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Muni Bonds, Basel Committee, Mergers: Compliance

Updated on

(Corrects to show that Moore Capital, not Pia, paid fine in CFTC item in Compliance Action section.)

Aug. 20 (Bloomberg) -- The Securities and Exchange Commission’s fraud case against New Jersey may presage a wave of lawsuits seeking to crack down on misdeeds by public officials who raise money in the $2.8 trillion municipal bond market.

New Jersey on Aug. 18 settled claims it didn’t disclose to investors that it failed to put enough cash into its two biggest pension plans when it sold $26 billion of bonds from 2001 to 2007. The case is the first SEC fraud charge against a state and follows the creation of a unit set up this year to focus on municipal securities and pension funds.

“They will be looking for other cases,” said James Doty, a former SEC general counsel who’s now an attorney with Baker Botts LLP in Washington. “It’s a harbinger that they expect disclosure standards to be scrutinized and be increased.”

SEC Chairwoman Mary Schapiro has pressed for tougher disclosure rules for municipal bonds, whose history as a safe investment has been jeopardized by dwindling tax collections and record budget deficits by states and rising defaults by local borrowers. Investment losses also left states $500 billion short of funds to cover promised pensions by mid-2008, even before the collapse of Lehman Brothers Holdings Inc. sent stocks tumbling, the Pew Center on the States said.

“There are a lot of states that are significantly underfunded,” said Lynn Turner, a former SEC chief accountant who served on an independent panel that investigated San Diego’s pension fund. The SEC sanctioned the city in 2006 for hiding gaps in its retirement system after the Internet stock bubble burst. “There’s likely to be a dozen that have the same type of problems as New Jersey, and it’s not just states but cities too.”

Miami has been under the SEC’s scrutiny since December for failing to tell investors that it used funds earmarked for capital projects to replenish its general fund in fiscal 2007 and 2008, according to documents for a bond sale last month.

The New Jersey case began in 2007 after the New York Times published a critical report on the state’s pension accounting. The SEC found the state masked years of underfunding by failing to inform investors that $704 million listed as pension payments in documents for 79 bond sales from 2001 to 2007 were actually transfers of money already in the retirement system.

The state also failed to disclose a $2.4 billion loss in the value of pension fund assets in 2001, the SEC said, which “created the false impression” that the Teachers’ Pension and Annuity Fund and the Public Employees’ Retirement System were adequately funded.

New Jersey settled the SEC charges without admitting or denying guilt or paying a fine. The state was billed $7.9 million by Fried, Frank, Harris, Shriver & Jacobson LLP of New York through November 2009 for legal work on the case, according to documents obtained by Bloomberg News through the state’s Open Public Records Act.

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Compliance Action

HSBC Fined $375,000 Over Sales of Mortgage Securities

The Financial Industry Regulatory Authority fined a U.S. unit of HSBC Holdings Plc $375,000 for recommending unsuitable sales of inverse floating rate collateralized mortgage obligations to retail customers.

HSBC Securities “failed to adequately supervise the suitability of the CMO sales and fully explain the risks of an inverse floating rate or other risky CMO investment to its customers,” Washington-based Finra said yesterday in a statement.

The company agreed to settle without admitting or denying wrongdoing, said Finra, the industry-funded regulator of U.S. brokerages.

Unilever Says EU Raises Objections to Sara Lee Deal

Unilever’s planned acquisition of Sara Lee Corp.’s shower-gel and European detergents business for 1.3 billion euros ($1.67 billion) faces formal objections from the European Union’s antitrust regulator.

The company received a statement of objections from the EU, Paul Matthews, a London-based spokesman for the company, said in an e-mail yesterday. He said the company remains confident that a “positive agreement” can be reached by the end of the year. He declined to comment on what issues the EU raised in the documents, which are confidential.

The European Commission, the 27-nation EU’s antitrust agency, in June extended its review of the transaction saying it “creates significant overlaps in a number of products” such as deodorants, skin cleansers and fabric-care goods. Unilever, the world’s second-largest consumer-goods maker, is seeking to buy the Sara Lee lines to focus further on international brands.

“I presume some small divestments will be needed to get the job done,” Jon Cox, an analyst at Kepler Capital Markets in Zurich said yesterday. He said the EU statement could delay the deal from closing “which delays the contribution to the sales and profitability from the purchase.”

