS Faces Legal Battle Over Failing Puerto Rico Bond Funds with Local Investors

Published on: October 3, 2013 | by Shepherd Smith Edwards & Kantas, LLP

As the value of proprietary closed-end bond funds invested created by a UBS AG unit (UBS) in Puerto Rico continue to drop, the financial firm and its 132 financial advisers find themselves facing what is expected to be a protracted legal battle with local investors who want their money back. The value of the Puerto Rico bond funds sank after over $10 billion were sold to investors. UBS is also contending with allegations that a number of its brokers persuaded clients to purchase the bond funds and bonds on a credit line and margin.

The UBS Puerto Rico funds are comprised of 14 close-end funds that were sold through UBS Financial Services Inc. of Puerto Rico’s registered representatives and brokers. As tension over the broader municipal bond market hit the US commonwealth, the net asset value of the funds became eroded, falling from an initial price of $10 to roughly $3 for some of the funds.

Unlike closed-end municipal bond funds domiciled in the US—these are only allowed to have leverage as high as 30% of the assets in the fund—the Puerto Rico bond funds’ leverage can reach as high as 50% of total assets (55%, under certain conditions). Such leverages can only make any losses greater.

Muni Bonds Draw Investors But Come With Serious Risks

Published on: June 11, 2013 | by Shepherd Smith Edwards & Kantas, LLP

With many municipalities exhibiting better financial health and tax-free bonds touting pretty good returns, municipal bonds are attracting investors. However, this doesn’t mean that you, as a prospective investor, shouldn’t approach munis with caution.

Investors don’t pay a commission when they purchase a municipal bond, but they do have to pay a “markup,” which is the difference between the price paid and the broker’s cost. Unfortunately, many brokers don’t tell customers about this markup, instead focusing on the benefits of yield rather than disclosing more about the price. Because of this, most retail investors don’t know how much these trades are costing them in charges. You should know that these markups can be pretty high.

The Wall Street Journal reports that according to a study from research firm Securities Litigation and Consulting Group, out of one in 20 trades, investors that purchased $250,000 or less in municipal bonds paid a 3.04% markup or greater, which, at today’s rates, is one year’s worth of interest income (compare that to the under $10 in commission investors pay when purchasing stock from the majority of online brokers-.004% interest on $250,000; meantime, management fees for mutual funds are approximately 1% yearly. The study examined close to 14 million trades involving long-term, fixed-rate munis between April ’05 to April ’13.

SEC Accuses Victorville, CA, Underwriter, and Others of Municipal Bond Fraud

Published on: April 29, 2013 | by Shepherd Smith Edwards & Kantas, LLP

The SEC has filed securities fraud charges against the city of Victorville, CA, one of the city’s officials, the Southern California Logistics Airport Authority, and Kinsell, Newcomb & DeDios, which underwrote the bonds. The SEC claims that they bilked investors by inflating valuations of property that secured a 2008 municipal bond offering.

According to the regulator, city official Keith C. Metzler and KND owner Jeffrey Kinsell and VP Janees L. Williams are to blame for misleading and false statements put out in the Airport Authority’s bond offering in April 2008. The SEC is also accusing KND of misusing over $2.7 million in bond proceeds to stay in business.

The Commission says that the Airport Authority took on a number of redevelopment projects and financed them by putting out tax increment bonds, and by April 2008 it had to issue even more bonds to refinance a portion of the debt incurred to keep going with these endeavors.

State of Illinois Settles Securities and Exchange Commission Fraud Charges

Published on: March 16, 2013 | by Shepherd Smith Edwards & Kantas, LLP

Without denying or admitting to the charges, the state of Illinois has settled the securities fraud case filed against it by the SEC. The Commission contends that Illinois misled investors about municipal bonds and the way it funds its pension obligations. There will be no fine imposed on the state. Illinois, has, however, implemented numerous remedial actions and put forth corrective disclosures related to the charges over the last few years.

Per the Commission, even as the state offered and sold over $2.2 billion of municipal bonds between 2005 and 2009, it did not tell investors the effect problems with its pension funding schedule might have. Illinois is also accused of not disclosing that it had underfunded its pension obligations, which upped the risk of its overall financial condition.

The regulator’s order contends that Illinois had set up a 50-year pension contribution schedule in the Illinois Pension Funding Act. However, it turns out that the schedule was not sufficient to take care of both a payment amortizing the plans’ actuarial liability, which was unfunded, and the price of benefits accrued during a current year. Also, the statutory plan ended up structurally underfunding the state’s pension duties while backloading most pension contributions into the future. The structure caused stress on both the pension systems and Illinois’s ability to fulfill its competing obligations.

