SEC fines Illinois firm, broker $200,000 for muni violations

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An Illinois broker-dealer and its president have agreed to pay $200,000 after the Securities and Exchange Commission found the firm exaggerated its customer list, selling many of its bonds to other broker-dealers creating risk in the competitive pricing process.

First Midstate Inc. and its president Paul Brown, 61, agreed to pay and be censured without admitting or denying the SEC’s findings that it violated both SEC and Municipal Securities Rulemaking Board rules. The SEC said the firm violated MSRB Rule G-17 on fair dealing and MSRB Rule G-21 on advertising. The firm also violated Section 15B(c)(1) of the Exchange Act for attempting or inducing the sale of municipal securities.

The firm will pay a civil penalty of $175,000 and Brown will pay $25,000. About $66,000 of that will go to the MSRB.

The Securities and Exchange Commission settled with an Illinois broker-dealer firm this week.

From June 1, 2014 to Oct. 1, 2018, the firm and Brown failed to give issuers certain material information about FMI’s underwriting practices, the SEC found. FMI and Brown represented on their site and through other communication that the firm had an extensive customer list that would allow it to sell the bonds to investors at competitive interest rates, the SEC said.

“In fact, FMI had a very limited customer base and its regular practice was to sell many of the offerings it underwrote to other broker-dealers, not to investors,” the SEC said.

FMI’s website said it had “developed an extensive list of municipal bond purchases.” The firm also said its list included institutional and individual municipal bond purchasers.

“This broad base affords us the ability to place each issue with investors most suitable for that particular project or maturity at competitive interest rates,” FMI said.

Contrarily, the SEC said FMI’s investor base was mostly banks and that FMI did not get offers from investors.

FMI also didn’t disclose to issuers that its practice was to sell many of the bonds it underwrote to various broker-dealers during the public offering period, if it did not receive orders from investors, the SEC found. The firm also didn’t say that that practice created a risk to competitive pricing for their bonds, the SEC said.

From part of 2014 to 2018, the firm sold 76% by par amount of all bonds it underwrote to other broker-dealers, not to investors. Specifically, FMI acted as an underwriter for 101 offerings with a total of $198 million in which FMI sold the entire offering to one broker-dealer, the SEC said.

“These transactions represent 35% of the total par amount of all bonds, and 31% of all offerings, underwritten by FMI during that period,” the SEC said. “For those 101 offerings, the purchasing broker-dealer then marked up the bonds and resold them to investors at higher prices (and corresponding lower yields).”

“Although investors were willing and agreed to pay the higher price and accept a lower yield for the bonds, the issuers did not benefit from those more advantageous prices and yields,” the SEC said. “If FMI had sold the bonds directly to investors, the issuers might have received more competitive pricing for their bonds.”

Some issuer representatives of offerings underwritten by FMI said they would have wanted to know that FMI was selling their bonds to another broker-dealer and not to investors, the SEC added.

FMI has undertaken to retain an independent consultant, who will write a report of its findings and recommend improvements to the firm’s policies and procedures. The firm did not respond to a request for comment.

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