* FINRA eyes "excessive entertaining" of rating agencies
* FINRA proposes debt research conflict-of-interest rules
* Ketchum says junk-bond retail sales also bear scrutiny
(Recasts lead paragraph)
By Joseph A. Giannone
NEW YORK, March 7 Securities industry
regulators are investigating municipal bond underwriters over
"excessive expenses" in entertaining officials of credit rating
agencies, bond issuers and their families to drum up business.
Financial Industry Regulatory Authority Chief Executive
Richard Ketchum, in disclosing the probe on Monday, did not
name specific firms but cited expensive meals and tickets to
sporting events and Broadway plays as examples of the
The municipal market has been plagued for years by
pay-to-play scandals involving broker-dealers, but they rarely
involved rating agencies.
"This is the first time I'm aware that these allegations
have been made in relation to a rating agency," said Ernesto
Lanza, general counsel of the Municipal Securities Rulemaking
Board, the municipal bond regulator that writes the rules that
FINRA and the SEC enforce.
The inappropriate behavior he cited is similar to Securities
and Exchange Commission probes in 2009 cases against firms that
flew issuer officials and some family members to New York in
prior cases. for the kinds of events cited by Ketchum.
"We have seen examples of excessive expenses for the
entertainment of issuer officials and rating agency officials,
which are then charged to the municipalities' cost of
issuance," he said at FINRA's annual fixed-income conference in
The effect is that underwriters get reimbursed for their
entertainment from bond proceeds, he said.
MSRB rules bar bond dealers from giving gifts in connection
with municipal securities activities, according to Lanza. The
definition is so broad that it encompasses many market
participants, even bond trustees, he said.
Moody's Investors Service and Standard and Poor's Ratings,
the two largest rating agencies, said they strictly enforce the
"While we are not aware of this investigation, Moody's has
implemented strict policies for our analysts that reinforce SEC
rules, which clearly prohibit the type of conduct alleged,"
said Michael Adler, a spokesman.
One of the large U.S. credit rating agencies, Standard &
Poor's, said it does not allow its employees to accept gifts in
exchange for business.
S&P spokesman Chris Atkins said the firm's code of conduct
"expressly prohibits our analysts from soliciting or accepting
gifts or entertainment. We don't permit it."
The investigation has also found payments to political
action committees listed as line items in new bond underwriting
expenses, as well as false representations of services never
performed by dealers, he said.
"These issues raise serious noncompliance issues and a
breach of ethics that we are continuing to investigate,"
FINRA's focus on underwriting expenses follows a move by
California's treasurer on Feb. 1 to bar underwriters from using
bond proceeds to pay fees to their lobbying group, the
Securities Industry and Financial Markets Association.
The investigation comes as the MSRB is considering
extending its "pay to play" rules for dealers to municipal
advisers. The self-regulatory group also has asked to SEC to
approve new rules that would force Wall Street firms to
disclose their political action committee membership lists and
Regulators for years have worked to bring more openness and
price visibility to fixed-income markets that, unlike equities,
have no central marketplace for price discovery.
"I wouldn't be surprised if it has been going on for more
than a little while," said Jacob Alpert, an executive vice
president at M.R. Beal, a municipal bond dealer in New York.
"People don't know where that line in the sand is (but) there
is a line definitely."
Ketchum also said Monday that FINRA wants fixed-income
research analysts to be subject to the same
conflict-of-interest rules as equity analysts.
Turning to customer disclosure, he said that brokerages and
their advisers need to be sure that customers understand the
credit and other risks of increasingly complex debt
He pointed to rising demand by individual investors for
high-yield bonds as an area of greater focus, since investors
and possibly many brokers do not fully understand the
instruments' credit and interest-rate risks.
In another example of the regulatory group's attention to
misdeeds in the muni community, FINRA said Monday that it fined
SWS Group Inc's SWS.N Southwest Securities unit $500,000 for
paying former Texas municipal officials and others to solicit
underwriting assignments in violation of MSRB rules.
The Dallas-based brokerage from October 2006 through April
2009 paid five individuals, including three former Texas
municipal officials, more than $200,000 for the services, FINRA
said. Southwest neither admitted nor denied the charges.
(Additional reporting by Joan Gralla and Lisa Lambert in
Washington, editing by Jed Horowitz and Chip Barnett)