Behind Closed Doors: The Private Bids For Public FundsLarry Light
Travelers on the New Jersey Turnpike must traverse one of the most unlovely spots on the planet--a massive oil-refinery complex with a memorable aroma. But there's another stink lately along the Garden State's storied throughway. It surrounds the New Jersey Turnpike Authority's 1991 and 1992 sale of six bond issues worth $2.9 billion. None of the bonds was sold through competitive, public bidding by Wall Street underwriters. The authority negotiated the bond sale with underwriters--and touched off a full-blown scandal. Amid suspicions of kickbacks and favoritism, federal prosecutors have launched a probe.
Trouble is, avoiding competitive bids is standard practice, both in New Jersey and around the country (chart). Last year, only 10% of the bonds issued by New Jersey or its authorities were publicly bid. Nationally, a mere 19% were. And that's a trend: In 1980, 41% of all muni bonds went through competitive bidding.
Critics argue that competitive bidding saves issuers money and reduces the likelihood of improprieties. Government bodies solicit bids from underwriters and simply select the one offering the lowest interest rate and fee. "You don't have to pay off anyone if it's competitive," comments Richard Lehman, head of the Bond Investors Assn. in Miami Lakes, Fla. "Competitive bidding should be compulsory."
HOMETOWN TILT. New York State requires all its bids to be competitive, except in extraordinary circumstances, such as a very complicated issue that buyers might spurn unless the underwriter has the right marketing savvy. That has happened only twice, in 1986 and 1992. New Jersey Governor Jim Florio, smarting from the scandal that has enveloped his chief of staff, adopted New York-like strictures on May 3--and went beyond New York by extending them to independent bodies like the turnpike authority.
Most states and localities, though, agree with Wall Street that negotiated deals usually make more sense. Typically, they solicit proposals on how investment firms would structure a deal, then choose the best, but not always the cheapest, plan. Fees on negotiated deals average $9.35 for each $1,000 bond vs. $8.99 for competitive deals. That doesn't look like a huge difference, yet it amounts to big money on multimillion-dollar transactions.
When a deal is complex, Wall Street argues, the usually higher fees afforded by negotiation are necessary for underwriters to stir customer interest. "The more complex the story, the more work underwriters face explaining it to investors," says J.B. Kurish, research director at the Government Finance Officers Assn. An airport authority, for instance, might disconcert investors if it were funded by multiple revenue streams--maybe a fee on taxis and a levy on hotels--instead of one easy-to-understand source. And increasingly, muni deals involve exotic financials, such as interest-rate swaps, making for an even tougher sales pitch. "Besides," says Heather L. Ruth, president of the Public Securities Assn., a Wall Street trade group, "corporate issuers don't use public bidding."
Municipal officials say privately that they have altruistic reasons for favoring negotiated deals, too: They are easier to tilt toward disadvantaged groups, such as underwriting firms that are owned by minorities, women, or disabled veterans. And also toward hometown firms that lack Wall Street heft, but who employ local folks. That's where politics can creep in.
Certainly, mandating that all bids be competitive is no magic cure for hanky-panky. Through the years, there have been numerous scandals involving corrupt public officials rigging competitive bids. One dodge is to leak the competition's bids to a favored underwriter, then secretly slip in his low bid after the deadline. To combat this, the state of Texas set up a special board five years ago to review all bond issues. That's one way to stop the politically connected from collecting municipal manna.
Larry Light, with Leah Nathans Spiro in New York