Lehman Brothers is contending that a programming flaw in Bloomberg LP's electronic bidding system cost the underwriting syndicate it led almost $700,000 when the firm purchased a $275 million South Carolina deal earlier this month.
In response, the firm is shying away from using electronic bid delivery whenever an alternative is available, and is considering legal action against Bloomberg, its top underwriter said.
Lehman's syndicate, which also included Goldman, Sachs & Co. and Morgan Stanley Dean Witter, had intended to submit a bid carrying a 4.37% true interest cost and a $2.47 underwriter takedown for South Carolina's first state infrastructure bank deal, said Peter Coleman, managing director of capital commitments at Lehman.
Coleman said a glitch in the system "zeroed out" the discount and sent the issuer a bid with a 4.34% TIC. However, Bloomberg contends that the controversy was due to a error by Lehman underwriters.
"This was a case of user error. The program functioned correctly, as it did for the other underwriters bidding on South Carolina, and as it has for other bids this user has submitted in the past," said Kevin Foley, manager of the electronic bidding system. "We responded immediately to the situation once we were made aware of it, but there was nothing we could do once we determined that the problem was caused by user error."
But Lehman maintains that the system was flawed.
"It was just happenstance that we stumbled upon a method that did not automatically total up and discount the underwriter's spread from our gross bid to the issuer," Coleman said. "We hit go, we shot it in ... We looked at the bottom and said, 'You know what, it didn't total it in.' We tried to call South Carolina but it was too late, it was already sent - $2.47 on $275 million, I think the math is $697,000. And that was 'Thank you, Bloomberg.' "
According to Coleman, the syndicate members shared the pain - which was compounded by a broad-based decline in bond prices after the deal.
Although Bloomberg was the only electronic bidding system used during the deal, South Carolina also permitted faxed or hand-delivered bids, Coleman added.
Chuck Sanders, South Carolina's director of investment and debt management, said Lehman contacted his office after the bidding period was over and unsuccessfully attempted to change the bid the issuer received.
According to Sanders, Lehman had informed his office that they did not want the bonds at that price. Lehman's intended TIC would have finished third in the bidding, behind Merrill Lynch & Co. and J.P. Morgan Securities Inc.
But, in the end, Lehman agreed to place the issue, Coleman said. The firm had no prior warnings to the potential pitfall and is currently reviewing its options for legal recourse, he added. In the meantime, Lehman will do what it can to avoid using Bloomberg - and electronic bidding in general - when it can.
"If we do have an alternative to Bloomberg currently, given our lack of satisfaction and their response to the Lehman syndicate, we will look to do that," Coleman said.
When first contacted by Lehman, Bloomberg was receptive to the underwriters' concerns, he said. However, Coleman said a later phone call from Bloomberg indicated a change in the firm's approach.
"Bloomberg (responded) about five hours later, and it was a very different Bloomberg," Coleman said. "In our opinion, when Margaret Trapp went to speak with her management, they all of a sudden came back with a different response - that the system worked as designed, they stand by it, and good luck."
While Bloomberg's competitors might see some benefit in this situation, they expressed concern that the controversy could tar the reputation of electronic bidding as a whole.
"My concern about this is, that kind of sloppiness affects all of us in the business," said Myles Harrington, president of MuniAuction Inc. "The problem is they're rushing to grab market share before they've got their machine running properly."
Cheryl Horowitz, vice president of marketing at Dalcomp, which also operates an electronic bidding system, echoed Harrington, saying: "It could taint the whole electronic bidding process, and I would hate to see that. It concerns me because of that." Dalcomp is owned by Thomson Financial Services, which also owns The Bond Buyer.
But sources throughout the industry believe that the chilling effects, if any, will be short-lived.
"I think there's a learning-curve process, and I think it's just moving up the curve until people feel more comfortable," said June Matte, a senior managing consultant at Public Financial Management Inc.'s Boston office.
Matte - who said both parties share the responsibility to a degree - had served as financial adviser for last week's Virginia school deal sold exclusively through Bloomberg and said she had to play an ambassador of sorts, convincing Lehman to bid on the deal.
But Coleman said Lehman's decision was based upon a long relationship with the issuer and not upon satisfaction with Bloomberg.
The bidding system, which has been used on 15 municipal deals, was originally designed to safeguard against bids that would violate issuer-set parameters. Since the Lehman situation, the system has been enhanced to protect against the omission of the takedown.
"For Lehman Brothers, we find it extremely interesting that although Bloomberg admits to no wrongdoing, they have changed the program so that what happened to us could no longer happen," Coleman said.
Nevertheless, bond sales by issuers such as Wisconsin and Minnesota - two states that have and will accept bids through any of the three electronic systems, as well as faxed or hand-delivered bids - will leave the decision on how to bid with the underwriters.
In fact, Lehman won Wisconsin's $110 million transportation deal last Wednesday with a hand-delivered bid.
"Electronic delivery, I think, enables people to control risk better, but that's up to the Street to decide what's best for them," said Frank Hoadley, Wisconsin's capital finance director. "I think the benefits are more to the procedural side, and I'd like to think they're more to the accuracy of the issue, that you would avoid mistakes. On the other hand, we have seen mistakes."
On that, Coleman agrees.
"The Street should have the ability to submit bids in any way that is acceptable to the issuer, the more the better, so that the underwriting community can decide what is really best for them and what affects the lowest interest cost to the issuer," he said. "Let that system prove out, whatever it is. If it's hand delivered, or one of the various electronic mediums, so be it."
