Back Scratching On The StreetLeah Nathans Spiro
For decades, Wall Street investment bankers and state and local politicians have enjoyed a mutually beneficial relationship. Politicians dispense more than $1 billion in taxpayer dollars a year to the Street in fees to underwrite municipal-bond issues. The Street, in turn, sends politicians millions in campaign contributions. Some critics have termed the arrangement institutionalized back-scratching.
Now, these cozy bedfellows are coming under increasing scrutiny. The U.S. Attorney's office and the Securities & Exchange Commission are looking into whether Merrill Lynch & Co. bestowed financial favors on a tiny Clementon (N.J.) brokerage to win $2.9 billion worth of New Jersey municipal-bond business. At issue is whether the firm, Armacon Securities, helped Merrill get business through Armacon's part owner, Joseph C. Salema, who happens to be New Jersey Governor James J. Florio's chief of staff. All parties deny any wrongdoing or that they are targets of the investigations. Salema has said his Armacon stake is in a blind trust.
LITTLE RESTRAINT. Similar incidents have been coming to light around the country. "State and city legislators develop relationships over decades with firms or friends that involve campaign contributions and support; these get rewarded with contracts or deals," says Robert B. Lamb, professor of finance and management at New York University's Stern School of Business. The main reason for such incestuousness isn't very surprising: Unlike corporations, state and local muni issuers are unregulated, except in extreme situations of fraud. Typically, issuers don't even have to establish criteria or provide reasons for choosing underwriters. Underwriters' activities, in turn, are regulated mainly by the Municipal Securities Review Board, an obscure Washington self-regulatory group without enforcement powers.
Politicians and the industry are feeling the heat to clean up their act. On May 4, Florio signed an executive order requiring that underwriters for future bond deals be chosen by open, competitive bidding instead of less public negotiation (box). Even some industry participants feel reform of the $278 billion market is needed. "Given the complexity and evolution of the muni market, it may be time to rethink issues of market practices, market structure, and market regulation," says one public-finance banker at a major Wall Street firm.Several common industry practices may receive more attention. One perfectly legal practice is for investment banks, in order to obtain muni business, to hire political consultants who have close ties to elected officials--without public disclosure. And in many cities, politicians are even allowed to head their own financial firms while they are in office.Consider Jackson Securities Inc. In late 1989, just after he was elected mayor of Atlanta, Maynard H. Jackson purchased a 75% stake in a brokerage firm that then adopted his name. Jackson had been making more than $500,000 a year as a bond lawyer, and he viewed the investment as a way to supplement his $100,000 city salary. The city's Board of Ethics issued a confidential opinion about the relationship. Jackson won't discuss the opinion. But he says he told the firm not to do business with Atlanta and that "anyone who would do business with us also would have to agree not to do business with Atlanta."
CONSULTANT COUPS. In early 1991, however, Jackson says Miami investment banker Howard V. Gary invited his firm to help sell an $8 million bond issue for a Dade County (Fla.) agency. Two months later, Gary's firm was chosen as a co-manager of a $27 million bond underwriting by the city of Atlanta, a decision Jackson approved. The deal produced a spate of public criticism. Jackson says he wasn't told Gary was involved in the bond sale, adding that "he broke his word to us" about not doing business with Atlanta. Gary declined to comment. Jackson also announced his firm would no longer do any muni business as long as he remained in office. "It's important that both the perception and the truth be above accusation," he says.
Another politician with feet in both government and business is Austin (Tex.) City Council Member Louise Epstein, who is the owner of Peleton Capital Group Inc., a small firm that gives financial and investment advice to governments. Epstein, though, has found it difficult to mix business and her $30,000-a-year public job. "I had to go all the way out to West Texas to find a client where I didn't have a conflict." She is leaving government to devote herself full-time to her company.
Willie L. Brown Jr., speaker of the California Assembly, has a thriving and often controversial parallel career. He is a muni-bond attorney and advises corporate clients on state legislation, a business that nets him more than $100,000 annually, according to state Fair Practices Commission filings. Brown could not be reached.
Another accepted muni practice is for investment banks to hire political consultants to help obtain underwriting assignments or to gather intelligence. Goldman, Sachs & Co. employed Rahm Emanuel in 1991, who says he did political analysis before he became President Clinton's political director. Another Goldman hire: James H. Quackenbush, a South Carolina lawyer and well-connected Democrat. One PaineWebber Inc. consultant until recently was Charles Citrin, a fund-raiser for Joe Gersten, a former Dade County commissioner. Citrin helped drum up bond work in South Florida for PaineWebber. Other firms, such as Morgan Stanley & Co., have a policy of not hiring consultants.
Consultants often prove very effective. "To the firm, consultants are worth their weight in gold because, `He got us into Michigan' or `We wouldn't have gotten this or that business unless this guy was hired,"' says NYU's Lamb.
CLOSER SCRUTINY. Some states, though, are taking a harder look at Wall Street's helpers. Two years ago, the Massachusetts State Treasurer's office asked all brokerage firms it did business with to disclose their political consultants. The move came in response to a scandal in 1991 involving a longtime adviser to the state's pension funds who was also a consultant to Aetna Life & Casualty. Without always disclosing his Aetna affiliation, the adviser used his clout to persuade numerous municipal pension boards to invest millions with the insurance firm. "I've viewed it as a big problem that's been widespread," says State Treasurer Joe Malone. "The system has been that if [an investment firm] wanted to play, it had to hire the right consultant." To resolve the issue, Aetna voluntarily paid $8.8 million to some of the pension boards.
One of the reasons such practices flourish is that under the 1975 Tower amendment to legislation that set up the Municipal Securities Rulemaking Board, muni-bond issuers, unlike corporations, cannot be subject to the SEC's disclosure requirements. The MSRB, which is run by a board of industry and public volunteers, only handles rulemaking and arbitration for muni dealers. "The MSRB has a limited role and has no jurisdiction over the issuer community, which is not regulated in any way," says Barbara Lucas, a partner at Cadwalader, Wickersham & Taft.
A few states such as Florida have passed legislation to toughen requirements on bond underwriters. Yet considering the huge benefits to politicians and underwriters under the current system, incentive for change is limited. "Fighting this one is like taking on the National Rifle Assn.," says Richard Lehmann, president of the Bond Investors Assn. in Miami Lakes, Fla. "But I guarantee it has a cost to the public because the issuer will end up paying more." More disclosures, though, could force the politicians and underwriters to start scratching their own backs.
CONFLICT OF INTEREST?
Many politicians have interests in private firms that do business with government. Atlanta Mayor Maynard Jackson controls a brokerage house that may have benefited from an Atlanta municipal-bond underwriting. After public criticism, Jackson said the firm would discontinue muni deals. Willie Brown, speaker of the California legislature, is also a private muni-bond attorney and corporate advisor. Brown couldn't be reached for comment. Joseph Salema, chief of staff for New Jersey Governor Jim Florio, is part-owner of a brokerage firm that may have helped Merrill Lynch get muni business from the state. Federal prosecutors are investigating, but no charges have been filed. Salema denies any wrongdoing.