‘Flip­ping’ Cases Raise Ques­tions

The Bond Buyer - - Front Page - By Kyle Glazier

– Ac­tiv­i­ties like the flip­ping and kick­back scheme reg­u­la­tors brought to light in Cal­i­for­nia last month could un­der­mine the in­tegrity of mu­nic­i­pal of­fer­ings, though one mar­ket par­tic­i­pant sug­gests such con­duct may be an un­in­tended con­se­quence of ef­forts to po­lice pri­or­ity or­der pe­ri­ods.

The Se­cu­ri­ties and Ex­change Com­mis­sion took ad­min­is­tra­tive ac­tions ear­lier this week to bar or sus­pend sev­eral more em­ploy­ees of RMR As­set Man­age­ment, a Cal­i­for­nia-based firm that al­legedly par­tic­i­pated in a years-long scheme that the SEC is con­tin­u­ing to in­ves­ti­gate.

It is un­clear how per­va­sive such con­duct is in the muni mar­ket, but the Mu­nic­i­pal Se­cu­ri­ties Rule­mak­ing Board is con­cerned enough with what it calls “pre-ar­ranged” trad­ing that it plans to is­sue a re­quest for com­ment re­gard­ing the prac­tice.

The ac­tions an­nounced late Tues­day in­cluded or­ders against RMR and seven in­di­vid­u­als charged with pos­ing as re­tail in­vestors in or­der to gain pri­or­ity ac­cess to new-is­sue mu­nis that were then “flipped” for profit to their own cus­tomers as well as the cus­tomers of other bro­ker-deal­ers. In ad­di­tion to sanc­tion­ing the firm, the SEC barred or sus­pended RMR ownWASHINGTON

er Ralph Riccardi as well as “in­de­pen­dent con­trac­tors” David Lut­tbeg, Philip Weiner, David Frost, Ti­mothy McAloon, Dou­glas Der­ry­berry, and Dewey Tran.

Nearly the en­tirety of RMR has now set­tled fol­low­ing sep­a­rate judg­ments levied against them in fed­eral court, while nei­ther ad­mit­ting nor deny­ing the SEC’s find­ings. Oth­ers con­tinue to face lit­i­ga­tion.

Ac­cord­ing to the SEC’s com­plaint, the men op­er­ated as un­reg­is­tered bro­kers from 2009-2016 when they used fake busi­ness names linked to lo­cal zip codes in or­der to fool is­suers of muni bonds into think­ing they were lo­cal re­tail in­vestors. This al­leged ruse gave them pri­or­ity to pur­chase bonds, which they then sold to cus­tomers who had in­di­cated in­ter­est in them. This was usu­ally “at a price of one dol­lar above the ini­tial of­fer­ing price, with­out ne­go­ti­a­tion and ir­re­spec­tive of mar­ket value,” the SEC said in its com­plaint.

The case also in­volved an­other firm al­legedly op­er­at­ing as an un­li­censed bro­ker-dealer, Core Per­for­mance Man­age­ment, and the for­mer head of mu­nic­i­pal un­der­writ­ing, sales and trad­ing at reg­is­tered New Jer­sey-based bro­ker-dealer NW Cap­i­tal Mar­kets Inc.

LeeAnn Gaunt, chief of the SEC En­force­ment Divi­sion’s Pub­lic Fi­nance Abuse Unit said last month that the con­duct al­leged in the com­plaints “pre­vented true re­tail in­vestors from re­ceiv­ing pri­or­ity in mu­nic­i­pal bond of­fer­ings.”

The SEC is not alone in its con­cerns, ac­cord­ing to MSRB Chief Reg­u­la­tory Of­fi­cer Lanny Schwartz and MSRB Gen­eral Coun­sel Michael Post. The two men noted that the MSRB amended its Rule G-11 on pri­mary of­fer­ing prac­tices in 2013 to re­quire deal­ers to re­port to un­der­writ­ers whether or­ders they re­ceived in a re­tail or­der pe­riod met the is­suer’s re­quire­ments for that or­der pe­riod.

MSRB rule­mak­ing over the years has aimed to give the is­suer con­sid­er­able power to make de­ter­mi­na­tions about re­tail or­der pe­ri­ods and other pref­er­ences, Schwartz and Post said, and con­duct un­der­min­ing those ef­forts trou­bles the board. “Yes, we are con­cerned,” Schwartz said Wed­nes­day.

The MSRB had been plan­ning to ask the mar­ket to weigh in on whether it should is­sue new guid­ance un­der Rule G-17 on fair deal­ing that would ad­dress so-called “pre-ar­ranged trad­ing” that in some cases can look like the con­duct al­leged in the SEC’s com­plaints against RMR and Core Per­for­mance Man­age­ment. After the SEC en­force­ment ac­tion, Schwartz said, the MSRB is now “wait­ing for the dust to set­tle.”

Ac­cord­ing to a doc­u­ment cir­cu­lated by the MSRB, the board is con­cerned about sit­u­a­tions in which a dealer con­trac­tu­ally agrees to buy bonds from an in­vestor at a markup in or­der to have a bet­ter chance of get­ting those bonds into its in­ven­tory. The dealer com­pen­sates the in­vestor with that mark-up be­cause it be­lieves it will be able to sell those bonds at an even higher price in the sec­ondary mar­ket. The MSRB said it has con­cerns about le­git­i­mate re­tail cus­tomer or­ders be­ing given less pri­or­ity.

Such ar­range­ments are of­ten made through in­sti­tu­tional in­vestors, rather than re­tail in­vestors, al­though some sources said re­tail in­vestors can also fig­ure into such ar­range­ments.

The MSRB wanted to know, ac­cord­ing to the doc­u­ment, whether such con­duct was fair and whether or not the MSRB’s con­cerns were valid. A lawyer who asked not to be iden­ti­fied said there ap­pears to be a roughly equal split on those ques­tions.

Dee Wisor, an at­tor­ney at But­ler Snow in Den­ver, said he was not aware of any per­va­sive prob­lem with “flip­ping” or pre-ar­ranged trad­ing. But he said is­suers would prob­a­bly care if re­tail or­der pe­ri­ods were be­ing flouted.

“That’s where they’d be con­cerned,” Wisor said. “If some­how bonds weren’t end­ing up with peo­ple in their lo­cal com­mu­ni­ties, if that’s what they want.”

An­other lawyer said that pre-ar­ranged trad­ing and flip­ping are in­cen­tivized by the MSRB’s ef­forts to crack down on the his­tor­i­cally more loosely-reg­u­lated area of re­tail and other pri­or­ity or­der pe­ri­ods. While the lawyer agreed that col­lud­ing to sub­vert the is­suer’s stated cri­te­ria for or­ders was wrong, he said he thought an in­vestor could le­git­i­mately pur­chase bonds to sell to an in­ter­ested dealer at a profit so long as such ac­tiv­ity was not fre­quent enough to be­come his or her “busi­ness,” as they might then be­come an un­reg­is­tered bro­ker dealer be­cause the law de­fines a dealer as one “en­gaged in the busi­ness” of buy­ing and selling se­cu­ri­ties.

“How tightly one should de­fine and en­force re­tail or­der pe­ri­ods is a ques­tion in it­self,” the lawyer said. “Are we just go­ing to be chas­ing our tails for years?” ◽

Dee Wisor, an at­tor­ney at But­ler Snow in Den­ver, said he is not aware of any per­va­sive prob­lem with “flip­ping” or pre-ar­ranged trad­ing.

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