MSRB Calls For Fed Action

WASHINGTON - The Municipal Securities Rulemaking Board strongly urged President-elect Barack Obama, his advisers, and the new Congress Friday to consider federally regulating brokers of guaranteed investment contracts and financial advisers in the municipal market that are not currently subject to regulation.

The board said in a statement that it was taking the action because of concern that ongoing federal investigations and investment advisers and other muni market participants had created "widespread confusion over how the market is regulated."

"Specifically, we believe that these currently unregulated participants - such as Guaranteed Investment Contracts (GICs) brokers and the various financial advisors - should be brought under federal regulation in order that all segments, and not only broker-dealers, meet the high standards a fair municipal market that protects investors requires," the board said, adding it "would be pleased to work with appropriate federal officials in discussing options and developing an appropriate regulatory scheme."

Securities Industry and Financial Markets Association and Regional Bond Dealers Association officials applauded the MSRB statement, saying broker-dealers are virtually the only regulated party in the muni market.

But former MSRB chairman Christopher Taylor, currently a consultant on financial markets and regulatory policy, said the board missed the mark by not calling for the regulation of interest-rate swaps, which have become a huge part of the muni market and are at the center of the Justice Department's antitrust and bid-rigging investigation in the municipal market.

"I was disappointed that they were unwilling to address swaps," he said. "There's not one word in that statement about interest-rate swaps, which are a major, major problem and a focus of the price-fixing inquiry. They were central to the [political corruption] probe in Philadelphia and they are central to the scandal in Jefferson County, Alabama."

Taylor was referring to a Justice Department political corruption and pay-to-play probe in Philadelphia several years ago that centered on bond and swap deals and resulted in the conviction of former Treasurer Corey Kemp, as well as Jefferson County's many swap deals and recent financial troubles.

"They are trying to divert the attention by focusing on GICs when, in fact, it's swaps," said Taylor. "The industry doesn't want to do away with the pot of money that's made through interest rate swaps. Many bond deals that done since the year 2000 have had swaps associated with them and that's where the profits are, that's why firms have been willing to do bond deals for little money and that's where the political corruption is."

Taylor said he warned about swaps and rumors of political corruption during the past several years and that he feels certain that this was one of the reasons he was pushed out of the MSRB.

"It was made clear to me in the final two or three years that some board members were upset with my speaking out on the whole question of interest rate swaps and derivatives and possible problems in the industry," he said.

The board announced in August 2006 that it would not renew Taylor's contract as executive director, saying it wanted "next generation leadership" to "help guide the organization into the future." He left the MSRB in mid-2007 and was replaced by Lynnette Hotchkiss, who had been SIFMA's managing director and associate general counsel.

Taylor said also that he met with officials at the Federal Reserve in 2002 to talk about swaps but "got blown off."

But Hotchkiss and Ronald Stack, the MSRB's chairman, said yesterday that the issue is not swaps, it is the fact that some muni market participants are unregulated.

"It is a patchwork of regulation, or lack of regulation, or state versus federal, that is just not working and one area that illustrates why it isn't working is the pay-to-play investigations that we've seen for years," said Hotchkiss. "G-37, at least with respect to broker-dealers, has definitely stopped pay-to-play, also the appearance of pay-to-play - but if you want to have a comprehensive effect on the overall municipal securities market, you have to have a consistent framework of prohibitions on pay-to-play" that covers all parties, she said.

"This is not about derivatives," said Stack, managing director and head of public finance at Barclays Capital. He had been head of public finance at Lehman Brothers, which was acquired by Barclays last year. "This is about financial advisers who, whether they offer advice on GICs or whether they offer advice on swaps, or whatever ... are totally unregulated. As a broker-dealer, I have to take a Series 7 exam, I have to take continuing education, I have lots of compliance rules from the MSRB on political contributions, rules on my conduct."

Asked why the MSRB chose Friday to issue the statement, Hotchkiss said, "We have consistently had conversations with fellow regulators, Capitol Hill, and others privately about the regulatory patchwork in our market and we have encouraged them to look at it and do things. It just never gets to the top of the agenda."

The Justice Department, Securities and Exchange Commission, and Internal Revenue Service have been conducting parallel criminal and civil investigations of anticompetitive behavior associated with derivatives and investments in the muni market since November 2006.

Those investigations began when the Federal Bureau of Investigation raided the offices of CDR Financial Products, Inc., in Beverly Hills, Calif., Investment Management Avisory Group Inc. in Pottstown, Pa., and Sound Capital Management in Eden Prairie, Minn.

Since then the Justice Department and SEC have subpoenaed dozens of firms and informed a number of them, as well as individual broker-dealers that they are either targets of the criminal investigation or that the SEC staff is considering recommending the commission take enforcement action against them.

In August, the New Mexico Finance Authority announced that it was cooperating with U.S. attorneys who were investigating CDR Financial Products. That investigation is focusing on whether CDR earmed more than $1.5 million for advising the authority and other issuers in the state on interest rate swaps and restructuring escrow funds because of political contributions it made to the political action committees of Gov. Bill Richardson.

The governor recently withdraw from being considered for head of the Commerce Department after Obama nominated him for the post.

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