A shadow world exists in the municipal bond business that has been all but ignored in the recent flurry of pledges and rules to clean up the market by banning campaign contributions.

According to a Bond Buyer investigation of the top municipal underwriters, virtually every major company relies on an intricate network of well-connected political consultants who would remain untouched by many of the proposed future regulations against influence peddling in municipal bonds.

In fact, most of the firms that recently pledged to cut off the campaign contribution spigot still employ consultants to win over the officials who choose underwriters.

And as was the case when the furor over campaign contributions captured the national spotlight, the industry defends the practice of employing consultants as entirely legal, ethical, and an integral part of the nature of public finance work.

But others, including some industry executives and the market's top cop, the Securities and Exchange Commission, warn that the largely secret system of relationships can easily lead to abuse. They say some taxpayer dollars could be going to municipal bond contracts awarded through connections rather than merit.

While it is difficult to link the hiring of a particular consultant to the awarding of specific bond deals, it is clear that in many cases associations between firms and consultants have preceded the awarding of bond contracts for the firms involved.

An aide who works for a New York-based issuer said that calls from political consultants supplement meetings with investment bankers. "They come and they say, ~we have this client in tow,'" the aide said. "To be honest, nobody has ever pressured me, although some people have insinuated" they have strong political ties.

Smith Barney Shearson has employed Michael Daley, the brother of Chicago Mayor Richard M. Daley, to lobby on state and county bond deals, a spokesman for the firm has confirmed. Daley's other brother, John, serves on the Cook County Board of Commissioners, which approves bond underwriters. Sources say Michael Daley is paid $15,000 a month.

Other connections reach to the White House. Rahm I. Emanuel, now a special assistant to President Clinton, worked as a consultant for Goldman, Sachs & Co. while serving as a top fund-raiser for the Clinton campaign.

To determine how extensive such relationships are, The Bond Buyer conducted a review that found:

* Nearly all major firms and a number of mid-sized bond houses use political consultants to help win municipal bond business, including firms that have been the most active in recent efforts to restrict campaign giving.

* Weak disclosure rules in many states allow municipal bond consultants to circumvent existing laws requiring other lobbyists to register with state agencies.

* Some consultants represent several firms simultaneously in the same geographic region, although most argue they do not work on the same bond deals for competing firms.

* The most common route to a consulting career is through city and state government, or through the multitude of public agencies and authorities that issue bonds.

Many consultants formerly held elective office and work for Wall Street firms. Others served on the staffs of governors, state legislators, and mayors. Either way, they make it their business to use old contacts and party ties to help their clients.

Some consultants are former securities professionals. And others are retained by municipal bond firms for their technical or legal expertise.

New York lawyer Basil A. Patterson, a former official in New York state and city government, and a friend of Mayor David N. Dinkins, said he "occasionally" does consulting work for Smith Barney in the area of "legal contracts." But, he said, "I've never made a contact for them."

Tonio Burgos, a former top aide to New York Gov. Mario M. Cuomo, said, "All that I do is give the client I represent the chance to make the case." Burgos, who serves with Patterson as a commissioner for the Port Authority of New York and New Jersey, is now a municipal bond consultant for Smith Barney and Glickenhaus & Co.

"I understand how government works," he said. "They have to get the business."

Many market executives take a harsher view of the practice.

In numerous interviews with The Bond Buyer, municipal finance executives said the continued use of consultants offers the potential for abuse at least as great as the perceived buying of business through contributions to state and local officials.

"There is nothing inherently wrong with lobbyists or consultants," said one public finance executive. "The problem is when there is a quid pro quo, when money is exchanged for business."

Market executives also said the fees paid to political consultants represent a hidden cost to taxpayers and bondholders. At least two securities professionals said they had reason to believe that senior managers of bond deals included consultant fees as part of the transaction's expenses, meaning that taxpayers shared the tab with investors.

"In many ways we have an inefficient market driven not by economic considerations, but by political patronage," said Mark D. Schwartz, a lawyer and former investment banker at Prudential Securities.

Schwartz does not see much prospect of change. "It seems as if those who are presently writing the rules on political contributions, themselves rely on a mechanism to get around those rules," he said.

Moving to Front Burner

But in recent weeks, municipal market regulators have begun to look more closely at political consultants.

In an Oct. 21 interview with The Bond Buyer's editorial board, Securities and Exchange Commissioner chairman Arthur Levitt Jr. said he was "very" concerned about the issue.