Criminal Sentences Issued in Municipal Bond Conspiracies Involving Three Ex-Financial Services Execs Accused of Contract Bidding & FINRA Looks at Whether Financial Firms Made Bond Ballot Campaign Contributions For Municipal Underwriting Business

Published on: October 31, 2012 | by Shepherd Smith Edwards & Kantas, LLP

In the U.S. District Court for the Southern District of New York, three ex-former financial services executives have received their respective sentences for taking part in conspiracies involving contract bidding for municipal finance contracts and the municipal bond proceed investments. The defendants, Peter S. Grimm, Steven E. Goldberg, and Dominick P. Carollo, are former General Electric (GE) affiliate executives. They were convicted earlier this year.

Per evidence at the criminal trial, between 1999 and 2006, while working for the GE affiliates, the three defendants took part in different conspiracies involving different insurance companies and financial institutions. These “providers” offered an investment agreement contract to governments and agencies throughout the country. These public entities wanted to invest money from different sources, mainly proceeds from municipal bonds proceeds they had issued to raise money, for public projects.

The three men and their co-conspirators are accused of corrupting the bidding process for many of these investment agreements to raise the profitability and amount of the agreements that were awarded to the provider companies where they worked. This led to municipalities not being able to avail of competitive interest rates for investing tax-exempt bond proceeds that they were going to use for different public works projects, which cost them millions of dollars.

Carollo, who was convicted on two counts of conspiracy to commit wire fraud and defraud the US, was sentenced to 36 months behind bars and he has to pay a $50,000 criminal fine. Goldberg, who was found guilty of four counts of the same charge, got a prison term of 48 months and he must pay a $90,000 fine. Grimm, whose conviction involves 3 counts of the same crime, also received a 36-month prison term. He has to pay a $50,000 fine.

Meantime, the Financial Industry Regulatory Authority is trying to determine whether brokerage firms made bond ballot campaign contributions that resulted in them receiving campaign-related municipal underwriting business. This closer examination by the SRO comes following media reports in these allegations.

Although municipal dealers contributing to campaigns usually is not a violation of rule G-37 of the Municipal Securities Rulemaking Board, the SRO wants to look into the perception that some contributions may have been influential and if, indeed, some broker-dealers have been assisting a “municipal issuer do what it is prohibited itself from doing,” said Robert Ketchum, FINRA CEO and chairman. Ketchum made his statements at the Bond Dealers Association’s annual conference earlier this month.

FINRA has been looking closely at bond markets (which in the last year have experienced a rise in retail investors), including municipal dealer firms with business activities dealing significantly with retail-sized transactions. The SRO wants to make sure that members reveal all material facts about a transaction to customers, check that products are suitable for investors, assess the credit risks involved with a municipal bond, and refrain from pay-to-play violations to influence issuer officials.

Ex-GE Bankers Convicted of Municipal Bond Bid-Rig Scheme, Bloomberg Businessweek, October 18, 2012

Remarks by Richard G. Ketchum Chairman and Chief Executive Officer, Bond Dealers Association Annual Conference, October 11, 2012

More Blog Posts:
Reform the Municipal Bond Market, Says the SEC, Institutional Investor Securities Blog,
July 31, 2012
JPMorgan Chase to Pay $211M to Settle Charges It Rigged Municipal Bond Transaction Bidding Competitions, Stockbroker Fraud Blog, July 9, 2011

Muni Debt Reform: SEC to Proceed with Field Hearing in Alabama, Stockbroker Fraud Blog, May 29, 2011

Reform the Municipal Bond Market, Says the SEC

Published on: July 31, 2012 | by Shepherd Smith Edwards & Kantas, LLP

The US Securities and Exchange Commission is calling for broad reforms to the $3.7 trillion municipal bond market. Today, it published a 165-page report that included its recommendations. One of its main concerns is that individual investors have the lower hand when they sell and buy purchase bonds that are issued by the states and cities. The SEC wants Congress to mandate that municipal bond issuers give investors the same information that they would get in other financial markets because right now, the market is not just “illiquid” but also “opaque.”

Whether through exchange-traded funds, mutual funds, or directly, investors currently hold 75% of the over 1 million bonds that are outstanding. One reason municipal bonds are so popular is that the income from these instruments are usually tax-exempt. However, problems with the market have recently surfaced that have caused the Commission concern.