Unilever, the London- and Rotterdam-based maker of Dove soap and Lipton tea, earlier this month said it expected the purchase to be completed in the fourth quarter, later than the third-quarter timeframe previously announced. Amelia Torres, a spokeswoman for the EU antitrust regulator in Brussels, said she couldn’t comment.

Ernesto Duran, a spokesman for Downers Grove, Illinois-based Sara Lee, said while the company hadn’t been contacted by the European Union, it was “aware of the recent developments.”

“We share Unilever’s confidence that a positive agreement can be reached by the end of the year,” he said in an e-mailed statement.

Unilever fell 1.9 percent to close at 21.02 euros in Amsterdam trading.

A statement of objections doesn’t necessarily mean the EU will attempt to block the deal. The EU approved TomTom NV’s purchase of digital-mapping company Tele Atlas NV in 2008 a few months after sending a statement warning that the purchase might violate antitrust rules.

Unilever has two weeks to respond in writing to the objections and can ask for an oral hearing to defend the deal. It can still offer remedies to soothe the commission’s concerns, such as selling off units to reduce market share in problem markets.

Paul McGeown, a partner at Hunton & Williams LLP in Brussels, said EU statements, formal charge sheets laying out potential competition worries, are becoming more common during extended merger reviews. He said regulators tend to “throw the kitchen sink” at companies after court rulings urged them to list all concerns.

“I would expect Unilever to put up a robust defense” and argue that supermarkets’ negotiating power makes it hard for consumer-goods makers to raise prices, McGeown said.

Unilever’s Chief Executive Officer Paul Polman last year broke the company’s nine-year streak of avoiding major takeovers with the Sara Lee purchase, which includes more than 90 brands in 19 European countries.

South Africa Probes Trades Before NTT Offer on Didata

South African regulators will investigate trading in Dimension Data Plc shares in the two days before Nippon Telegraph & Telephone Corp. made a 2.1 billion-pound ($3.3 billion) takeover offer for the company.

The Financial Services Board will lead the probe and discuss its findings next month, Alex Pascoe, deputy director of the Pretoria-based regulator’s division for market abuse, said in a phone interview today. He declined to provide further details.

Tokyo-based NTT spokesman Toru Maruoka said by phone that the company can’t comment without looking further into the matter.

“Dimension Data is aware that the Financial Services Board is proceeding with an investigation,” Hilary King, a spokeswoman for the company known as Didata, said by e-mail. “Dimension Data fully supports the Financial Services Board in their efforts. At this point in time, Dimension Data has no further comment.”

NTT on July 15 agreed to buy South Africa’s largest technology services provider in the biggest bid by a Japanese company for an overseas asset so far this year. Two days before the announcement, trading in Didata shares in Johannesburg tripled in volume compared with the year’s average at the time, as 7.98 million shares changed hands and the stock rose 4.9 percent. Trading the next day was double the 2.57 million-share average.

Under South African law, a person found guilty of insider trading can be fined as much as three times the equivalent of the profit or loss made on the trade.

Moore Said to Pay $25 Million to Settle CFTC Complaint, WSJ Says

The U.S. Commodity Futures Trading Commission is investigating whether Christopher Pia’s trading while at Moore Capital Management LLC involved market manipulation, the Wall Street Journal reported, citing an unidentified person close to the situation.

Moore paid a $25 million fine to settle a civil complaint filed by the CFTC in late April on the matter, the newspaper said. Moore neither admitted nor denied wrongdoing, the newspaper said.

An unidentified spokesman for Pia, who now runs Pia Capital Management LLC, declined to comment, according to the Journal.

Pia didn’t immediately respond to a message from Bloomberg News left on his office phone after business hours.

Compliance Policy

Basel Committee Says Bondholders Should Take Losses

The Basel Committee on Banking Supervision is proposing that debt counted as bank capital should be converted to stock or written off in a crisis, forcing bond investors to bear some of the cost of future bailouts.

All regulatory capital instruments sold by banks should be capable of absorbing losses if the company can’t fund itself, the committee said in a consultative paper that was released yesterday. Before taxpayers’ cash is used to rescue a lender, so-called contingent capital should be converted to equity or written off.

The committee, which sets international banking rules, wants to avoid a repeat of the financial crisis when government assistance to failing banks helped holders of some subordinated bonds dodge losses. Banks’ cost of capital may rise as investors demand compensation for the increased risk they won’t be repaid.

