WASHINGTON -- Issuers should make sure they have policies in place to prevent the release of inside information before advanced refundings in the municipal market, a Securities and Exchange Commission adviser said last week.

"There are a lot of rumors about this occurring in the municipal market," said Edward Pittman, a panelist at the Michigan Treasurer's Conference in Traverse City, Mich.

"You should be sensitive" to this, he said. "If you don't have policies in place right now to prevent this kind of information from being released to the market prematurely then you ought to be thinking about that."

Mr. Pittman is counsel to former Alabama bond counsel Richard Roberts, who sits on the commission.

Until now, the SEC has focused its investigations of insider trading on the equity markets. But that is changing, said Mr. Pittman, whose boss has been pushing the agency to step up its oversight of the bond markets.

"We are beginning to notice a lot of preannouncement trading in [corporate] junk bonds that has heightened our interest," he said. "We are going to be looking at some of those in the course of our investigations over the next year. We may also be focusing on insider trading prior to advanced refundings of municipal bonds."

He rejected arguments by some market observers that insider trading does not exist in the bond markets.

"The insider trading laws probably apply equally in this context," he said, referring to advanced refundings. "We may have to use some different theories," he said. "But I can tell you that we are a very inventive group of people."

Mr. Pittman, who was a key drafter of the SEC's year-and-a-half-old municipal disclosure rule, said the agency may look for guidance to the different policies in force in the states, many of which have laws that prevent the misuse of confidential information.

"I know there are people being criminally prosecuted in the state of Kentucky for releasing similar information about an upcoming bond tender," Mr. Pittman said, referring to what is believed to be the first instance in which municipal market participants have been charged with insider trading.

In an advanced refunding, an outstanding issue of bonds is replaced by a new issue of bonds prior to the date the existing bonds can be redeemed. The bonds to be refunded will eventually be rated triple-A by Moody's Investors Service and Standard & Poor's Corp. because the proceeds from the new bonds will be invested in government securities and thereby guarantee principal and interest on the old bonds. Because of that, they will demand higher prices.

Theoretically, a government source said, one way insider trading could occur is if a given investment banking firm's underwriting department is handling a refunding and its trading desk learns about the upcoming transaction. Knowing that the advanced refunding will bump up the price of the bonds, the desk scarfs up the securities and sells them later.

They buy low and sell high by trading on an event they themselves are going to engineer. No lawsuit has ever been brought charging a firm with such insider trading.

In the Kentucky case, the former secretary treasurer of the Kentucky Infrastructure Authority and his father are charged with conspiring to buy $110,000 of 1973 bonds from a Louisville bank on July 5, 1990, and then to resell them to the authority in early August -- knowing that a tender option program involving the bonds would allow them to profit from the transaction.

In other comments, the SEC aide said that the commission is stepping up enforcement over all in the municipal bond area, although he doubts that it will ever be as active there as in equities.

"I can tell you today that we have more enforcement actions on the back burner that haven't surfaced yet that involve municipal issuers and underwriters than at any point in time that I can remember.

"I don't mean to scare you," he added. "I don't think you are ever going to see the kind of enforcement program in the municipal market that we have in the corporate equity market.

"But major defaults involving a lot of unsophisticated investors such as we've seen in Colorado and with retirement bonds over the past two years really put a lot of pressure on the commission to become more actively involved in this market."

Mr. Pittman outlined some "red flags" that the market should watch for, including failures to disclose the effects of the current recession on the local economy. "If there's any kind of known trend or commitment problems you see developing as a result of recession that are reasonably likely to have an impact on taxes or revenues, you need to be sensitive to that and make sure that's in disclosue documents.

"So when you are in the process of marking up last year's official statement for your note offering, think twice about these issues, because if there is a credit problem down the road, it's the kind of thing that's easy for plaintiffs' lawyers to spot."

Another "red flag" for the SEC, Mr. Pittman said, is conflicts of interest that are not disclosed to investors. He referred to "related party transactions," such as when the issuer is a corporation formed by the developer.

He urged market participants to pay close attention to the Government Finance Officers Association's new disclosure guidelines when preparing official statements. "There is a great portion of those guidelines that is germane to most offerings," he said. And although they do not have the force of law, "I foresee that in the future if you are for some reason involved in civil litigation, people are going to be [referring] to these guidelines as industry standards. So be alert today."

Mr. Pittman warned that if voluntary industry guidelines do not work, "you could end up with a 50-state regulatory scheme.

"Each of the individual states are becoming more active in disclosure now, and I could easily envision a world such as we have for corporate securities today where we have to go through every state and make sure all requirements of that particular securities administrator are satisfied before you can market your bonds," he said. "That's the hammer if the voluntary disclosure efforts don't work."

The SEC aide said that another area that is "gaining momentum" at the SEC is the need for better price dissemination in the municipal market. He said that in 1975, the SEC embarked on a major project of improving "price transparency" for trades in corporate equities in the over the counter market. The decision was made at that point not to take on the debt markets, he said.

"Now 15 years later, there's an enormous disparity between the kind of information you can get from sitting at a Quotron machine trading equities and the amount of information available to the typical bond investor," he said. "There should not be that kind of spread in quotes," he said, pointing to poor reporting of prices as the problem.

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