About a week later, the commission extended its inquiry into the ways municipal bond firms win underwriting business, asking the market's largest participants to detail their relationships with consultants, as well as employees who had served in government.

Christopher Taylor, executive director of the Municipal Securities Rulemaking Board, the market's self-regulatory agency, said the agency will soon examine how firms use consultants to win bond business.

"I am well aware" of the problems with political consultants, Taylor said. "Their use may not be necessarily bad. But the issue of political consultants is something that the board will be looking into."

One firm, Lazard Freres & Co., recently unveiled a statement saying consultants should not be hired if that would "subject the firm to embarrassment" if exposed "in the national media."

According to sources and public documents, political consultants are used by Prudential Securities; Lehman Brothers; Goldman Sachs; Smith Barney; Lazard Freres; CS First Boston; PaineWebber Inc.; Dillon Read & Co.; Donaldson, Lufkin & Jenrette Securities; J.P. Morgan & Co.; Merrill Lynch & Co.; and Bear Steams & Co.

One notable exception is Morgan Stanley & Co. A spokeswoman said the firm's municipal department does not use political consultants. "We believe business should be awarded based on good ideas, service, and the lowest cost of capital," the spokeswoman said. "If a consultant is needed to win business, then one may question the basis of the award."

With more attention being paid to Wall Street's use of consultants, at least one major firm is rethinking its strategy. David Clapp, a partner at Goldman, Sachs & Co., said that for the most part the firm is "phasing them out."

Clapp said that at the moment the firm employs about 10 consultants around the country, all on long-term contracts. "I thinks it's our general intention at the moment to phase them out," Clapp said, but the firm may continue to use consultants when necessary in "parts of the country where we don't know anybody."

In the White House

Market sources say Rahm Emanuel, President Clinton's special assistant, demonstrates why political consultants are in such demand from municipal bond departments.

Before joining the White House in January, Emanuel simultaneously worked for Goldman Sachs, the Clinton presidential campaign, the campaign committee for Chicago Mayor Richard M. Daley, and a consulting company called the Research Group.

Investment banking sources say Emanuel's multiple relationships gave Goldman unprecedented political connections throughout the country, demonstrating the conflict of interest problems associated with the use of consultants.

A spokesman for Goldman Sachs said nothing is wrong with Emanuel's serving in multiple roles. The spokesman said that while Emanuel was working at Goldman Sachs, he did not seek bond business from Chicago, where he once raised money for the Daley campaign. He was also prohibited from fund-raising for any current campaign.

However, others think Goldman could exploit Emanuel's Chicago connections in other regions of the country.

"It just shows that business is not earned through bond brilliance, and taxpayers and investors may be paying a premium for what could be an inefficient market," said one investment banker, who does not use consultants.

Emanuel earned a name as an aggressive fund-raiser for the Daley mayoral campaign. In a Feb. 22, 1989, draft memo, Stephen F. Olsen, associate vice president for Prudential Securities, "apologized" for the firm's "tardiness in getting checks" to Emanuel. The draft memo says Prudential had raised $3,500 for the Daley campaign, and planned to raise $15,000 more. Prudential officials have said they did not send the memo to Emanuel.

According to the latest federal disclosure documents, Emanuel worked as a consultant for Goldman Sachs, where he earned $35,000 in 1992.

The documents show that while Emanuel worked for Goldman Sachs from September 1991 to December 1992, he served as director of finance for the Clinton campaign, a position he held from November 1991, though November 1992, at a yearly salary of $60,000.

In an interview with The Bond Buyer, Emanuel termed his relationship with Goldman Sachs as a "consultant for Goldman's municipal division," working on "general political stuff" on a national level. He said he was paid $3,000 a month.

Emanuel would not go into details about his work for Goldman Sachs. A spokesman for the firm said Emanuel worked "on several projects" but did no consulting in Illinois.

Like Emanuel, Washington lawyer David Ifshin has helped Wall Street municipal departments make political inroads on a national level. Ifshin, who served as campaign counsel to President Clinton, a general counsel to the failed presidential campaign of Walter Mondale, and is currently a general counsel with the American Israel Public Affairs Committee, also works as a consultant for Prudential Securities.

Ifshin is widely regarded as an expert in election law and campaign financing, a talent he put to use at Prudential. He also has a talent for meeting state and national figures. As part of one friendship, Ifshin once took the son of former Ohio Gov. Richard Celeste on a trip to Israel in the late 1980s, a source with knowledge of the trip said.

