Problem Puerto Rico Bond Trades Erased, Survey Shows More Troubled Sales

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WASHINGTON — Dozens of dealer sales of Puerto Rico bonds to customers that violated the $100,000 minimum denomination requirement, and were then cancelled, have been erased from EMMA or altered as if they never occurred. An examination by The Bond Buyer shows that, similar to the Puerto Rico bonds, the minimum denomination requirements appear to have been violated in at least nine other deals during the last few years, four of which conditioned the restriction on ratings.

As of late Monday, only 15 of the 70 illegal Puerto Rico trades uncovered by The Bond Buyer remained. These sales are continuing, with another $25,000 sale to a customer Monday morning.

The official statement for the recently issued Puerto Rico general obligation bonds said the GOs could not be sold in denominations of less than $100,000 unless they received an investment-grade rating from one of three major rating agencies The goal was to ensure the bonds would not be sold to retail investors who might not fully understand the risks. The bonds had speculative-grade ratings when issued on March 11.

Now most of the offending trades have been either removed from, or altered in a way that can't be identified, on EMMA, which some observers said is a failure to provide transparency for retail investors and the public. Information vendors, like Bloomberg, which receive MSRB trade data, show the original trades as well as the cancellations, but the MSRB erases them. The regulators, however can still see any offending trades and any cancellations or alterations.

"The MSRB is supposed to protect investors," said Craig McCann, principal at the Securities Litigation and Consulting Group in Fairfax, Va. and former Securities and Exchange Commission economist who has been studying markups and other aspects of the Puerto Rico trades for his own blog post. "The MSRB's re-writing of inconvenient settled trade history highlights how the MSRB is more concerned about bond dealers than it is about concerned issuers and investors. MSRB continues to condone more subtle forms of investor abuse such as excessive markups and protect dealers from the sunshine."

An MSRB spokeswoman said EMMA provides public transparency on prices and that the board makes all trade history data available to the Financial Industry Regulatory Authority and the SEC for audit trials.

McCann said the situation is still a problem. "While FINRA investigates the trades the MSRB has tried to edit out of history, the SEC needs to force the MSRB to take its investor protection mandate seriously," he said.

FINRA and the SEC are already probing the trades under $100,000, which violate the MSRB Rules G-15 on confirmation and possibly G-17 on fair dealing. LeeAnn Gaunt, chief of the muni and pension enforcement unit at the SEC, said dealers have to be diligent to avoid violations. "We believe that MSRB Rule G-15(f) is an important investor protection rule and dealers should have procedures in place to make sure they don't run afoul of it," she said.

Malcolm Northam, the former head of fixed income regulation at FINRA who now has his own consulting firm, said MSRB shouldn't be faulted if the regulators have access to information showing which trades were problematic and cancelled or altered. "As long as the regulators have access to, and routinely review, all reported transactions, it makes little sense for the public data used by investors and dealers for transaction and price transparency to contain clearly erroneous data," he said.

MSRB Rule G-12 on Uniform Practice states that a "reclamation" of a trade can occur for up to 18 months under some circumstances.

Meanwhile, a survey by The Bond Buyer shows there seem to have been at least three recent nonrated municipal bond transactions and another six over the past five and a half years where broker-dealers sold bonds to customers below the $100,000 minimum denomination requirements of the issuers. SLCG helped with the survey by providing the paper with deals that have minimum denomination requirements, a feature provided by Bloomberg, which uses MSRB trade data, that EMMA does not have.

Four of the deals were similar to Puerto Rico's in that the $100,000 minimum denominations could be reduced to $5,000 if the bonds received investment-grade credit ratings. But information on EMMA showed these deals never received ratings.

The most recent deal involved $4.2 million of Series A-1 capital improvement revenue bonds issued by the Silverleaf Community Development District in Manatee County, Fla. The issuer restricted primary market sales of the bonds to customers to $100,000 or less. The first trade was Jan. 31, but $30,000 of bonds were sold to a customer on Feb. 12 and marked "when issued," meaning the sale was lined up and executed on a contingent basis as part of the primary offering.

In December 2013, the Collier County Industrial Development Authority issued $190 million of continuing care community revenue bonds and stipulated the bonds should not be sold in amounts below $100,000 and only to institutions or sophisticated investors unless the bonds received investment grade ratings. There were two sales of $95,000 of bonds each to customers in January.

Also in December, the Colorado Health Facilities Authority issued $48.57 million of health care facilities revenue bonds, set the minimum denomination at $100,000, and said the bonds should only be sold to accredited investors or individuals with high incomes. On Dec. 30, $50,000 of bonds were sold to a customer.

In June 2012, the Development Authority of Cobb County, Ga., sold $15.76 million of charter school revenue bonds and set a $100,000 minimum denomination unless the bonds receive investment grade ratings or are purchased by clients who have a contract with a registered investment advisor. There have been 26 sales to customers below $100,000. EMMA does not publicly show who purchased the bonds or whether they had an IA.

In April 2012, the Michigan Finance Authority sold more than $3 million of public school academy limited obligation revenue refunding bonds with a minimum denomination of $100,000 and said sales should only be made to sophisticated investors that have no intent of purchasing them for more than one account. A customer was sold $25,000 of the bonds in July 2013.

The Harbor Point Infrastructure Improvement District in Stamford, Conn. issued $145 million of tax-exempt and taxable special obligation revenue bonds in January 2010 and set a $100,000 minimum denomination for individuals unless the bonds received investment grade ratings. There have been 33 sales to customers of bonds below $100,000, including two sales of $5,000 each.

In December 2009, The Industrial Development Authority of the City of Phoenix, Ariz. issued $11.23 million of education revenue bonds with a minimum denomination of $100,000 and said the bonds should only be sold to accredited investors such as banks and high-income individuals or qualified institutional buyers. There have been three sales of bonds below that limit to customers, one for $25,000 and two of $5,000 each.

In August 2008, the Utah State Charter School Finance Authority issued almost $14 million of tax-exempt and taxable charter school revenue bonds, setting sales at $100,000 or more unless the bonds received investment-grade ratings. There have been 45 sales of bonds below $100,000 to customers, including one of $5,000.

At about the same time, the Kentucky Economic Development Finance Authority issued $349 million of Louisville arena project revenue bonds, $9.9 million of which were taxable subordinate Series C bonds with minimum denominations of $100,000. There have been eight sales of the Series C bonds below $100,000 to customers, including one of $5,000.

Two other bond deals were flagged, on Bloomberg, as having restricted minimum denominations to $100,000, but the official statements were not available on EMMA so it was impossible to tell whether the restrictions applied to all of the bonds and whether there were conditions. It is unclear why the OS' were not available because they should have been filed on EMMA.

One involved $18.93 million of bonds issued in September 2011 by the Massachusetts State Development Agency for Linden Ponds, Inc. EMMA data showed six extremely small trades, including two at $3,525 each for yields of more than 15% and two at $102 each for yields of more than 10%. The other was $17 million of bonds sold in August 2010 by the California Statewide Communities Development Authority for Thomas Jefferson School of Law in San Diego. EMMA data showed five sales to customers below $100,000.

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Enforcement Law and regulation Puerto Rico
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