Arthur Levitt, Jr., the new chairman of the Securities and Exchange Commission, says he plans to continue to build up the agency's expertise in the municipal bond market by hiring some staff members with backgrounds in state and local finance.
"I'm looking at a variety of people who have expertise in this area that I want to come on board and assist us," Levitt said in an hour-long interview with reporters and editors at The Bond Buyer's New York City headquarters on Tuesday.
The plan to beef up the SEC staff in the tax-exempt area is Levitt's latest move to significant increase oversight of a market long considered a backwater by the SEC.
During the interview, the former chairman of the New York City Economic Development Corp. also offered views on the need for tougher standards governing disclosure of secondary market information and of markups, and for standards governing the quality and diversity of holdings of tax-exempt money market funds.
The son of long-time New York State Comptroller Arthur Levitt Sr., the new SEC chairman also headed the American Stock Exchange from 1978 to 1989 and later ran Levitt Media Co., a New York firm that is majority owner of the well-known newspaper that covers Congress, Roll Call.
Levitt's comments in the interview came as several key divisions at the agency are focusing increased attention on the municipal market. Yesterday, for instance, officials from the corporate finance division met with municipal industry representatives to begin developing a list of standard disclosure items that issuers should routinely make in the secondary market about their bonds.
The agency's market regulation division is studying a variety of proposals, including whether to bar dealers from selling bonds to investors where the issuer has not pledged to provide ongoing disclosure. The SEC's investment management division is expected to propose rules next year that would require money market fund managers to heighten the quality and increase the diversity of bonds included in tax-exempt money market funds.
Levitt's comments also came a day after he hold a press conference that the agency's enforcement division has a "number of inquiries underway" into "questionable activities" in the municipal bond market.
He told Bond Buyer reporters on Tuesday that enforcement officials are "proceeding" with the agency's investigation into allegations of influence peddling in the sale of New Jersey bonds. "We haven't announced anything yet," he said. Levitt would not comment on other possible investigations.
"I think there are a lot of problems with the debt markets in this country," Levitt said. "There are problems with insider trading, which we're seeing more and more of. There are problems with disclosure. There are enormous problems in terms of political contributions."
When it comes to contributions, he said, "this market is supposed to be the safest of the safe." But with all the "gameplaying" going on, it looks like an "oriental bazaar," he said. The problem has "gotten out of hand, outrageously out of hand," Levitt said, arguing that once a market's integrity is compromised it becomes a much more expensive place to do business.
"We can't afford to have the perception that has been reported on all over the country now that this is a payoff business," he said. "The customer is going to demand a higher premium for what he's buying. It's going to be more expensive to sell" bonds.
Levitt's remarks came one day after a group of Wall Street executives representing 17 firms agreed to voluntarily bar their municipal bond departments and top brass from making contributions to state and local officials who are responsible for awarding lucrative negotiated bond underwriting deals.
The move dovetails with a two-pronged rule proposed by the Municipal Securities Rulemaking Board on Aug. 30 that is aimed at limiting the growth of business-related contributions by Wall Street firms.
The MSRB rule would bar contributions by underwriters that are aimed at obtaining or retaining an issuer's business. The rule also would require dealers to report to the MSRB all contributions to issuers with whom they do business two years before and two years after each offering.
Levitt stressed that while the dealer's moratorium on contributions and the MSRB's rule would go a long way in curbing contributions, they are not "foolproof."
"I think we can squeeze the outrage out of it, but we are not going to squeeze favoritism out of our markets," Levitt said. "Nothing is going to eliminate the problem. You can't dot every ~i' and cross every ~t'. But it will do a lot to minimize it."
"The community appears to be impressed about our seriousness," Levitt said, referring to the announcement of Monday's moratorium by 17 firms on political contributions. "The best way to stop it is if the leaders of firms say, ~I'm not going to play this game any more.'" Levitt called "pretty terrific," for instance, the internal voluntary plan for limiting contributions submitted by Lazard Freres.
