Changing of the Guard

WASHINGTON - Next year is fraught with uncertainty for municipal and other securities markets as a new chairman takes over the helm of the Securities and Exchange Commission and financial services regulatory reform takes center stage in Washington.

Outgoing SEC chairman Christopher Cox has pushed for reforms for the muni market and it is not clear what his expected successor, Mary Schapiro, whom President-elect Barack Obama has chosen for the post, will do with regard to those.

Schapiro, however, has a great deal of knowledge about municipal securities. She was acting SEC chairman in July 1993 when Arthur Levitt was confirmed to lead the commission and she was at the SEC for the first year and a half of Levitt's tenure when he launched a campaign to reform the muni market and beefed up the commission's expertise and regulatory and enforcement efforts on munis. She was very supportive of those efforts, according to market participants.

Mary Schapiro
In 1996, she became president of NASD Regulation, now the Financial Industry Regulatory Authority, and was involved in the enforcement of Municipal Securities Rulemaking Board rules, including G-37, which was intended to ban pay-to-play by effectively prohibiting broker-dealers from making significant political contributions to muni issuers.

But the SEC will be faced with several more urgent issues in the coming year, including whether it will continue to exist. Cox and the commission have been criticized for being slow to react to the financial crisis and for not taking action against abuses. Earlier this week, for example, Cox took the unprecedented step of issuing a mea culpa after his agency failed to uncover New York financier Bernard Madoff's $50 billion Ponzi scheme, even though concerns had been raised with the commission's staff.

On muni issues, though, Cox and the SEC have taken some actions. Last year, Cox urged Congress to consider a series of proposals to boost municipal disclosure and accounting standards, but when they garnered little support on Capitol Hill, he instead opted to use the SEC's existing rulemaking authority to improve investor access to disclosure documents through a system called EMMA, for Electronic Municipal Market Access, that is under development by the MSRB.

But given the challenges facing the new administration and Congress, particularly the specter of broad regulatory reform, it is unlikely that improving municipal disclosure will be on top of anyone's list in the coming year.

At least initially, the locus of regulatory reform is likely to revolve around the work of House Financial Services Committee chairman Barney Frank, D-Mass, who is expected to call for the establishment of a systemic regulator. Congressional hearings are to begin shortly after the new year, possibly even before Obama is inaugurated on Jan. 20, congressional sources have said, adding that they are working closely with the Obama transition team.

Barney Frank
A systemic regulator would address the issue of firms that are either too big, or too interconnected, to fail and could result in "new actors and new responsibilities [being] placed into existing institutions" such as the Federal Reserve, according to a source involved in these issues. The fate of individual agencies like the SEC, as well as the possible regulation of derivatives, will likely be addressed at a later date, he added.


The MSRB is expected to dominate the securities side of the muni market during the year, market participants said, noting that the board plans to roll out several high-profile components of EMMA.

Currently, EMMA is functioning in a pilot format and includes only primary market documents and trade data. But by the summer, when it is expected to be fully up and running, EMMA should become the central hub for all primary and secondary market disclosure documents, short-term market transparency information, as well as trade data and market research.

"I foresee the launch of EMMA as the most exciting development likely in 2009," said Martha Mahan Haines, the SEC's municipal securities chief. "It will require, of course, a great deal of outreach to educate issuers, investors, and other market participants about its existence and features."

Martha Mahan Haines
Earlier this month, the SEC approved rulemaking changes to its Rule 15c2-12 on disclosure that effectively designates the MSRB's EMMA system as a free, centralized repository to which issuers must file bond-related secondary-market disclosure documents beginning July 1. The board plans in the spring to begin a pilot period for issuers to get used to using the continuing disclosure portion of the system.

Another component of EMMA that the board plans to roll out early next year in three phases will provide price transparency, bidding information, and documentation for the short-term auction-rate securities and variable-rate demand obligation markets.

The first phase of the system, dubbed SHORT, or the Short-term Obligation Rate Transparency system, is tentatively set for launch on Jan. 30, 2009, though some firms contend they need more time to make needed system changes. Information submitted through SHORT will be displayed on EMMA.

