Affirmative, Yes But Is It Fair?

At first glance, it seems an unlikely partnership. To underwrite a $409 million water-and-sewer bond issue for Florida's Dade County last December, Merrill Lynch, the nation's largest brokerage, with $1.1 billion in surplus capital and 36,500 employees, agreed to share lead underwriting duties and fees with AIBC Investment Services Corp., which at the time had six employees and $65,000 in capital. Although AIBC didn't sell a single bond, it earned a sweet $350,000 for its role in the deal.

How did AIBC pull off such a coup? The main reason: AIBC is 52% owned by Wilfredo Gort, a Hispanic and a Miami City Commissioner. Such is the way business often gets done as more and more cities and states adopt affirmative-action programs in awarding municipal-bond underwriting business.

For tiny securities firms like AIBC, minority requirements work wonders on the bottom line. Both Dade County Finance Director Edward Marquez and Merrill say AIBC worked hard on the deal at every stage, and AIBC has since moved to increase its capital and staffing. But in Miami, its work did not consist of selling bonds, the traditional duty of co-managers. Rather, says AIBC Senior Vice-President William R. Burdette, AIBC coordinated the transaction with the nine other participating minority firms. And it played another role, he says, referring to Miami's effort to spread muni-bond work among minority-owned firms: winning the deal in the first place. "We helped put Merrill at the top of the list" of bids, says Burdette.

To critics, arrangements such as the Florida deal are politicizing the securities-underwriting business and undermining the market's efficiency. Over the past decade, affirmative-action programs have helped establish a healthy cadre of more than two dozen minority- and woman-owned securities firms able to compete with the major Wall Street firms that had a longstanding lock on public finance. With staffs of several dozen and capital bases of $1 million or more, they possess the expertise to play important roles in bond-underwriting syndicates.

NEW BREED. Yet more recently, the growing number of requirements for minority participation in bond deals has attracted a new breed of small firms. Many of them are independent and growth-minded. But others appear to be little more than thinly capitalized shells set up by well-connected individuals, or fronts set up by bigger firms. These firms are winning spots in underwriting syndicates mainly because lead underwriters are required to include minority-owned firms. Other new firms have the expertise and capital to operate independently--but even these firms are also often partly owned by major firms. Major firms often use their links to the minority firms to secure underwriting business.

The small firms are taking significant business away from established minority firms and threatening their ability to generate the capital they need to participate in bigger deals and expand into new financial services. And the problem is getting worse. While state and local muni deals are the main locus of affirmative-action programs, they are also being adopted by federal agencies such as the Resolution Trust Corp. and in other areas of government finance.

Established companies question whether a well-meaning social policy is in fact rewarding those with political connections rather than underwriting knowhow. Muriel F. Siebert, who owns her own New York-based firm, frets that front and shell operations, estimated by market experts at over half the 150 to 300 minority-owned firms, "are going to ruin it for everybody." She adds: "It ends up closing some doors to us."

Most observers agree that, overall, policies to encourage minority securities firms have been very successful. Small minority-owned firms used to have a tough time breaking into the muni business, which generates fees exceeding $1 billion a year. But now governors and mayors in over 20 cities and states have enacted rules to spread business among firms owned by women and minorities. For smaller firms just getting started, "it's a matter of life and death," says Norma Yaeger, founder of Yaeger Capital Markets Inc. in Los Angeles.

California has led the way. It was one of the first states to set fee-sharing targets for each muni issue: 15% for minority-owned firms, 5% for woman-owned, and 3% for disabled veterans. Last year, dhese firms earned $6.3 million through bond sales, the highest ever in the program's five-year history.

"THE RIGHT THING." Other strong advocates include Florida, Georgia, Illinois, New York, Washington, D.C., and Chicago. "The efforts are not only appropriate, they are the right thing to do," says Francisco L. Borges, a former Connecticut treasurer and managing director of Financial Guaranty Insurance Co.

Muriel Siebert & Co., the country's oldest securities firm owned by a woman, is among the best- known beneficiaries of minority set-asides. Started in 1967 as a retail brokerage operation, the concern has become a significant underwriter in the past eight years. Last year, Siebert underwrote pieces of bond issues that totaled $19 billion, according to Securities Data Co.

