WASHINGTON - Competitive bidding provides no guarantee that the Securities and Exchange Commission will not investigate escrow securities for excessive markups or other possible securities law violations in connection with yield-burning concerns, SEC officials told bond lawyers meeting here yesterday.
Competitive bidding "is a requirement that stems from tax law considerations and not necessarily securities law considerations," William R. Baker 3d, an associate director in the SEC's enforcement division, said at the National Association of Bond Lawyers annual Washington seminar.
Baker said that, as a practical matter, the SEC would be hard-pressed to file securities fraud charges over excessive markups against a dealer that sold escrow securities to an issuer if the markups the firm took on the securities were in line with those proposed by other dealers through a competitive bid process.
But Baker and Paul Maco, director of the SEC's Office of Municipal Securities, both said that while competitive bidding may create a safe harbor in the tax area - under which it is initially presumed the securities were sold to the issuer at fair market value - it does not provide any such safe harbor in the securities area. The SEC might still be concerned about excessive markups or that the bidding was rigged in some way, they said.
Their remarks were not comforting to many bond lawyers at the NABL meeting who had hoped to be able to provide some assurance to issuer and underwriter clients that competitive bidding would help to insulate them from yield-burning probes designed to uncover tax and securities law violations. The lawyers, like other market participants, are particularly concerned about markups because there are no clear-cut federal standards. In addition, the SEC has charged Rauscher Pierce Refsnes Inc., now Dain Rauscher Inc., with excessive markups in a yield-burning case, in which the markup was less than one half of one percent.
The SEC officials' remarks also spell trouble for The Bond Market Association which has been working with issuers and other groups to try to come up with a common set of characteristics that would rule out refundings from the SEC or the Internal Revenue Service enforcement actions involving yield burning. TBMA officials have contended that refundings should not be subject to federal scrutiny if there was competitive bidding for the escrow securities.
Meanwhile, Baker dodged a question about whether he expects the IRS will refrain from imposing Section 6700 tax penalties on dealers in global settlements of yield-burning abuses - since the IRS did not do so in a recent landmark settlement with CoreStates Financial Corp., which is supposed to serve as a template for other firms. Baker said it is up to the IRS to decide whether to impose such penalties. He added, however, that the CoreStates settlement was "carefully crafted" to protect innocent issuers and bondholders and said, "We will be doing our jobs well if we can resolve all cases in that manner."
CoreStates and other dealers have refused to take part in settlement talks involving Section 6700 tax penalties.
Baker also said there are no statute of limitations problems for the SEC when it seeks disgorgement of ill-gotten gains from dealers in yield- burning cases. However, he said there would be a statute of limitations for penalties such that the SEC would not seek penalties against a firm if more than five years had passed since the fraud occurred.
Several NABL members questioned whether federal securities laws permit the SEC to take the position that underwriters have fiduciary obligations to issuers when they provide those issuers with escrow securities or investment advice.
In a series of cases, including the one involving CoreStates and Meridian Capital Markets Inc., the SEC charged underwriters with breaching their fiduciary duties when they sold issuers escrow securities or helped them choose forward supply or investment contract providers, and then failed to disclose any profits, payments, or alleged kickbacks. The bond lawyers said one could take the view these firms provided the issuer with separate sets of unrelated services.
But Baker said, "Any time a transaction that's supposed to be (at) arms length and is advertised as arms length is less than that, the commission's going to be concerned and take some enforcement action."
In another area of enforcement, Bruce Hiler, a partner at O'Melveny & Myers here, questioned whether the SEC should have filed securities fraud charges against Syracuse, N.Y., and two of its former officials, in a case involving misleading disclosures of financial information. Hiler said this appeared to be a case of sloppiness rather than any intent to commit securities fraud.
He noted that the SEC recently settled securities fraud charges with Nevada County and two other issuers in California under Section 17(2) and (3) of the Securities Act of 1933. In other words, the SEC only charged the issuers with negligence and not, as the SEC had originally charged, with committing fraud knowingly or recklessly under Section 10b5 of the Securities Exchange Act of 1934.
Hiler asked Baker if the SEC might consider limiting its securities fraud charges against issuers in the future to the Section 17 negligence standard. Baker said possibly, but that the SEC would not want to spend a lot of resources on negligence cases.
Meanwhile, Maco, who had appeared on an earlier panel, reminded underwriters' counsel that issuers subject to the SEC's secondary market disclosure rules must disclose in their official statements any instances in which they have breached their continuing disclosure contracts during the past five years. Issuers also must file material event notices whenever they fail to file annual financial information, he said later.
Mark Zehner, an attorney-fellow in the SEC's Office of Municipal Securities, explained the SEC's recent guidance on escrowed-to-maturity securities. Zehner said a footnote in the release, the SEC makes clear that if securities are callable they should never be called, listed, or labeled as escrowed-to-maturity securities.
As expected, Maco said municipal issuers should consider whether they have material information that needs to be disclosed about their costs and efforts to fix Year 2000 disclosure problems. He also urged issuers to "use plain English" in their official statements. "Your brethren in the corporate bar are rising to this challenge today. It should be within your grasp," he said.