Meanwhile, the board also expects to launch its Access-Equals-Delivery system that will require underwriters to send electronic official statements to the board, which would then post them on EMMA for retrieval, in lieu of having to send paper documents to investors. The board plans to propose the Access-Equals-Delivery system to the SEC sometime during the first quarter.

MSRB executive director Lynnette Hotchkiss said that the board wants to have these systems in place for EMMA by July 1, after which it will consider other kinds of features and functions that market participants think should be added to EMMA.

Lynnette Hotchkiss
Market participants have said that the board should be lauded for agreeing to develop and host EMMA. The central repository was part of Cox's list of muni initiatives that he unveiled last year, and it was the only idea the entire market could agree to establish.

"EMMA is an enormous step forward," said Robert Doty, president of the financial advisory firm American Governmental Financial Services Co. in Sacramento. "The MSRB is due an enormous amount of credit."

Under the changes to Rule 15c2-12 that the SEC approved earlier this month, EMMA will replace the four existing nationally recognized municipal securities information repositories, or NRMSIRs.

Previously, the rule said that dealers could not underwrite most muni securities unless issuers had agreed in writing to file annual financial and operating information and notices of material events with each of four NRMSIRs.

But when the NRMSIR system was put into place in the 1990s, some issuers did not send disclosure documents to all four repositories and when they did, the documents were often labeled and maintained differently. This made it difficult for broker-dealers to check issuers' disclosures, which they are required to do. It also made it difficult for investors, who had to pay for the documents, to obtain disclosure information.

"It will be nice because individual investors will be able to get reports without having to pay for them and it will resolve the question of NRMSIRs saying that issuers don't file reports or do so improperly and issuers who say NRMSIRs are losing their documents," Doty said. EMMA should help the SEC monitor compliance with continuing disclosure agreements, he added.

Leslie Norwood
Leslie Norwood, managing director and associate general counsel at the Securities Industry and Financial Markets Association, which fully supports EMMA and SHORT, said SIFMA plans to ask the MSRB to consider an April 1 start date for SHORT.

The delay is necessary, she said, because the board released the specifications for the system just this week, as broker-dealers have entered into year-end system lock-downs in December and January that prevent them from changing their computer systems . After the turn of the new year, broker-dealers will need more than four weeks to program and test their computer systems for this new regulatory requirement, she said.

"Jan. 30 is just too soon and a more rational date would be in April," said Norwood, who stressed that SIFMA supports the system and is sympathetic to investors who are demanding greater short-term transparency.

SHORT comes after the roughly $330 billion auction-rate market collapsed in February when dealers withdrew support for auctions, shunning ARS because they were backed by insurance from downgraded bond insurers and lacked the put option of VRDOs.

Data collected by Bloomberg LP this fall suggests that there remain more than $80 billion of municipal ARS outstanding - down from about $170 billion last year. There are well over $400 billion of outstanding VRDOs, according to the MSRB. However, there is no source of comprehensive same-day information about either type of security available to non-market professionals.

Under the board's proposal, ARS and VRDO interest rate information must be submitted to the board by 6:30 p.m. Eastern Standard Time on the day of the auction or remarketing.

For ARS, the board wants to collect, among other things, the Cusip number, the interest rate produced by the auction process, and designation of whether the interest rate is a maximum rate, all-hold rate, or rate set by auction, and the identity of all program dealers that submitted orders, including hold orders.

For VRDOs, the board wants to collect the Cusip number; the interest rate and designation of whether the rate is a maximum rate, set by formula or the remarketing agent, and the identity of the remarketing agent as well as other data.


Market participants are eagerly waiting for the shoe to drop in the Justice Department's and the SEC's parallel criminal and civil investigations of anti-competitive activities in the municipal derivatives and investments markets, which have been ongoing since at least the fall of 2006. Those two agencies have subpoenaed dozens of firms for information going back for a period of six to 14 years through the end of 2006.

"I would be very surprised if there's not some major news about this investigation this year," said Charles Anderson, the retired field operations manager of the Internal Revenue Service's tax-exempt bond office who is now an independent consultant.

Charles Anderson
Anderson speculated that the financial crisis has delayed major settlements with some of the big banks involved in the probes but he said he would be "astounded if something doesn't happen this year."

In addition to the Justice and SEC investigations, multiple state attorneys general have begun a coordinated investigation and subpoenaed roughly 38 Wall Street and other firms involved in guaranteed investment contracts and derivatives.

