First Southwest In 'Tainted' JPM Deal

WASHINGTON — First Southwest Co., as bidding agent for a repurchase agreement related to a $233 million bond deal in Texas for which it was financial adviser, improperly allowed JPMorgan Securities to lower its bid for the repo, reducing the issuer’s investment rate, according to documents and transaction participants.

The Securities and Exchange Commission said the deal, involving bonds issued in 2005 by the Central Texas Regional Mobility Authority, was one of many that involved “fraudulent bidding practices” that JPMorgan engaged in with the assistance of bidding agents.

The SEC described the transaction without identifying the bidding agents or issuers in the complaint. It was filed last week against JPMorgan in connection with its $51.2 million settlement of securities fraud violations for bid-rigging of muni-bond related reinvestment contracts. The complaint only noted that the bidding agent for the repo in the Texas authority’s deal was one of the FAs for the bond deal.

But the final judgment issued a few days ago by a federal judge in New Jersey — which approved the settlement and imposed a permanent injunction against JPMorgan prohibiting further violations — listed the bond issuers. Transaction participants identified First Southwest as the FA for the bond deal and the bidding agent.

This is the first time court documents filed in connection with the massive federal and state probes of anti-competitive practices have clearly implicated First Southwest as one of 11 bidding agents the SEC says were involved in reinvestment transactions that were “tainted” by bid-rigging.

The investigations have been ongoing since 2005. In October 2009, the Justice Department filed criminal charges against Beverly Hills, Calif.-based CDR Financial Products Inc., another bidding agent. The charges were filed after federal agents in ­November 2006 raided CDR’s offices and the offices of Investment Management Advisory Group Inc., in Pottstown, Pa., and Sound Capital Management in Eden Prairie, Minn..

First Southwest vice chairman Michael Bartolotta is currently chairman of the Municipal Securities Rulemaking Board. The MSRB was given regulatory authority over bidding agents for bond-related reinvestment and derivatives products by the Dodd-Frank Act last year. The legislation, along with the MSRB rules that implement it, treat bidding agents as muni advisers who are subject to a fiduciary duty and must put their issuer clients’ interests ahead of their own.

Hill Feinberg, First Southwest’s chairman and chief executive officer, said Tuesday he was surprised to see a transaction involving the firm in the SEC complaint against JPMorgan.

Feinberg said First Southwest, which has a large financial advisory practice, has often served as an intermediary for issuers when they seek bids on bond-related investment contracts. “We’ve done that all along,” he said.

But he added, “We’ve always put our clients first and ahead of any [investment contract] provider.”

Issuers typically use bond proceeds to purchase the contracts as investments to earn interest before the proceeds are used to fund projects.

Feinberg said his firm “has not been contacted about this specific transaction” by federal or state investigators. He conceded that First Southwest has had general contract with the Department of Justice and the SEC regarding their respective probes.

“We’ve cooperated with the SEC and the DOJ and we will continue to do so,” he said.

The Central Texas Regional Mobility Authority transaction is one of 93 bond issues totaling more than $14.3 billion where bids for contracts were rigged, according to the SEC. Virtually all of JPMorgan’s $51.2 million settlement payment to the SEC will go to issuers and borrowers. The largest amount of that, $5.79 million, will go to the Regional Transportation Authority in Chicago, along with another payment of $2.85 million for a separate transaction. The smallest amount, $26,420, will go to The Harrisburg Authority in Dauphin County, Pa.

The Office of the Comptroller of the Currency’s agreement with JPMorgan Chase Bank NA — under which it agreed to pay $35 million and take remedial actions — lists another 48 borrowers that will share more than $13 million from the settlement.

The largest payments include $3.32 million for the Pennsylvania Intergovernmental Cooperation Authority, $1.375 million for Philadelphia International Airport, and $1.32 million for Chicago.

The smallest payment — $11,311 — would go the New Jersey Educational Finance Authority for Centenary College.

The agreements with the SEC and OCC were part of a $228 million global settlement that JPMorgan also reached with the Justice Department, the Internal Revenue Service, the Federal Reserve Board and 25 state attorneys general. The amount actually will involve a net payout of only $211.2 million from the firm because states agreed to credit it for $17 million of payments already made to the SEC and OCC. About $129.7 million of that amount will be restitution to muni issuers and nonprofit and corporate borrowers.

According to the SEC complaint and bond documents, UBS Financial Services was the lead underwriter for the Central Texas Regional Mobility Authority deal and JPMorgan was part of the syndicate. The bond and note proceeds were to be used to finance turnpike projects.

JPMorgan bid to provide the CTRMA with a repurchase agreement and was permitted by First Southwest to revise its winning bid to lower the interest rate it had already agreed to pay. That increased its profit while lowering the investment return for the authority, according to the SEC.

First Southwest drafted an “Invitation to bid for the Repurchase Agreement” that said the objective was to “lock in the highest available level of interest earnings,” the SEC said in its complaint.

Bids for the repurchase agreement were due by 11:00 a.m. Eastern Standard Time on Feb. 15, 2005. But soon after 11:00, a JPMorgan Securities marketer telephoned a First Southwest employee to tell him that the banks’s rate was 3.371%. They discussed termination and downgrade provisions. JPMorgan inquired about a legal opinion. The First Southwest employee responded, “Well, if you need it, you’re going to have to pay for it,” and asked if the firm wanted to reduce its bid rate. The JPMorgan marketer reduced the firm’s bid to 3.365% to reflect the $4,500 cost of the legal opinion.

The First Southwest employee then “signaled” to the JPMorgan marketer that he had left “money on the table” and gave him the opportunity to further reduce the bid, accoding to the SEC. The marketer reduced his bid, which was already the winning bid, to 3.35%.

“Despite the fact that JPMS fraudulently won the bid by reducing an already winning bid rate to a lower level suggested by the bidding agent, JPMS falsely certified, among other things, that [its] bid was the product of an arm’s length transaction, that it was determined without regard to any other formal or informal agreement that [it] had with the issuer or any other person (whether or not in connection with the bond issue), and that [it] did not have the opportunity to review other bids before providing its bid,” the SEC said in its complaint.

“Similarly, [the] bidding agent... certified that it had made a bona fide solicitation for the investment contract at issue; that all potential providers had had an equal opportunity to bid; and that the winning bid was the highest yielding bona fide bid for the investment contract (determined net of broker’s fees),” the commission said.

As a result, the issuer certified that the repurchase agreement was awarded through a bona fide solicitation and that all providers had an equal opportunity to bid, the SEC said.

Some tax experts were surprised that this transaction occurred in 2005, saying Internal Revenue Service officials had been warning in public speeches the previous year that bid-rigging of investment contracts could violate tax laws and rules and jeopardize the tax-exempt status of the underlying bonds.

Regulators contend that bid-rigging, besides violating securities laws, hurts issuers and sometimes the federal government. The issuer is hurt if its investment yield is significantly below the bond yield, resulting in so-called negative arbitrage. And the failure of firms to conduct a bona fide competitive bidding process jeopardizes the tax-exempt status of the bonds. The federal government loses money if the issuer’s investment yield was artificially lowered, when it should have been higher than the bond yield so that the issuer would have had to rebate its arbitrage profits to the government.


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