Standards of behavior long considered innocuous by market players are toppling under the weight of a new nationwide scrutiny, and ethics experts say a much stricter code of conduct is likely to emerge.

Secret contracts and political pay-offs, campaign contributions made with expectations of a quid pro quo, political influence peddling - all are practices that in recent months have surfaced at the center of scandals involving municipal bonds.

The defense has been raised that such practices, which are usually described in more benign terms by the bankers involved, have been the norm for many in the industry for decades.

The norm, that is, until April 28.

On that day, public reports first surfaced that the U.S. attorney's office in Manhattan had issued a host of subpoenas to New Jersey addresses. The targets included the Turnpike Authority, the governor's office, Merrill Lynch & Co., and the owners of the now infamous Armacon Securities, based in Clementon, N.J.

Armacon, the story quickly emerged, was being investigated for trading irregularities with Merrill Lynch.

But the implication of the investigation has been that Armacon's owners, close political allies of Gov. Jim Florio, were awarded business or paid off in other ways to trade their influence in the administration on behalf of market players.

Several bankers, asked by reporters for their opinion of the investigation, said they were at a loss to explain what might be considered wrong with the practice of trading political influence for money or new business opportunities.

"These relationships are the currency of public finance work." one industry official said.

But outside analysts say serious matters are at stake.

Maintaining public trust means avoiding even the appearance of a conflict of interest. said Samuel L. Hayes, a professor of business ethics at Harvard University's business school. "The average citizen is not in the position to assess the underlying rationale of a transaction." he said.

Soul-Searching

The New Jersey inquiry and resulting debate touched off an unprecedented soul-searching in the industry and, with the disclosure of similar cases elsewhere, is likely to change company policies for a long time, according to several outside observers.

"The municipal market has been an informal market" for many years, said Hayes. That informality breeds opportunities for abuse. As more and more instances of corruption surface, reforms will be enacted that will ultimately make the industry more closely resemble its highly regulated corporate cousin, Hayes said.

"In the corporate sector, there are expectations of behavior which have been more codified than has been true in the municipal sector," Hayes said.

Robert Lamb, a professor of business ethics at New York University and author of several books on the municipal bond industry, said he expects regulators to pass new disclosure rules and possibly impose limits on campaign contributions.

The corporate market has seen abuses like secret payments and channeling business to the politically connected, "but they don't happen with as much frequency and are more likely to be revealed in the prospectus because of the threat of a shareholder suit," Hayes said.

Hayes was previously the chairman of the Finance Advisory Board of Massachusetts, which oversees local bonding plans and makes fiscal recommendations to cities and towns in the state.

In the mid-1970s, Hayes said, disclosure on some municipal bond deals in the state amounted to a three-page official statement. Since then, disclosure has improved in response to investor demand. For example, as municipalities sought to market their bonds to more sophisticated institutions, investors demanded and received more detailed explanations of how the deal was structured and who was profiting from it.

Still, regulations codifying such improvements in disclosure have been slow in coming. Currently, municipal issuers are exempt from most of the federal disclosure regulations that govern other kinds of bond issuers.

But in response to the growing scandals, the Public Securities Association recently called on the Securities and Exchange Commission to require issuers to provide more detailed secondary market information and to disclose political contributions they get from all segments of the municipal market.

But the association stopped short of calling for the broad array of disclosure required of corporate issuers, citing the cost to taxpayers.

The Municipal Securities Rulemaking Board, meanwhile, is developing its own proposals for shoring up public confidence.

Sources say board members are considering whether to ban political contributions to officials from the underwriters they hire, or requiring official statements to carry information about the extent of an underwriter's campaign contributions.

Small Contributions

Lamb said many of the practices now under attack have been around for decades, and usually do not involve corruption.

Political contributions, for example, usually fall in the $1,000 to $3,000 range, Lamb said. At those levels, there is little difference between members of the municipal bond industry and officials of any other industry who make contributions to support local politicians.

"It is not usually a quid pro quo," Lamb said. Contributions "have been the practice for decades and most of the amounts are quite small."

Lamb described the small-scale political contributions that have become so common in the industry as the "ante" bankers pay to make sure their proposals are given serious consideration by politicians.

"I think many of the firms that pay $ 1,000 view it as a cost of doing business, and don't expect to automatically get included in a deal because of that." Lamb said.

He said the danger emerges when the contributions become more sizable, or when they imply a more intimate relationship between bond underwriters and politicians. When reports of such situations are publicized, Lamb said, the public tends to believe it is indicative of more widespread corruption.

"I think the entire industry is being smeared with one brush," Lamb said. "There's no doubt corruption does take place and there are major ethical problems, but that is not the norm."

In addition, he said, underwriters are not the only group that needs to reexamine formerly accepted practices.

Financial advisory work, for example, is rife with instances in which potential conflicts of interest can emerge, as officials at the Massachusetts Water Resources Authority can attest.

Recently, the authority dismissed Mark S. Ferber as its financial adviser after he was forced to disclose details of a private fee-splitting arrangement he maintained with Merrill Lynch & Co. Authority officials say they knew almost nothing about the agreement.

The relationship, which lasted several years, raised questions for state officials about the ability of a financial adviser to provide unbiased advice when he simultaneously earned millions of dollars in fees from one of the companies vying for the authority's underwriting business.

The incident has underscored differences between the two major camps in the municipal financial advisory world - advisers who also underwrite bonds and earn fees from other aspects of the industry, and advisers who forgo the underwriting business for the sake of maintaining their independence.

Although on the surface, the second camp might appear to hold the more defensible position, Lamb said problems emerge with independent advisers as well.

Completely reliant on deals coming to market for their fees, some of these advisers become virtual "rubber stamps" for any bond issue a politician wants to propose, he said.

"So either [kind of adviser] could be ethical or unethical," Lamb said.

Lamb, who is also a debt adviser to several municipal issuers, also said that financial advisory firms that also maintain trading desks have a pricing advantage over independent firms. because they have a more direct line to the Street.

"Independent advisers have to depend on other firms for pricing information, " Lamb said.

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