The SEC filed charges against two firms and 18 individuals for conspiring to improperly channel new issue municipal bonds to institutional accounts.
According to the SEC Complaints, municipal issuers typically require underwriters to give retail investors priority in subscribing for new issues of municipal bonds, and often give highest priority to retail investors who reside within the jurisdiction of the municipality. As municipal bond offerings are often oversubscribed, broker-dealers that wish to purchase new issue bonds are often unable to do so. According to the SEC Complaints, the defendants (the "Flipping Firms") assisted broker-dealers in obtaining new issues of municipal securities by misrepresenting that the Flipping Firms were subscribing for municipal bonds on behalf of retail customers, and then selling the bonds to broker-dealers for a fee. In doing so, the SEC alleged, the Flipping Firms violated the anti-fraud provisions of the U.S. federal securities laws, and acted as unregistered broker-dealers.
In a related action, the SEC settled charges against a broker-dealer and its former head of municipal underwriting for participation in the flipping scheme. The SEC alleged that the individual (i) received kickbacks for agreeing to purchase new issue bonds from a flipping firm, and (ii) engaged in prohibited "parking" of securities by allocating bonds underwritten by the broker-dealer to the flipping firm with the understanding that the broker-dealer would buy the bonds back at a higher price. The SEC also found that the individual's supervisor failed to implement written supervisory procedures aimed at detecting prohibited "parking" practices.
Commentary / Mark Highman
The SEC Complaints include a useful primer on the priority of orders for new issues of municipal bonds (see, e.g., paragraphs 2 and 19-22 of the Core Performance Complaint) and certain deceptive practices used by the Flipping Firms. These include linking orders to fraudulent ZIP codes within the municipality's jurisdiction, use of multiple "doing business as" accounts to maximize the allocations they would receive, and changing information on sales tickets to disguise flipping transactions to broker-dealers.
It is also noteworthy that the SEC fined the supervisor of a muni firm's head of municipal underwriting, stating: "Although he reviewed the firm's trades monthly, [the supervisor] did not specifically review them to detect parking schemes and did not conduct quarterly reviews for parking as required by [the broker-dealer's] written supervisory policies and procedures." See paragraph 21 of the NW Capital Markets Complaint. Supervisors should be mindful that if they do not specifically follow the procedures in the firm's written supervisory procedures, they are personally at risk of enforcement action, particularly in the context of egregious conduct by personnel under their supervision.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.