“It looks like the banks are going to be paying more for regulatory capital,” said John Raymond, an analyst at credit research firm CreditSights Inc. in London. “They’ll also have to look for a different investor base.”

The proposals will reduce moral hazard and excessive risk-taking by discouraging investors from buying securities with the assumption they will avoid losses if a bank fails, the committee said. It would also make private investors the first source of new equity to rescue a bank when it nears collapse, cutting down on the need for government bailouts.

“A public sector injection of capital needed to avoid the failure of a bank should not protect investors in regulatory capital instruments,” the committee said in the report, published on its website yesterday. The committee said it will welcome comments on the proposals until Oct. 1.

The Basel committee, which represents central banks and regulators in 27 nations and sets capital standards for banks worldwide, was asked by Group of 20 leaders to draft rules after the worst financial crisis since the 1930s. The committee is planning to present a final package of reforms to the G-20 leaders meeting in Seoul in November.

Regulators are proposing an “instrument that’s very different from what we have now and there’s no standard investor base to buy it,” said Oliver Judd, an analyst at Aviva Investors, the investment unit of the U.K.’s second-biggest insurer. “There needs to be some form of liquid market out there for investors to be willing to buy and that simply doesn’t exist.”

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Bond Dealers Want to Change Plan to Ban Advice on Muni Sales

The head lobbyist for U.S. regional bond dealers said a proposal to prevent banks from both advising on and underwriting municipal deals may raise financing costs for small towns and school districts.

They might not be able to get enough bidders for their debt, Mike Nicholas, chief executive officer of the Washington-based Regional Bond Dealers Association, said yesterday. The Municipal Securities Rulemaking Board, which this week proposed a ban, should allow firms to serve in a dual role in some cases, such as competitive auctions of debt, he said.

Mary Schapiro, the chairman of the U.S. Securities and Exchange Commission said May 7 that she wants to stop the practice, calling it an inherent conflict of interest. It can lead firms to recommend transactions that aren’t suitable or that aren’t offered at the best price, she said.

“If the chairman of the SEC is making a strong case for a change in practices, issuer-underwriter practices, it’s tough to see how that’s not going to happen,” Nicholas said in an interview in New York. “We’re looking forward to working with the SEC and MSRB on making sure it’s done in a conscientious way.”

The rulemaking board devises regulations for the industry; the SEC enforces them.

Unlike corporations, many local governments don’t have employees who specialize in raising capital, forcing them to rely on finance firms for advice on borrowing in the $2.8 trillion municipal bond market.

About 80 percent of the market is “negotiated” -- governments agree in advance to sell the securities to a preselected underwriter -- so dealers have an interest in exclusive relationships with municipalities. In a negotiated sale, prices and interest rates are set by the underwriter, rather than by banks at a competitive auction.

Barring dealers from working as advisers on competitive deals and then bidding on the bonds might raise borrowing costs for small issuers by limiting competition to buy the debt, Nicholas said.

“They have fewer firms that want to come in and underwrite that $7 million issue for fire trucks for Brownsville, Maryland,” said Nicholas. “We hear stories all the time of issuers that can’t get bids.”

He wasn’t able to immediately identify them.

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U.S. DOJ, FTC Revise Merger Antitrust Guidelines

The U.S. Department of Justice and the Federal Trade Commission said they issued revised “Horizontal Merger Guidelines” that outline how they evaluate the likely competitive impact of acquisitions and whether those mergers comply with U.S. antitrust law, in the first major revision of the guidelines in 18 years. The agencies commented in an e-mailed statement.

Mobile Phones Would Get FM Signals in Radio, Label Accord

Mobile telephones sold in the U.S. would need to receive FM radio signals under a proposal pushed by broadcasters as part of a tentative agreement to end a dispute over music royalties.

Requiring phones to become radio receivers would be part of a deal to pay artists for airplay between the National Association of Broadcasters, representing radio companies led by CBS Corp. and Entercom Communications Corp., and the MusicFirst Coalition of artists and record labels. A trade group for makers of mobile phones opposes the plan.

The possible requirement is a “back-room scheme” and “the height of absurdity,” Gary Shapiro, chief executive officer of the Consumer Electronics Association, said in an e-mail. The group in Arlington, Virginia, lists among members, Apple Inc., Hewlett-Packard Co. and Motorola Inc.