A number of municipalities have tried to escape their bondholder commitments by filing for bankruptcy. Meantime, bankers have had to go to trial for alleged bid rigging while taking advantage of states and cities. Also, the general lack of information for investors about the municipal bonds that they are purchasing makes it difficult for them to assess prices (Because the majority of bonds are not traded daily, brokerages and banks are the ones that primarily get to determine how the bonds are priced) and financial firms are having an easier time charging municipalities too much when assisting them in issuing bonds.

Stockbroker Fraud Roundup: SEC Issues Alert for Broker-Dealers and Investors Over Municipal Bonds, Man Who Posed As Investment Adviser Pleads Guilty to Securities Fraud, and Citigroup Settles FINRA Claims of Excessive Markups/Markdowns

Published on: April 10, 2012 | by Shepherd Smith Edwards & Kantas, LLP

The SEC’s Office of Compliance Inspections and Examinations has put out an alert reminding broker-dealers about what their supervisory and due diligence duties are when it comes to underwriting municipal securities offerings. According to the examination staff, there are financial firms that are not maintaining enough written evidence to show that they are in compliance with their responsibilities as they related to supervision and due diligence. OCIE Director Carlo di Florio stressed how sufficient due diligence when determining the operational and financial condition of municipalities and states before selling their securities, is key to investor protection.

The SEC has also issued an Investor Bulletin to provide individual investors with key information about municipal bonds. Its Office of Investor Education and Advocacy wants to make sure investors know that the risks involved include:

Call risk: the possibility that an issuer will have to pay back a bond before it matures, which can occur if interest rates drop.

Credit risk: The chance that financial problems may result for the bond issuer, making it challenging or impossible to pay back principal and interest in full.

Interest rate risk: Should US interest rates go up, investors with a low fixed-rate municipal bond who try to sell the bond prior to maturity might lose money.

Inflation risk: Inflation can lower buying power, which can prove harmful for investors that are getting a fixed income rate.

Liquidity risk: In the event that an investor is unable to find an active market for the municipal bond, this could stop them from selling or buying when they want to or getting a certain bond price.

As a municipal bond buyer, an investor is lending money to the bond issuer (usually a state, city, county, or other government entity) in return for the promise of regular interest payments and the return of principal. The maturity date of a municipal bond, which is when the bond issuer would pay back the principal, might be years-especially for long-term bonds. Short-term bonds have a maturity date of one to three years.

In other stockbroker fraud news, Citigroup Inc. (C) subsidiary Citi International Financial Services LLC has agreed to pay almost $1.25 million in restitution and fines to settle claims by FINRA that it charged excessive markups and markdowns on corporate and agency bond transactions between July 2007 and September 2010. The SRO says that the markdowns and markups ranged from 2.73% to over 10% and were too much if you factor in the market’s condition during that time period, how much it actually cost to complete the transactions, and the services that the clients were actually provided. FINRA also claims Citi International failed to exercise “reasonable diligence” to ensure that clients were billed the most favorable price possible. To settle the SRO’s claims, Citi International will pay about $648,000 in restitution, plus interest, and a $600,000 fine.

Also, a man falsely claiming to be an investment advisor has pleaded guilty to securities fraud. Telson Okhio, president of the purported financial firm Ohio Group Holdings Inc., has pleaded guilty to wire fraud over a financial scam that defrauded one Hawaiian investor of about $1 million.

Okhio solicited $5 million from the investor while claiming that the money would be invested in the foreign currency exchange market using a $100 million trading platform. He said the investment was risk-free and would earn 200% during the first month. Okhio is accused of immediately taking $1 million of the investor’s money and placing the funds in his personal account. He faces up to 20 years behind bars.

Investor Bulletin: Municipal Bonds, SEC.gov
Individual Posing as Investment Advisor Pleads Guilty to Wire Fraud Charges, FBI, March 16, 2012

FINRA Fines Citi International Financial $600,000 and Orders Restitution of $648,000 for Excessive Markups and Markdowns, FINRA, March 19, 2012

More Blog Posts:
Principals of Global Arena Capital Corp. and Berthel, Fisher & Company Financial Services, Inc. Settle FINRA Securities Allegations, Stockbroker Fraud Blog, April 6, 2012

CFTC Says RBC Took Part in Massive Trading Scam to Avail of Tax Benefits, Stockbroker Fraud Blog, April 4, 2012
Wirehouses Struggle to Retain Their Share of the High-Net-Worth-Market, Institutional Investor Securities Blog, April 6, 2012 Continue Reading ›

Not All Municipal Bond Issuers Are Adjusting Well to the SEC’s Efforts to Make the Market More Transparent

Published on: February 22, 2012 | by Shepherd Smith Edwards & Kantas, LLP

According to The New York Times, the Securities and Exchange Commission is attempting to make the municipal bond market less “opaque.” One way it is doing this is by adding more disclosure requirements. For example, muni bond issuers now have to publish bond rating changes, financial statements, and other material on the Municipal Securities Rulemaking Board’s EMMA data site in a timely manner. However, the Times reports that not all 55,000 muni bond issuers are adjusting well to this era of greater transparency.