Black-owned operations also have made strides. The country's largest minority firm--Pryor, McClendon, Counts & Co.--was senior manager on $1.8 billion in muni underwritings last year. In the past three years, the Philadelphia firm doubled to 60 professionals. It's running neck and neck with San Francisco's Grigsby Brandford & Co., which senior-managed deals worth $1.7 billion in 1993. W.R. Lazard & Co., though shaken by its founder's death from a cocaine-and-alcohol overdose, is the largest black-owned money manager, with $2.8 billion under management.

The established minority firms are increasingly going head-to-head with a bumper crop of fledgling firms, some of them tied to major Wall Street firms. Says Robert B. Lamb, a management professor at New York University's Stern School of Business and the author of an upcoming study of minority-owned firms: "Established minority firms are now faced with an unlevel playing field where bigger firms are doing linkups with tiny or weak firms they can control."

Some leading Wall Street firms aren't helping matters. In managing muni syndicates, major Street firms often prefer to deal with small minority-owned firms to keep total control of the deal. Rather than give a strong minority player the full 15% of the deal to meet a state mandate, a lead manager may bring in 10 little firms and give each 1.5% of the bonds. Lacking staff and expertise, some tiny firms often just turn over bonds to the majority partners and split the commissions. "Investment banking should not be a welfare program," gripes Napoleon Brandford, co-chairman of Grigsby Brandford.

There are similar patterns in trading by minority firms. To meet state and local mandates, some public pension funds must allocate to minority firms a portion of their brokerage business. Yet in many cases, a pension fund will allow a major firm to handle the business for a minority firm. Major firms readily commit to such an arrangement because it wins them the lion's share of the business. "The minority firms will literally get checks in the mail for trades they weren't aware occurred," says the head of a large minority firm.

In many cases, minority- and woman-owned firms have financial links with major firms, which typically help both parties get business. Wheat, First Securities Inc. recently invested in Jackson Securities, founded by Atlanta's former mayor, Maynard H. Jackson. A Wheat spokesperson says only that "it was an investment opportunity." After leaving the San Antonio mayor's office, Henry G. Cisneros founded his own money-management firm with a 15% investment from Criterion Investment Management Co., a Houston firm managing $11 billion in assets. Criterion CEO Terence S. Ellis says it "just seemed like a good idea." Cisneros resigned after becoming Clinton's Secretary of Housing & Urban Development. Goldman, Sachs & Co. provided a subordinated $1 million line of credit to Artemis Capital Group Inc., a firm founded by five former Goldman women professionals and one other woman. A Goldman spokesman says they wanted to support "a new business where the principals were former employees."

A major firm's goal in these arrangements is often to help get a struggling young firm off the ground, which can give the patron firm a public-relations boost. But it also can help the larger firm financially. Since Merrill Lynch trader John O. Utendahl, who is black, struck out on his own, Merrill has ponied up seed money of $3 million and a $9.9 million line of credit--and become an owner of 10% to 25% in Utendahl Capital Partners, according to a Securities & Exchange Commission filing. Utendahl specializes in underwriting U.S. agency securities. After just a year, Utendahl has $13.8 million in assets and surplus capital of $12.2 million.

Merrill and Utendahl won't disclose what Merrill earns on its investment. But Merrill is joining forces with Utendahl to help underwrite an upcoming $2 billion issue by the Government National Mortgage Assn., which gives spots to minority firms. The two have also teamed up on RTC issues. Utendahl declined comment. "We wanted to help one of our employees," says a Merrill spokesman.

Just how independent minority firms are in these arrangements is less than clear. Last December, Ronald E. Blaylock, a founding Utendahl partner, decided to split off on his own. To help set him up, Bear, Stearns & Co. bought roughly 25% of R.E. Blaylock Partners and has supplied about $10 million in capital. Bear Stearns units handle Blaylock's securities clearing and books and records. The relationship already is paying off for both firms. Blaylock and Bear Stearns have teamed up in syndicates to underwrite two Chrysler Financial Corp. asset-backed issues totaling $1 billion, and they will be co-leaders on a $1 billion RTC offering in a few months. And the firm already has 21 employees, about 75% women and minorities. "Bear Stearns has no day-to-day say in the operation of my business," Blaylock says emphatically. But "let's just say I listen when an investor speaks," he jokes. A Bear Stearns spokeswoman says: "Blaylock is independent."

