Seven Brokerage Firms Settle NASD Regulation Charges of Yield Burning
Nancy A. Condon
Washington, D.C.—NASD Regulation, Inc., announced today that as a result of a coordinated investigation with the United States Attorney for the Southern District of New York and the Internal Revenue Service, it has censured seven brokerage firms for engaging in the practice of yield burning. In settling the charges, the seven firms named in these actions, Butler Wick & Co., Inc.; Cain Brothers & Company, LLC; First Chicago Capital Markets, Inc.; John Nuveen & Co., Inc.; Peacock, Hislop, Staley & Given, Inc.; SHP Capital Markets, Inc.; and Scott & Stringfellow, Inc., neither admitted nor denied NASD Regulation’s findings.
NASD Regulation ordered total payments of $13.5 million as follows:
- Butler Wick & Co., Inc.; First Chicago Capital Markets, Inc.; John Nuveen & Co., Incorporated; Peacock, Hislop, Staley & Given, Inc.; and Scott & Stringfellow, Inc. to pay a total of approximately $7,495,000 to the U.S. Treasury.
- First Chicago Capital Markets, Inc.; John Nuveen & Co., Incorporated; and Peacock, Hislop, Staley & Given, Inc. to make payments totaling approximately $4,200,000 directly to 22 municipal issuers.
- Cain Brothers & Company, LLC and SHP Capital Markets, Inc. to reimburse other brokerage firms in the amount of approximately $1,180,000 for payments previously made to the U.S. Government on behalf of those firms.
- The seven firms will pay a total of $640,500 to NASD Regulation.
NASD Regulation found that each firm had violated the rule 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 and 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 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.
NASD Regulation’s New Orleans District Office conducted the examinations that led up to the filing of these disciplinary actions. Earlier this year, NASD Regulation settled yield burning charges with seven other firms whereby they paid $21.4 million to the U.S. Treasury and disgorgement to 38 municipal issuers. (See NASD Regulation Press Release, April 6, 2000.)
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, or by sending an e-mail through NASD Regulation’s Web site, www.nasdr.com.
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.