Underwriters Paying to Pass Bond Issues Face Scrutiny
Soon after investment bank Morgan Keegan Inc. gave $1,000 to a committee backing voter passage of a bond authorization for Rogers, Arkansas, in September, the bank earned $502,000 selling the approved debt.
The town’s fee to raise $77 million exceeded the national average for similar debt sales by 14 percent, according to data compiled by Bloomberg. It went to the investment bank, a unit of St. Petersburg, Florida-based Raymond James Financial Inc. (RJF)
“If you contribute, you get selected,” said Christopher “Kit” Taylor, a former executive director of the Alexandria, Virginia-based Municipal Securities Rulemaking Board, which sets guidelines for the municipal bond market. “For the bank, it is well worth the rate of return on the contribution.”
Underwriters that fund bond-authorization campaigns and then collect fees from approved debt sales are among the unresolved pay-to-play issues in the $3.7 trillion municipal market. The MSRB, after collecting data on dealer contributions to bond campaigns for two years, is starting to examine the need for restrictions based on such contributions, said Ernesto Lanza, deputy executive director and chief legal officer.
Hiring an underwriter based on whether it supports a campaign rather than its ability to market bonds can lead to issues from mispricing, which can hurt investors, to higher fees and borrowing costs for taxpayers. The rulemaking board’s focus is on ensuring investors are protected, Lanza said by telephone.
“When people aren’t hired on merit, the potential for a deal going bad increases,” Lanza said. “We’re trying to do the best we can to promote underwriters being hired on merit and not based on whether they contributed to a campaign.”
The MSRB has banned would-be underwriters from giving to most campaigns for elected officials who could influence the award of bond sales. Banks have been divided over whether they should be allowed to support drives in favor of referendums authorizing debt issues that they later underwrite. Some say it creates the appearance of undue influence, while others say it merely helps issuers win the votes and finance needed projects.
“There’s an explicit tit-for-tat,” said Taylor. “Politicians say they can’t afford to support the bond election and it wouldn’t get done. This is a subtle form for taxpayer money supporting the election.”
Making such contributions is more widespread among smaller underwriters, such as RBC Capital, Piper Jaffray and Morgan Keegan, than larger dealers, including JPMorgan Chase & Co. (JPM), Bank of America Merrill Lynch and Citigroup Inc., according to disclosure filings with the rulemaking board.
The bankers involved tend to work with school districts and smaller cities, such as Rogers, Arkansas. Steve Hollister, a Raymond James spokesman, didn’t immediately respond to a telephone call and e-mail seeking comment on Morgan Keegan’s role in the Rogers sale, which paid for street and park improvements, fire and police equipment, and debt refinancing.
Lynn Keith, the executive assistant to Rogers Mayor Greg Hines, didn’t immediately respond to an e-mailed request for comment on the bank’s election role and the subsequent sale.
In some cases banks contribute cash to campaign committees. In others, they provide election services, such as preparing brochures explaining bond issues to voters. The practice, which occurs in many parts of the U.S., is more prevalent in Colorado, California and states in the Midwest and South.
Over the past five years, underwriters gave $1.8 million to successful school-bond campaigns in California and got almost all the work selling the approved bonds, California Watch reported earlier this month.
The rulemaking board is looking at and analyzing a number of issues tied to the practice. They include the distinction between a dealer giving to a campaign and running one, whether more disclosure or more limits are needed, current state laws and what effect any new restrictions could have on existing MSRB rules banning contributions to elected officials, Lanza said.
“There is a clear correlation between giving and getting the underwriting business,” he said.
The solution, according to Taylor, is for more bonds to be sold through competitive bidding rather than hiring underwriters to negotiate a debt sale.
“It’s a tough one because issuers know how to exploit the situation by saying, ‘If you don’t contribute, we aren’t hiring you,”’ Taylor said. “They can extort money if it’s done negotiated, and no one is the wiser.”
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