WASHINGTON — The Securities and Exchange Commission’s muni enforcement priorities include staying on top of undisclosed pension liabilities, faulty bond valuation and pricing, and undisclosed potential tax violations that could jeopardize the tax-exempt status of bonds, the SEC’s top cop said Wednesday.
“In the municipal securities market, we must be up to date on pension liability disclosures, valuation issues, and tax-arbitrage activities,” Robert Khuzami, director of the SEC’s enforcement division, wrote in a speech given at the Securities Industry and Financial Markets Association’s Compliance and Legal Society annual seminar in Phoenix. “These examples are just part of a broader array of challenges stemming from fast-paced change and increasing complexity apparent in the financial products, markets, transactions, and practices that the division confronts.”
The SEC’s muni enforcement actions are carried out by one of five specialized investigative units — municipal securities and public pensions — established last year as part of a restructuring. The group has roughly 30 to 35 individuals.
Concerns about public pension disclosures have grown in recent months as some governments, with huge budget shortfalls, have stopped making contributions to pension plans or have been overly optimistic in projecting investment earnings.
In addition, federal lawmakers have held hearings on the growing unfunded liabilities of public pension systems.
Three Republicans in the House and one in the Senate have proposed identical bills that would require governments to determine their pension liabilities using a so-called riskless rate based on a Treasury bond rate and report them to the federal government. Issuers who failed to comply with the requirements would lose their ability to issue tax-exempt bonds.
The SEC has filed two major enforcement actions against issuers over pension disclosures. In November 2006 it sanctioned San Diego for failing to disclose in bond documents, financial statements, and discussions with rating agencies that soaring unfunded pension and retiree health care liabilities placed it in serious financial straits.
Then last August, the SEC sanctioned New Jersey for failing to disclose to bond investors that it was underfunding its two largest pension plans. There were no fines in either case, just cease-and-desist orders. San Diego was ordered to improve disclosure practices.
The SEC has been concerned for years about the pricing of high-yield, infrequently traded muni bonds. In January 2008, Milwaukee-based Heartland Advisors Inc. and six former or then-current officials agreed to pay a total of almost $4 million to settle SEC charges that they mispriced bonds in two then-defunct high-yield muni bond funds.
But the commission’s concerns appear to have broadened as the loss of bond insurance and volatility of the market have made it harder to price many munis.
In addition, the Internal Revenue Service last year raised concerns about broker-dealers “flipping” Build America Bonds and whether they were certifying as to the correct issue price of bonds, which was a factor in determining the interest costs and the federal subsidy payments for the BABs.
In flipping, a broker-dealer sells bonds to another dealer or institutional investor and the bonds are “traded up” in a series of almost simultaneous trades to the detriment of the ultimate retail buyer.
In the most recent tax-related case, Banc of America Securities LLC, now Bank of America Merrill Lynch, agreed to pay more than $137 million and to take remedial steps to settle charges with the SEC, banking and tax regulators, and 20 attorneys general over its participation in a scheme to rig bids for muni reinvestment contracts and pay undisclosed kickbacks.