Securities and Exchange Commissioner Richard Roberts, cautioning that some letter of credit banks may be pressuring municipal bond firms to give banks underwriting business, said Saturday he will seek regulations if necessary to block such "tying" arrangements.
Speaking to dealers meeting in Irvington, Va., Mr. Roberts also continued to press for regulation of sales of some conduit or unrated bonds. He outlined some new options for dealing with the problem of risky bonds, beyond his recent call for written suitability determinations.
Mr. Roberts told the Bond Club of Virginia he has been receiving complaints that some banks are linking providing letters of credit or other credit enhancements with using the bank for underwriting.
"I have been informed that banks frequently link credit extensions to an issuer, or enhancements to an offering, to use of the bank or its affiliate as an underwriter of the offering," Mr. Roberts said.
Such "tying" by a bank of one service to another is barred under federal law, he said.
He added, however, that private lawsuits are rarely, if ever, brought for these violations, partly because the violations are so hard to prove and firms are reluctant to alienate bond issuers and lenders.
And, "for whatever reason," he said, enforcement actions are rarely brought by regulators.
Mr. Roberts did not identify those who have complained.
But an official with one Alabama-based dealer, Merchant Capital Corp., yesterday disclosed that he and others at his firm have sent letters to Mr. Roberts recently warning that this practice is common and growing rapidly.
"Once they have a company hostage on the credit side, they can do what they damn well want to on the other side," Thomas Harris, senior managing director for Merchant Capital Corp., warned in a June 2 letter. Attached to the letter is a copy of paperwork fro an Ohio-based bank that the Merchant official says is a "blatant example of unfair competition."
One of the "conditions" on the issuance of the letter of credit, according to a commitment paper from the bank, is that, "The proposed credit enhancement by way of [the bank's] letter of credit is subject to the bank's financial corporation representation as agent of marketing of the bond issue."
Writing to Commissioner Roberts, Mr. Harris stated, "In today's tough credit environment, companies are reluctant to stand up against the banks on this issue for fear that they will be denied access to loans needed to operate and grow their businesses.
"When firms like us, and there are many, pull out of this market because of unfair competition, the banks will have it all to themselves," Mr. Harris says.
Mr. Roberts said that strict adherence to the fundamental anti-tying provisions of banking law is particularly important now as regulators eliminate many of the fire walls between banks and their affiliates. He said this is an area that should be monitored carefully to ensure that conflicts of interest abuses do not threaten the integrity of the municipal market.
"If it becomes clear to me that banks are continuing to violate these restrictions, then I am of the opinion that the SEC should consider" a rule on the subject, he said. He noted that the SEC in 1974 proposed a rule but later withdrew it, saying that "tie-in" violations are covered by existing antifraud provisions of the federal securities laws. Mr. Roberts said he has doubts they can.
He said the fact he is getting complaints from a variety of sources "causes me to take the seriously, although I am unable to state with certainty that they are valid."
Also Saturday, Mr. Roberts continued to loss out ideas for curbing abusive sales of conduit and non-rated bonds, while admitting some may be extreme. In a speech to the Public Securities Association in February, he proposed that brokers-dealers put in writing at the time of sale why they think a particular bond is suitable for a customer -- a requirement recently applied by the SEC to sales of penny stocks.
The SEC could go much further and require firms to not only make written suitability statements but require the customer to sign and return the statement prior to the trade -- called a cooling off period. Such a period could be useful, but "regulatory overkill," Mr. Roberts said.
A less intrusive approach, he said, would be to require broker dealers to get specific information from a customer before recommending a transaction and retain it in the firm's records. Or, broker dealers could be expressly required to inform customers of special risks concerning a bond before the trade.
Also, the SEC could require broker-dealers to provide a preliminary official statement to a customer 48 hours in advance of selling certain newly issued bonds to a customer, Mr. Roberts said. He also suggested the commission could propose legislation calling for registration of high-risk municipal bonds, although that may not affect Colorado special district bonds or many nursing home and hospital bonds that could be excluded as 501(c)(3) organizations, he said.
But Mr. Roberts said he does not yet have "factual data" to support any particular alternative. "You guys are the only ones who can provide us with that, so that burden has been shifted to you," he said. "If you think those abuses are not there, then it is incumbent upon you to make the case that they aren't."
He said, however, that his current aim is to try to "isolate those segments of the market where all the defaults are taking place, identify them somehow definitionally, and create a separate set of regulatory hurdles that those transactions must jump through to minimize the abusive environment that occurs."
"Most of us have an inherent fear of regulatory overkill," warned one Bond Club official, citing new Office of Thrift Supervision regulations for the savings industry "that have become this giant behemoth now that no one seems to be able to stop."
"One of the problems we see with regulations is that unless it is so perfectly defined, it's the chemotherapy effect," he said. "It kills the bad stuff but it kills all the good stuff around it at the same time. [As a result, we] tend to close our eyes and say, ~Don't give us anything because you can't seem to deliver the good stuff and keep out the bad.'"
Mr. Roberts said the official's objections "are certainly valid." So "now's the time to put your thinking caps on and give some thought to these things and come up with some constructive suggestions or alternatives, because otherwise we're left to our own devices," he said.
"Isn't this the municipal seatbelt law?" another participant warned. "If you are an investor you have to wear a seatbelt whether you want to or not."
Another questioner wanted to know why the SEC does not go after banks or special assessment districts.
Mr. Roberts answered, "Unfortunately or fortunately, the ability of the SEC issuers is severely circumscribed. There is little we can do."
"So that puts us in the penalty box," one participant retorted.
"Or go to Congress and get the law changed," Mr. Roberts said.
Asked to what degree he thinks the MSRB's continuing disclosure pilot system will help the situation, Mr. Roberts said, "It's hard to tell at this time. It takes time.
"At some point it is my opinion that the market will require secondary market disclosure and at that point CDI will be very helpful. But there will be a substantial time lag before that occurs. It's hard for me to assess how useful it will be immediately. Probably not very," he said.