Seven Brokerage Firms Settle NASD Regulation Charges of Yield Burning
Nancy A. Condon
Washington, D.C.—NASD Regulation, Inc., announced today that it has censured seven brokerage firms for engaging in the practice of yield burning. Additionally, NASD Regulation ordered them to pay a total of $21.4 million to the U.S. Treasury, under an agreement with the Internal Revenue Service and the United States Attorney for the Southern District of New York, and to pay disgorgement directly to 38 municipal issuers. In settling the charges, the seven firms named in these actions, A.G. Edwards & Sons, Inc.; CS First Boston Corporation; J.C. Bradford & Co.; U.S. Bancorp Piper Jaffray, Inc.; Raymond James & Associates, Inc.; Southwest Securities, Inc.; and Wheat, First Securities, Inc., neither admitted nor denied NASD Regulation’s findings.
NASD Regulation found that each firm had violated the NASD rule governing just and equitable principals of trade that requires members to observe high standards of commercial honor, as well as federal securities laws, by selling U.S. Treasury securities to municipalities at prices not reasonably related to the current wholesale market prices for those securities. NASD Regulation found that the excessive markups jeopardized the tax-exempt status of those municipalities’ refunding bonds and diverted money from the U.S. Treasury to the firms in certain transactions and reduced the savings available to the municipalities from the refundings in other transactions.
In a falling interest rate environment, state and local governments often seek to reduce their borrowing costs by paying off outstanding bonds through the issuance of new bonds at lower interest rates. When the old bonds cannot be paid off until a future call date, the municipality can still take advantage of lower interest rates through an "advance refunding." In an advance refunding, the proceeds of the bond issuance are invested in U.S. Treasury securities, which are placed in an escrow account to pay the principal and interest obligations on the old bonds. Brokerage firms sell U.S. Treasury securities to municipalities for these escrow accounts. To prevent abuse of the benefit the federal government gives municipal issuers by not taxing interest on their bonds, federal law limits the yield an issuer can earn on Treasury securities bought for advance refundings. The practice known as "yield burning" occurs when a brokerage firm charges excessive markups on the sale of U.S. Treasury securities to municipalities for refundings to reduce the yield on those securities so they do not violate the yield restrictions. If yield burning occurs, holders of the new refunding bonds can be required to pay federal income tax on the bond interest they receive.
The cases are the result of extensive NASD Regulation examinations conducted over a three-year period coordinated with the Securities and Exchange Commission, which announced similar settlements with an additional 10 firms. The examinations were conducted by NASD Regulation Offices in New Orleans, Dallas, and New York, and with the Department of Enforcement. The disciplinary actions were filed by the District Office in New Orleans.
Each firm was censured and ordered to make payments to the U.S. Treasury, under an agreement with the Internal Revenue Service and the United States Attorney for the Southern District of New York, and to pay disgorgement directly to 38 municipal issuers, if required as a part of the settlement.
Investors can obtain more information about NASD Regulation as well as the disciplinary record of any NASD-registered broker or brokerage firm by calling (800) 289-9999.
NASD Regulation oversees all U.S. stockbrokers and brokerage firms. NASD Regulation, Inc., The Nasdaq Stock Market, Inc., and the Amex are subsidiaries of the National Association of Securities Dealers, Inc. (NASD), the largest securities-industry self-regulatory organization in the United States.