Some established, independent minority firms dislike these arrangements. "You have a minority firm competing against one of the major firms on Wall Street that, in effect, is cloaked in a minority status," complains Harold E.

Doley Jr. of Doley Securities Inc.

The most questionable arrangements involve some nonminority firms whose ties to a minority firm are so tight that the two are virtually indistinguishable. At issue: just who benefits from business that public officials are trying to award to minority firms.

One example is Gallegos Institutional Investors Corp. in San Francisco, which was founded three years ago as a minority securities trading firm and which does business with such clients as the San Francisco public pension funds under minority-allotment provisions. The two well-connected Hispanic owners, Norman W. Berryessa and Herman E. Gallegos, have a two-thirds stake in the firm. But Gallegos Institutional operates as an extension of its 33% investor, McClurg Capital Corp. McClurg collects fees from Gallegos for back-office work. McClurg President David G. McClurg and his wife, who are not minorities, are two of five employees at Gallegos, which operates from McClurg Capital offices. "Somebody has to do the grunt work. I didn't want to set up an administrative operation," says Berryessa, the firm's chief executive. He says the firm "is not a front. We're fully qualified."

PASSIVE ROLE? Last November, Jefferies & Co., a Los Angeles-based brokerage, set up Williams Capital Group, a trading firm run by Christopher J. Williams, who is still a Jefferies employee.

Jefferies has a 39% stake in Williams Capital, which sublets space in Jefferies' Manhattan office building, and executes Williams Capital's trades. Williams, who is black, says Williams Capital solicits business as a minority firm and claims the Jefferies investment is passive. "We only have a clearing relationship," he says. "Any firm that has an outside investment interest is taking great pains to insure that the minority firms are independent." Jefferies CEO Frank E. Baxter describes it as "strictly an arm's-length business relationship."

Momentum is building to curb arrangements that critics feel undermine affirmative-action rules. Federal agencies already screen carefully. But state and local governments are only just starting reforms. A recent Chicago ordinance requires minority firms to submit muni bid proposals that include proof of their firms' minority ownership and securities qualifications. "To do a bond deal, you have to be competent and be able to do the work," says Maria Pappas, a Cook County (Ill.) commissioner. "Incompetence should not be rewarded." Unfair advantages shouldn't, either.


The Resolution Trust Corp. and the Government National Mortgage Assn. both require that a portion of their business of issuing mortgage-backed securities be handled by minority- and woman-owned firms.


Many municipal-bond issues must be underwritten in part by minority- and woman-owned underwriting firms. Atlanta, for example, allocates underwriting 30% to African-American-owned firms, 3% to woman-owned, 2% to Hispanic-owned, and 1% to Asian-owned. Others, such as Dade County and New York City, must simply aim for minority inclusion.


Some municipal pension funds, such as the Illinois Investment Board and the California Public Employees Retirement System, must use minority-owned firms to manage a part of their assets. A few must also use minority firms to execute some trades.


                            THE BIG PLAYERS
                                                       Fiscal 1993
                             Underwriting            Retained Surplus
                        principal amount*   Assets   earnings capital
      Firm                        Billions  Millions Millions Millions
      *Total value of municipal bond issues in which firms participated as a member of underwriting syndicate
      ARTEMIS CAPITAL                $53.5   $4.6    $0.3     1.5
      PRYOR, MCCLENDON, COUNTS & CO.  44.5    10.0    6.4     3.2
      GRIGSBY BRANDFORD               36.9    9.8     2.5     3.7
      W.R. LAZARD                     33.2    6.4     0.1     1.2
      MURIEL SIEBERT & CO.            19.4    12.1    3.3     3.4
      SAMUEL A. RAMIREZ & CO.         16.9    4.9     2.4     1.8
      REINOSO & CO.                   16.7    6.4     4.7     5.3
      *Total value of municipal bond issuesin which firms participated as a member of underwriting sydicate

Michael Schroeder and Keith L. Alexander, with Leah Nathans Spiro in New York and bureau reports

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