“Forced inclusion of an additional antenna, processor and radio receiver will compromise features that consumers truly desire, such as long battery life and light weight,” Shapiro said. Broadcasters and the music industry are “like buggy-whip industries that refuse to innovate and seek to impose penalties on those that do,” he said.

Music labels that sell compact discs and radio stations that play recordings are struggling as consumers use the Internet and devices such as the iPod from Cupertino, California-based Apple.

The broadcasters and the recording industry say they would endorse adding the FM radio requirement to legislation Congress is considering that would for the first time require payment to artists and labels when their recordings are played on stations. Broadcasters have opposed the measure. Satellite and Internet radio already pay such fees.

An agreement over royalties is “a tremendous breakthrough,” Marty Machowsky, a spokesman for MusicFirst Coalition, said yesterday in an e-mail. The Washington-based group includes musicians and the Recording Industry Association of America that represents labels.

“There is no deal yet,” Machowsky said. He said his group will continue to push for legislation.

Radio executives meeting Aug. 6 in Washington said they oppose the pending legislation, and urged more negotiations, NAB spokesman Dennis Wharton said in an e-mailed statement that listed features of “potential terms.” The group didn’t vote on the agreement and discussions are continuing, he said.

“It is critically important to have broadcast radio’s unparalleled lifeline service available instantaneously in times of emergency,” Wharton said yesterday in an e-mail. “NAB would oppose any legislation related to royalties” that lacked the FM radio feature.

For more, click here.


HSBC Should Reveal Reports on Madoff Risk, Judge Says

HSBC Holdings Plc, Europe’s biggest bank, should turn over internal reviews of potential fraud and other operational risks at Bernard Madoff’s business from 2006 and 2008, a New York judge ruled.

U.S. Bankruptcy Judge Burton Lifland agreed on Aug. 17 to seek an order from the High Court in London forcing HSBC to hand over reports, contracts, audio recordings and documents related to examinations of Madoff’s firm conducted by an affiliate of KPMG International. HSBC acted as custodian bank for several funds that invested with the con man.

The last review was commissioned by HSBC in September 2008, about three months before Madoff’s arrest, according to the ruling. London-based HSBC and trustee Irving Picard in New York reached an agreement on which documents should be turned over if the U.K. order is issued, Manhattan court filings show.

HSBC and UBS AG, based in Zurich, are among banks being sued for billions of dollars by investors in so-called feeder funds who claim the banks failed in their duties as custodians. Lawsuits are pending mostly in Luxembourg and Ireland, where funds collapsed after Madoff’s arrest in December 2008.

The KPMG reports were entitled “HSBC Bank Plc Review of fraud and related operational risks at Bernard L. Madoff Investment Securities LLC,” according to the ruling. The bank also has an audio recording of a July 17, 2008, presentation by KPMG related to its reviews of Madoff risk.

HSBC spokesman Adrian Russell said the company can’t comment on ongoing litigation.

Banco Santander SA, the Spanish bank that lost $3.2 billion in the scam, did a similar study of potential risk at Madoff’s firm in 2006, according to court records in a lawsuit filed by investors. The bank allegedly identified threats tied to his secrecy and accounting practices without notifying customers.

Picard in July 2009 sued HSBC and Cayman Islands-based Herald Fund Spc for the return of $578 million of “fake” profit withdrawn from Madoff’s firm. A hearing on a request to dismiss the case is scheduled for Nov. 4 in New York. Herald has also sued HSBC.

Picard is seeking the return of about $15 billion to repay victims through lawsuits filed against hedge funds and other parties that profited from the $65 billion fraud. Madoff, 72, pleaded guilty last year and is serving a 150-year sentence.

HSBC’s Luxembourg unit was custodian for Herald (Lux) US Absolute Return Fund, which was forced to dissolve because of Madoff-related losses. The bank was sued by investors in Ireland for allegedly failing in its duties as custodian for Thema International Fund Plc and AA (Alternative Advantage) Plc, two funds that lost money in the fraud.

HSBC in January was ordered by a court in Ireland to disclose how much control Madoff had over assets the bank transferred to him from two Dublin funds.

To contact the reporter on this story: Ellen Rosen in New York at

To contact the editor responsible for this story: David E. Rovella at

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