The newspaper cites the West Penn Allegheny Health System, which has been the target of an SEC probe for more three years after an earnings restatement in July 2008. The examination turned into a formal probe in 2009. (The multi-hospital system is one of the largest municipal bond issuers, with nearly $740 million bonds outstanding.)

Although West Penn posted $1.6B of revenue for fiscal year 2011, during the last six months of the year, it lost $56M. The company’s pension plan is underfunded by $200M. Last year, Fitch Ratings and Moody’s downgraded the West Penn bond rating so that it’s well in the junk category. Also, as of December 31, 2011, the system was in possession of just 58-days worth of cash. Meantime, as West Penn is awaiting the approval of a partnership with health insurer High Mark Inc., which said it would commit up to $475M over three years to support West Penn hospitals, the union has garnered the attention of the Justice Department’s antitrust division. Also, the SEC has been asking for information about West Penn’s financial statements.

Citigroup Request to Overturn $54.1M Municipal Bond Arbitration Ruling Denied by Judge

Published on: December 27, 2011 | by Shepherd Smith Edwards & Kantas, LLP

A US judge has denied Citigroup’s request that the $54.1M Financial Industry Regulatory Authority arbitration award issued to investors that sustained losses in municipal bond funds be overturned. This is one of the largest securities arbitration awards that a broker-dealer has been ordered to pay individual investors. Brush Creek Capital, retired lawyer Gerald D. Hosier, and investor Jerry Murdock Jr. are the award’s recipients. However, these Claimants are not the only investors to come forward contending that they were told the funds were suitable for investors that wanted to preserve their capital.

The investor losses were related to several leveraged municipal bond arbitrage funds that saw their value significantly drop between 2007 and 2008. Citigroup Global Markets had sold the municipal bond funds through MAT Finance LLC. Proceeds were invested in longer-term muni bunds while borrowing took place at low, short-term rates. The strategy proved to be unsuccessful, resulting in investors losing up to 80% of their money.

According to The Wall Street Journal, when it issued its ruling the arbitration panel appeared to reject three defenses that financial firms usually make:

• The financial crisis, and not the financial firm, is to blame for the losses.
• Sophisticated, rich investors should have known what risks were involved.
• The prospectus had warned in advance that investors could lose everything.

The Claimants alleged fraud, failure to supervise, and unsuitability. They had sought no less than $48 million in compensatory damages, fees, lost-opportunity costs, commission, lawyers’ fees, and interest.

The FINRA arbitration panel awarded $21.6 million in compensatory damages, plus 8% per annum, to Hosier, $3.9 million in compensatory damages, plus 8% per annum, to Murdock, Jr, and $8.4 million in compensatory damages, plus 8% per annum, to Brush Creek Capital LLC.

All Claimants were also awarded $3 million in lawyers’ fees, $17 million in punitive damages, $33,500 in expert witness fees, $13,168 in court reporter expenses, and $600 for the Claimant’s filing fee.

Following the FINRA ruling, Citigroup contended that the arbitration panel had ignored the law when arriving at the award. The brokerage firm also claimed that investors could not have depended on verbal statements that the financial firm had expressed about purchases because the clients had acknowledged through signed agreements that they could lose everything they invested. By denying Citigroup’s request to throw out the arbitration award, Judge Christine Arguello, however, said that the court found Citigroup’s “argument wholly unpersuasive.”

A Crack in Wall Street’s Defenses, New York Times, April 24, 2011

Citigroup Slammed With $54 Million Award by FINRA Arbitrators in MAT / ASTA Case, Municipal Bond, April 12, 2011

Citigroup loses suit to overturn $54-million ruling, Reuters, December 22, 2011

More Blog Posts:
JPMorgan Chase to Pay $211M to Settle Charges It Rigged Municipal Bond Transaction Bidding Competitions, Stockbroker Fraud Blog, July 9, 2011

Citigroup Ordered by FINRA to Pay $54.1M to Two Investors Over Municipal Bond Fund Losses, Stockbroker Fraud Blog, April 13, 2011

Citigroup’s $285M Mortgage-Related CDO Settlement with Raises Concerns About SEC’s Enforcement Practices for Judge Rakoff, Institutional Investor Securities Blog, November 9, 2011