SEC Enforcer Probes ‘Egregious Conduct’ as Muni Scrutiny Widens
Elaine Greenberg, whose crackdown on regulatory abuses in the $2.8 trillion U.S. municipal bond market is the most ambitious since the 1990s, knows a public- debt scandal when she sees one.
In more than 20 years at the Securities and Exchange Commission, Greenberg, 49, sued officials of Pennsylvania’s biggest non-profit hospital system for fraud and stripped the securities license from an underwriter who sold risky debt to school districts.
Now she’ll direct the SEC’s attention to states and cities as part of a focus on the tax-exempt market by Chairman Mary Schapiro, 54. In her sights are possible bid-rigging for municipal-investment contracts by banks including JPMorgan Chase & Co. and Bank of America Corp., public officials who hire advisers based on political contributions and local governments that fail to disclose their true financial condition.
“There’s some very egregious conduct that goes on,” Greenberg said in an interview at the SEC’s Philadelphia office, where she’s an associate director. “The deterrent effect of cases the SEC brings in this area has the potential to be high.”
Greenberg was tapped in January to head the SEC’s municipal securities and public pensions unit, one of five task forces created after the global credit crisis and the SEC’s failure to detect Bernard Madoff’s $65 billion Ponzi scheme. It comes as states and cities confront more than $1 trillion of budget and pension deficits, according to the Center on Budget and Policy Priorities and the Pew Center on the States, two Washington- based researchers.
The new scrutiny also follows the collapse of the $330 billion auction-rate securities market that left governments and investors with debt they couldn’t trade, a sewer-bond default and bribery scandal in Alabama’s biggest county exposing corruption in derivatives sales to municipalities, and probes into public-pension investment practices in New York, California and New Mexico.
Municipal securities enforcement “was terribly neglected in recent years,” said Arthur Levitt, SEC chairman from 1993 to 2001. “Fraud in the municipal market and incompetence, which in some ways is worse than fraud, has never been greater,” said Levitt, a director of Bloomberg LP, parent of Bloomberg News.
Greenberg and her deputy, Mark Zehner, 50, a former tax- exempt bond lawyer involved in SEC municipal enforcement for 12 years, are recruiting ex-investment bankers, traders and pension specialists who can sniff out wrongdoing and new areas of risk.
The size of the unit, staffed from SEC offices around the U.S., hasn’t been set. A job posting for a municipal securities specialist offers a salary of $126,661 to $198,333 a year.
School for Enforcers
“More resources means we can do more to police the municipal securities market,” said Greenberg, a graduate of Temple University and its law school, the alma mater of two SEC enforcement chiefs, William McLucas and Richard Walker.
Greenberg is the ideal defender of investors’ interests in a market where 50,000 issuers sell more than $400 billion of securities a year, said Daniel Hawke, head of the SEC’s Philadelphia office.
“She knows going in where she wants to end up,” Hawke, who was named in January to run the agency’s market-abuse unit, said in an e-mail. “When defense counsel seeks to chip away at penalty amounts, she will hold the line. She’s very tough.”
Greenberg, a mother of three who commutes to Philadelphia from Bucks County, about 20 miles (32 kilometers) north, joined the SEC in October 1987, days after the Black Monday stock market crash in which the Dow Jones Industrial Average fell 22.6 percent, its biggest-ever percentage decline.
Her first municipal-bond assignment came a decade later, when she settled a case against Meridian Securities, a Reading, Pennsylvania-based dealer. The SEC said Meridian marked up prices of Treasury securities used by municipalities in Pennsylvania and West Virginia to refund older debt. Meridian consented to $3.7 million of penalties without admitting or denying wrongdoing.
The practice of artificially lowering yields on Treasuries to a level permitted by U.S. rules on municipal-bond investments was known as yield burning. Greenberg’s bid-rigging inquiry, in which at least seven companies disclosed that they were subject to SEC suits, follows the late-1990s yield-burning probes where 21 financial firms paid $170 million of penalties.
The SEC, Justice Department and Internal Revenue Service are looking into the possible manipulation of bids by brokers that allowed banks to pay municipalities below-market interest rates on the investment of proceeds of bond issues. The commission has informed companies including JPMorgan Chase, Bank of America, UBS AG,Wachovia Corp. and General Electric Capital Corp.’s Trinity Funding unit that it determined sufficient wrongdoing occurred to warrant civil charges.
“When you look at the market participants in terms of the underwriting firms, the investment-banking firms, it’s really a core group that’s involved in the majority of these transactions,” said Greenberg, who declined to be more specific.
The SEC is also enforcing a rule barring securities-firm executives from making political donations to win municipal business.
It said March 18 that the so-called pay-to-play ban applies to corporate officers after it found an unidentified JPMorgan Chase vice chairman had raised funds for former California Treasurer Phil Angelides in 2002, less than two years before the bank’s securities unit underwrote $15.8 billion of state bonds. JPMorgan consented to the inquiry’s conclusions without admitting or denying wrongdoing, the agency said.
In November, two former JPMorgan Securities Inc. managing directors were sued by the SEC for alleged pay-to-play activity that allowed the New York-based bank to get $5 billion of bond and interest-rate-swap business from Jefferson County, Alabama. The transactions nearly bankrupted the state’s most populous county.
Yesterday, the SEC said Southwest Securities Inc., a Dallas-based broker, agreed to pay $470,000 to settle allegations it violated the pay-to-play rule when a one-time executive gave money to former Massachusetts Treasurer Timothy Cahill from 2003 to 2008. That was within two years of $14 billion of state bond sales co-underwritten by the firm, the SEC said. Southwest didn’t admit or deny wrongdoing.
The municipal market, where 70 percent of the debt is held by individual investors, deserves regulatory attention, Greenberg said. Federal law exempts state and local issuers from the disclosure required of companies, putting public-bond holders at a disadvantage, she said.
“When a municipality or a state or any local issuer goes out and seeks to raise money from investors across the country, it’s critical they adequately disclose their liabilities,” Greenberg said.
States and localities have also turned to unregulated derivatives to lower borrowing costs and generate cash to close budget deficits. Many of the contracts had to be unwound at a cost of billions of dollars because the floating-rate debt they were hedging was affected when bond insurers lost their top credit ratings.
“You combine difficult financial circumstances with some of these complex issues of valuations or assessing liabilities, and that contributes to our conclusion that this is an area worthy of specialized focus,” Robert Khuzami, the SEC’s director of enforcement, said in a telephone interview.
Greenberg’s next municipal case after Meridian was an administrative proceeding in 2000 against the Allegheny Health Education and Research Foundation. The system of 14 Pennsylvania hospitals overstated income by more than $150 million, boosting risk for investors holding more than $900 million of debt.
Two former Allegheny chief financial officers and an accountant at PricewaterhouseCoopers LLP agreed to pay a total of $105,000 in fines to settle the case without admitting or denying wrongdoing.
In 2006, Greenberg oversaw a suit against Dolphin & Bradbury, a Pennsylvania investment bank that sold school districts risky short-term notes issued to finance a golf course. The notes defaulted, resulting in $11 million in losses.
The firm’s securities registration was revoked and it, along with its chairman, Robert Bradbury, and his wife paid $5 million in fines. Bradbury, who agreed to be barred from the industry, pleaded guilty in a criminal case and was sentenced to a year and a day in prison.
“You see what happened to Mr. Bradbury,” said Greenberg. “There’s no safe harbor out there by virtue of where you work.”