In a telephone interview, Ifshin said he began his career with Prudential's public finance department in the fall of 1989 after stints with E.F. Hutton & Co. and Kemper Securities. He was asked to join Prudential by Gerald P. McBride, executive vice president and manager of the firm's municipal division, who asked him to "develop a national political public financing strategy."

Ifshin said one of his first tasks with Prudential was to develop a plan for expanding the firm's municipal-finance presence "without giving major contributions." He said he worked out contributions guidelines so that bankers would know "what's legal and what's illegal ... what's appropriate and what's inappropriate."

After a few months as a consultant, Ifshin became a Prudential employee to develop what he called a Washington capital markets department, he said.

"I was active in trying to take a public policy approach to demonstrate you can do the business by focusing on the merit of the case and by building relationships," Ifshin said. Ifshin confirmed that he actively sought business in New Jersey and Indiana, helping officials in the second state to understand the Clean Water Act and how to use municipal bonds to comply with its mandates.

Ifshin said he had asked to leave the firm as a full-time employee sometime last year because top executives told him that Prudential would not establish a Washington capital markets office.

When asked about the controversy surrounding the use of consultants and campaign contributions to win business, Ifshin said: "I feel very strongly that any business driven by campaign contributions is awful. I got involved to steer clear of that."

While Emanuel and Ifshin apply their craft on a national level, sources say many more consultants work locally. In Florida, for example, Merrill Lynch hired the firm of Chiles Communications to provide "public affairs and community relations assistance" to its public finance department, a Merrill spokesman said. The firm was owned by Lawton Chiles 3d, the son of Florida Gov. Lawton Chiles, until its sale in August of this year. Merrill used the firm from July 1992 until a month before Chiles sold the outfit, the spokesman said.

The spokesman said Chiles Communications would guide Merrill public finance executives as to "who they should talk to" in the state to obtain bond business, and as to "where business opportunities might present themselves."

A spokesman for the Florida governor said that the firm "divested itself" from lobbying in the state when Chiles took office in January 1991, and "converted to public relations."

Prudential also takes an interest in Florida. According to internal billing records from the firm, Prudential has spent tens of thousands of dollars on lobbyists and politically connected lawyers in Florida.

John Glidden, named the head of public finance at Prudential in April 1988, confirmed that the firm had numerous retainers paying "a couple thousand dollars a month" to firms. He said he sought to eliminate many of the agreements because they produced few results.

"There were a lot of retainer relationships around the country, not just in Florida, that weren't working so we got rid of them," said Glidden, who is now the manager of public finance at E.A. Moos & Co., a Summit, N.J., brokerage.

Disclosure laws often hamper efforts to determine exactly who lobbyists and consultants represent.

And in some cases, consultants will represent two or more firms that are attempting to win municipal bond business in the same general area. Robert Slagle, chairman of the Texas Democratic Party, has been a political consultant for Smith Barney Shearson for the past 13 years, helping the firm's bankers meet officials across the state.

But from 1990 to 1992, Slagle said he also worked for Goldman Sachs in largely the same capacity, although without working on the same project for both firms. "I represented Smith Barney and Goldman Sachs at the same time, but never against each other," he said.

Consultants are paid in a variety of ways. "Some consultants are paid huge finders fees, others are on retainer and still others receive success fees," said one veteran political lobbyist.

The payment of consultants based on their success in helping a firm win business is particularly disturbing, several executives said, because the practice fosters an atmosphere where business is not awarded on the merits of a financing proposal.

Consultants employed by governments agencies have also worked for Wall Street municipal bond firms. The San Diego County water authority uses Ben Clay, from the firm Carpi & Clay, as its lobbyist in Sacramento, the state capital. At the same time, Clay works as a municipal bond consultant for Prudential Securities in the San Diego area. Clay, who says he does not lobby the authority on behalf of Prudential, said he never recommends that clients select Prudential.

Instead he sets up meetings between Prudential bankers and the government aides who make most of the underwriter selections in the area. "Talking to the mayor doesn't cut it," he said. "They need to talk to the finance directors."

Clay's wife, Nikki, who works for Stoorza Ziegaus Metzger Advertising in San Diego, confirmed that she has also worked as a political consultant for Lehman Brothers, while the authority has hired her employers for advertising work.

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