The requests by the attorneys general seek documents and other information going back more than 10 years to Jan. 1, 1998, and the list of firms contacted by the state officials includes the three investment advisory firms that were raided by the Federal Bureau of Investigation in November 2006 - CDR Financial Products in Beverly Hills, Calif.; Investment Management Advisory Group Inc. in Pottstown, Pa.; and Sound Capital Management Inc in Eden Prairie, Minn.

Separately, different groups of local governments have filed class actions suits against roughly the same 38 Wall Street and other firms involved in the GICs and derivatives investigations. Most of the class action suits have been consolidated in a federal court in Manhattan.

In recent months, more than a dozen current and former broker-dealers have been notified by the Justice Department that they are targets of a grand jury investigation ongoing in New York City. Several firms have received "Wells Notices" from the SEC's enforcement staff notifying them that the staff is preparing to recommend the commission file charges against them in connection with alleged bid-rigging and other illicit activities.

In addition, a federal grand jury in Albuquerque is reportedly looking into CDR's contributions to political action committees run by New Mexico Gov. Bill Richardson in exchange for state municipal derivatives business.

The grand jury probe involving contributions to PACs of Richardson, Obama's nominee to head the Commerce Department, is reportedly focusing on the $1.5 million in fees CDR received from the New Mexico Finance Authority in 2004 after the firm and its president, David Rubin, contributed about $100,000 to two PACs run by Richardson.

Of the enforcement or court cases likely to generate action or rulings in 2009, perhaps the most high-profile proceeding revolves around the criminal and civil charges brought against Birmingham, Ala., Mayor Larry Langford, his long-time friend and lobbyist Albert LaPierre, and Montgomery bond dealer William Blount.

The 101-count criminal suit against the trio, which was filed in late November by U.S. attorneys in a federal court in Birmingham, alleges conspiracy, bribery, fraud, money laundering, and filing false tax returns in connection with a long-running bribery scheme related to bond and other financial transactions in Jefferson County.

Most, if not all, of the alleged illegal activities relate to Langford's tenure as president of the Jefferson County Commission when $3.2 billion of debt was sold to finance the county's sewer system. That debt and related swaps have contributed to Alabama's largest county's financial troubles.

The Justice Department charges that Blount and LaPierre provided Langford with about $235,000 in expensive clothes, Rolex watches, and cash to pay his growing debt. In exchange, Blount's firm, Blount Parrish & Co., allegedly awarded consulting roles on the county's bond and derivative transactions and paid fees topping $7 million.

While a federal grand jury had been investigating Jefferson County's bond financings for months, the SEC charged Langford, LaPierre, and Blount with securities fraud and related charges in a separate civil suit filed on April 30.

The SEC charges, which are similar to the Justice Department's, are expected to be placed on the back burner until the courts resolve the criminal complaint. A tentative criminal trial date has been set for Feb. 2, though attorneys for the trio have asked the court to provide them with more time to prepare.

A separate criminal matter that is expected to go to trial Feb. 17 revolves around charges the Justice Department charges brought against defunct underwriter Dolphin & Bradbury and its former top executive, Robert J. Bradbury. They were charged with defrauding four Pennsylvania school districts by selling them unsuitably risky notes between 1998 and 2004.

The suit against Bradbury, filed by the U.S. attorneys in the U.S. District Court for the Eastern District of Pennsylvania in Philadelphia last year, includes eight counts of mail fraud and one count of securities fraud. If convicted, Bradbury could face a maximum of 160 years in prison and $2 million of fines.

In a similar civil case involving the school districts, the SEC sued Bradbury in 2006 for allegedly violating the securities fraud laws and Rule 15c2-12. He was charged with selling the four school districts the risky notes, without any disclosure documents, to finance the Whitetail golf course project, which ultimately went belly up. That case is on hold until after the criminal trial.

Meanwhile, the four school districts - North Penn School District, Boyertown Area School District, Perkiomen Valley School District, and Red Lion Area School District, which are located in and around Philadelphia - filed nearly identical lawsuits in state court. Their suits, which are pending before a court in Pennsylvania's Montgomery County, also are not proceeding until the criminal trial wraps up, an attorney representing one of them said.



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