Promises, promises: Finra probes B-Ds' retail muni sales practices

Questions whether issuers were given fair access to small investors

Sep 27, 2009 @ 12:01 am

By Jed Horowitz

The Financial Industry Regulatory Authority Inc. is investigating whether broker-dealers are meeting their obligations to municipal-bond issuers who seek distribution to retail investors.

The probe, which so far hasn't been raised to the level of a sweep investigation, has been spurred by the growing number of muni-bond tombstone advertisements designating specific sales periods for retail investors.

“We're looking at the terms of the distribution agreements with municipal issuers,” Malcolm Northan, Finra's director of fixed-income securities, said Thursday at a legal and compliance conference in New York sponsored by the Securities Industry and Financial Markets Association.

Finra doesn't have access to firms' retail allocation databases, but wants to know how brokers are defining the word “retail” and whether they are meeting promises made in requests for proposals and other documents to distribute a certain portion of a deal to small investors. Issuers sometimes prefer retail investors because they tend to hold the bonds longer than some institutional investors.


The regulator's interest in the mechanics of so-called retail order periods — priority days in which sales are reserved for retail investors — was piqued by recent questions in the press and other circles about whether some popular billion-dollar bond issues from California and other issuers really could be absorbed by small investors in the limited order periods designated, Mr. Northan said at the conference.

Last week, California priced a giant $8.8 billion issue of revenue anticipation notes, with retail investors ordering 75.4% of the sale. The deal, whose various series yielded 1.5% and lower, was oversubscribed, the state said.

Finra also wants to determine if some brokers are parking shares of hot muni bonds with friendly institutional clients who agree to return the securities to underwriters, who then sell them to retail investors at higher prices in the secondary market. That could leave issuers at a disadvantage, because they may have been able to get lower rates for the original issue.

Mr. Northan wouldn't discuss a time frame for the investigation or say how many brokers may be examined. The Municipal Securities Rulemaking Board, which issues rules to promote fair and efficient markets for muni bonds, also is interested in the issue, said its executive director, Lynnette Hotchkiss.

Separately, Mr. Northan and an official from the Securities and Exchange Commission said that regulators continue to pursue settlements with brokerage firms that sold now-illiquid auction rate securities to clients, but didn't organize the auctions. Regulators and investors who have lawsuits against brokers have claimed that auction rate securities were promoted fraudulently as liquid, slightly higher-yielding alternatives to money market instruments.

Auctions, at which investors could buy or sell the securities every seven to 35 days, have been largely moribund since February 2008. More than $330 billion of the securities were left outstanding.

“It still is a very big problem,” said Mary Simpkins, a senior special counsel in the SEC's Office of Municipal Securities. “There are a lot of people who are still stuck in those securities.”

Investors continue to swamp regulators with complaints about auction rate illiquidity, Ms. Simpkins said.


Many large broker-dealers — such as The Goldman Sachs Group Inc. and UBS — that orchestrated the auctions have agreed to multibillion-dollar settlements. And though some mutual fund companies and muni issuers have redeemed the issues, regulators are now pursuing “downstream” brokerages that sold the securities to investors.

TD Ameritrade Holding Corp. in July agreed to repurchase $456 million of auction rate securities from investors who bought them directly from the firm. While about 10 firms that have made similar settlements, some firms, such as The Charles Schwab Corp. and Morgan Keegan & Co., have denied liability and are being sued by the SEC, state regulators and other authorities.

The paradox for regulators pursuing a solution is that many smaller firms don't have the money to repurchase the securities, or risk violating their capital requirements if they settle.

“The auction rate investigations are continuing, and we are concerned about capital issues,” Ms. Simpkins said.

Finra continues to pursue downstream firms to make auction rate clients whole, Mr. Northan said, but he told the audience of brokerage firm lawyers and compliance officials that the regulator doesn't think that firms deliberately deceived investors. The auction rate market had been operating successfully for more than 20 years before last year's credit crisis caused its collapse.

“It was a messy time, and these are messy products,” he said. “We need to work our way out of it.”

E-mail Jed Horowitz at


What do you think?

View comments

Recommended for you

Upcoming Event

May 14


Retirement Income Summit

Join InvestmentNews at the 13th annual Retirement Income Summit—the industry’s premier retirement planning conference.Clients and investors continue to search for retirement income solutions and personalized investing advice. This... Learn more

Featured video


Why advisers are pessimistic about the economy

Deputy editor Bob Hordt and senior research analyst Matt Sirinides discuss a recent InvestmentNews survey of advisers, most of whom see a recession ahead before the next presidential election.

Recommended Video

Keys to a successful deal

Latest news & opinion

Advisers throw cold water on FIRE movement

Millennials love it, advisers don't: Turns out, extreme early retirement is a suitable goal for almost nobody.

10 universities with the most billionaire alumni

These 10 American schools have the greatest number of alumni who are billionaires.

Top-performing ETFs of 2018

The markets took a beating last year, but these exchange-traded funds bucked the trend

Morningstar says investors rushed the exits in 2018

Net flows into mutual funds and ETFs were the lowest since the 2008 financial crisis, while money-market funds captured inflows.

Widow awarded $4.2 million by Finra panel for theft by ex-Royal Alliance broker

The former broker, Gary Basralian, earlier pleaded guilty to theft and is facing up to 20 years in prison.


Hi! Glad you're here and we hope you like all the great work we do here at InvestmentNews. But what we do is expensive and is funded in part by our sponsors. So won't you show our sponsors a little love by whitelisting It'll help us continue to serve you.

Yes, show me how to whitelist

Ad blocker detected. Please whitelist us or give premium a try.


Subscribe and Save 60%

Premium Access
Print + Digital

Learn more
Subscribe to Print