Levitt also gave a tentative thumbs up to a proposal made by the Public Securities Association on Oct. 5 that regulators include in the MSRB rule a "safe harbor" that would permit employees to continue to give contributions to issuers as long as the amounts fall under a set minimum.
"I haven't thought about it. My first response to that is that it would appear to be reasonable," he said.
He said that small contributions from individuals are not the problem, but rather the "bundling" of employees' contributions.
"It's the calling [of everyone] together and saying, ~Look, the comptroller of the state of California is coming to New York for breakfast. Everyone should give $250 dollars. We've got to raise [a given amount] to be respectable.' It's that kind of thing that we have to stop. There's a lot of that going on."
The SEC's chairman said he has grave concerns about whether today's retail customers have enough information about the bonds they are buying and the prices they are paying.
"They buy what their broker tells them to buy and very often they don't understand all of the details. The don't know whether their bond is rated, no less what it is rated. They don't know what price they are really paying and they don't know about call provisions. There's a whole host of other things that I think they should know about."
Levitt said he supports tightening the agency's Rule 2a-7, which sets quality and diversification standards for tax-exempt money market funds. The agency issued tough new standards for taxable funds last year, but a draft standard aimed at tax-exempt bonds was put on the back burner when the Bush Administration announced its 1992 moratorium on new rulemaking. The chairman said, however, that the agency is not likely to vote on a rule before 1994.
The chairman said it is "too early to tell" whether the SEC will propose a rule to require dealers to disclose price markups on investor confirmations. Levitt told a House panel last month that the agency is studying whether to require dealers to disclose markups on "riskless principal transactions" so that customers can better evaluate the prices they pay for their bonds.
Such transactions are prearranged sales where a dealer is purchasing from one customer and selling to another already lined up.
Dealers have argued that riskless principal transactions do not occur in the municipal market, but Levitt disagreed. "I believe there is a riskless transaction," Levitt said. "It is hard for me to accept the notion of a highly rated bond being bought in the morning, sold in the afternoon, and an hour later being [considered] non-riskless."
One reporter asked Levitt to discuss concerns that a secondary market disclosure rule being eyed by the SEC's market regulation division will disrupt sales. The agency may bar dealers from recommending bonds of those issuers that do not pledge to provide ongoing disclosure.
"Yes, it's a valid concern," Levitt said. "But the concern, in my judgment, does not outweigh the risk that is assumed by not having the disclosure. I think the advantages of disclosure are so overwhelmingly great that if a small community feels they can't comply with it because of the costs, they should not be in the market. Those are the very bonds that investors can't afford."
Levitt said he is "very concerned" that consultants are being used to "gain greater inroads" in underwritings. "I don't think those arrangements always work to the benefit of the [bondholder] and sometimes not to the benefit of the issuer," he said. Asked if the agency is considering a rule of the subject, Levitt said, "The group that is meeting on political contributions has been asked by me to consider investment advisers, and consultants and any of the other arrangements that are used to bring compensation to issuers of municipal bonds.
But Levitt said that with the increasing complexity of municipal bonds that are being marketed, there is a legitimate place of certain kinds of consultants. "To try to ban them as a group would be a mistake."
Levitt called it "a difficult line to draw. Hypothetically, you could see a municipality hiring somebody that served as a city finance official of one kind or another who had great expertise and competence in terms of structuring certain kinds of financings.
"Another banking firm, however, might hire someone whose only function is his contacts," he said. "It is very difficult to create a rule that distinguishes those two. In some cases it becomes very blatant. Those are the cases where our enforcement people around the country are going to look at very, very carefully."
Levitt also said he continues to have serious concerns about the level of negotiated deals in the municipal market and the fact that municipal officials select all syndicate participants.
"I am concerned about issuers who are nonprofessionals selecting the whole universe of underwriters that underwrite a given issue down to the smallest participants," he said. "In the corporate business it's rare that more than the upper bracket is selected by the issuer."
