WASHINGTON — The massive, nationwide scope of a federal criminal probe into bid-rigging in connection with municipal guaranteed investment contracts came into focus yesterday as nine firms— including GIC brokers, insurance companies, and broker-dealers — confirmed they had received subpoenas from the U.S. Department of Justice’s antitrust division.
The Securities and Exchange Commission’s separate, parallel civil investigation of bid-rigging also came to light yesterday as Financial Security Assurance Holdings Ltd. and First Southwest Securities announced they had received subpoenas from the SEC. In the criminal probe, a third GIC broker, Sound Capital Management, disclosed yesterday that the Federal Bureau of Investigation had raided its Eden Prairie, Minn., offices.
Industry sources say 20 to 25 firms were served with subpoenas Wednesday. Nine have announced them or confirmed that they were received: IXIS Corporate & Investment Bank, CDR Financial Products, Investment Management Advisory Group Inc., Financial Guaranty Insurance Co., Kinsell Newcomb & De Dios Inc., XL Capital Assurance Inc., First Southwest Securities, FSA, and Sound Capital.
The Sound Capital raid came as the FBI also raided the offices of CDR and IMAGE Wednesday.
Knowledgeable sources said three other firms have been served with subpoenas from the Justice Dept., but those either would not comment or could not be reached: Sociéte Générale, George K. Baum & Co., and Feld Winters Financial LLC.
Other major industry players, including Bear, Stearns & Co., Banc of America Securities LLC, JPMorgan, and UBS Securities LLC, refused to comment on whether they had received subpoenas.
The federal, criminal, and civil investigations, which involve officials from the Internal Revenue Service’s criminal investigation division as well as the Justice Department, the FBI, and the SEC, appear to stem in part from the Philadelphia corruption case and resulting SEC investigation of investment advisory firms, as well as the agency’s increasing focus on GIC transactions last year and audits conducted by the IRS tax-exempt bond office. Sources say that several government officials are aware of recorded phone conversations suggesting firms colluded with each other. These recordings have been crucial evidence in the investigations, they say.
Justice is likely looking at price fixing or collusion under the Sherman Antitrust Act, while the SEC is likely looking for securities fraud. Some firms claimed their GIC bidding processes were competitive when they were rigged, or failed to disclose kickbacks or fees made in exchange for rigging bids, sources said.
“In the last five years, regulators have become very aggressive across the board with respect to financial matters — some might even say overly aggressive — but the bottom line is, it’s not your mother’s municipal market anymore,” said Paul Maco, partner at Vinson & Elkins LLP here and former director of SEC’s office of municipal securities.
“A decade ago, there was minimal interest in the part of the Justice Department in the municipal market, but that’s changed,” Maco added.
Tax-exempt bond issuers flush with bond proceeds from a recent sale typically place the funds in various investment vehicles, such as a GIC, until they are needed. In securing a GIC the issuer often hires a broker to conduct the bidding. A GIC provider is normally selected via a competitive process with at least three bidders. Bid-rigging often occurs when only one firm submits a reasonable bid and the other two firms submit courtesy, or unrealistic, bids.
Prices for GICs are important because they affect the investment contracts’ prices, which thereby impact yields. When an issuer invests bond proceeds, federal law stipulates that the investments’ yield cannot exceed the bonds’ yield by more than .001%. Any arbitrage earned above that percentage must be rebated to the federal government.
The IRS stepped up its examination of bid-rigging early last year. In some cases, it found, bidding processes were structured to allow the provider to underpay for a GIC and then overpay for other investment agreements and remarketing fees, effectively diverting arbitrage back to the GIC broker or underwriter.
GICs have become popular in the muni market because issuers can lock up their money “at a guaranteed rate that ensures it won’t earn illegal arbitrage,” one industry source said yesterday. “Why should the issuer take its chances on a portfolio?”
But the opaqueness of the business makes it challenging to estimate how many GICs exist and which brokers or providers do the most transactions, according to one market participant involved in the business who wished to remain unidentified.
“We don’t know much about it, and nobody else knows anything about it. It’s not a transparent business and anytime you don’t have transparency all sorts of stuff goes on.”
The individual also said GIC brokers frequently conduct the bidding process for GIC providers but also agree to serve as “finders” of muni business for securities dealers or banks, and receive finder’s fees or even monthly retainers for those services.
Shady practices have occurred because people did not want to admit that what they were doing was wrong, the source said. “People have had their heads in the sand the same way they did in yield burning.”
IRS, SEC, and Justice Dept. officials declined to comment yesterday.
The Municipal Securities Rulemaking Board has no jurisdiction over the investments of municipal bond proceeds and was not involved in the yield-burning investigations, which were the only other wide-ranging, multi-agency investigation of the muni market. But executive director Christopher Taylor said, “I don’t want the public to lose sight of the fact that the bond market continues to serve the needs of this nation.”
Taylor said that even if there are abuses in the GIC market, they have not affected the bonds or investors. “Nothing has brought injury to investors in the sense that the interest and principle payments have been made on time and the tax-exempt status of the bonds has been preserved.”
Jon Teall, spokesman from Securities Industry and Financial Markets Association, said SIFMA is watching news developments.
“The association has taken a long-standing position that any criminal activity should be investigated and prosecuted,” he said.
SUBPOENAS
Market firms announcing the subpoenas and raids kept their cards close to their chests this week. Sound Capital Management said in a press release that federal investigators “collected documents” and “served a subpoena for more documents” at its offices yesterday.
“SCM and its employees are not aware of any charges or claims against them. Because SCM cooperated in furnishing requested information, our business continues uninterrupted.”
The firm also said in the release that it has retained Minneapolis law firm Fredrikson & Bryon PA to advise it “on how to continue to work with the authorities.”
FSA had announced the Justice subpoena Wednesday but said in a second press release yesterday afternoon that it had received a subpoena from the SEC “related to an ongoing civil investigation of brokers of municipal” GICs.
“The company, which issues municipal GICs and other financial products through its financial products segment, is not aware of specific allegations concerning its own practices,” FSA said in the statement. “The company intends to cooperate fully with both investigations.”
CDR said in a press release that it was providing information related to GICs as requested in connection “with a broad-based investigation by the U.S. Justice Department into the municipal reinvestment market.”
“CDR is cooperating fully with government investigators in providing information on all transactions covering the time periods reviewed by the Justice Department,” it said in a statement. “The firm believes it has acted appropriately in all of the financings under review.”
CDR, which said it has advised issuers, underwriters, and financial institutions on nearly $160 billion in public finance transactions, “stands on its record of helping state and local government entities across the U.S. issue high-quality tax-exempt financings covering a multitude of important projects and public works.”
“We want to underscore that CDR is open for business and will continue to serve the needs of our municipal and financial institution clients as this process continues,” said CDR founder and chief executive David Rubin.
David Askren, spokesman for IXIS, which used to be CDC Funding Corp., confirmed that IXIS received a Justice subpoena yesterday but said the company was “simply a fact witness” in the investigation. “They just want to know what our involvement in the industry is. We’ll cooperate fully with that. We’re putting together documents that may be required,” he said.
FGIC spokesman Brian Moore confirmed that the company had received a Justice subpoena, but said he was not aware of one from the SEC. Moore declined to discuss the subpoena beyond saying that it “relates to municipal investment contracts. There’s nothing specific about FGIC in this.”
