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This summer, while the baseball world was focused on Barry Bonds, the white collar world was focused on municipal bonds. This occurred because the federal government has significantly stepped up its enforcement in this arena. For example, the Securities and Exchange Commission (SEC) created a nationwide municipal bond enforcement group, headquartered in Philadelphia. SEC Chairman Christopher Cox also made well-publicized pleas for greater municipal bond scrutiny and enforcement. In July, Cox asked Congress to pass new legislation delineating the roles of the players in municipal bond transactions, creating an easily accessible web-based site for municipal bond-related disclosures, and requiring state, local and municipal authorities to use generally accepted accounting principles. All of this presages an increase in securities fraud cases involving the issuance or marketing of municipal bonds. Prior Lax Enforcement Traditionally, municipal bonds and securities � debt obligations of a municipality � were ho-hum investments that drew little attention. A series of scandals, however, beginning with New York City’s near-default in the mid-1970s followed by the Washington Public Power Supply System’s $2 billion default in the mid-1980s, demonstrated that municipal securities could cause large-scale financial disasters. The Orange County, Calif., fiasco in 1994 � where the county nearly went bankrupt � similarly demonstrated that municipal market ripples could cause market waves. Large institutions and wealthy individuals typically purchased municipal bonds, seeking to benefit from tax-exempt interest payments. Indeed, individuals were such inconsequential purchasers of municipal bonds that Congress largely exempted these bonds when it passed the laws that underlay current securities enforcement. In recent years, however, individuals increasingly have invested in municipal bonds. For the last 10 years, individuals have been the largest holders of municipal debt. At the same time, the value of municipal bond issuances has grown exponentially and the number of related scandals has skyrocketed. Some recent scandals and investigations are discussed below. Bid-Rigging and Pay-to-Play The Internal Revenue Service, the Federal Bureau of Investigation and the SEC have been conducting a coordinated, nationwide probe into whether brokers who provide municipal finance services have been cheating their municipal clients. The FBI recently raided the offices of two such brokers, CDR Financial Products in Beverly Hills, Calif., and Image in Philadelphia. Federal prosecutors have also issued dozens of subpoenas on other brokerage firms. The government is investigating whether these brokers, when they are hired by municipalities to invest bond proceeds, are conspiring to rig their bids and to inflate commissions. The government is also considering whether the brokers are obscuring their true costs by providing low prices for certain services and overcharging for other, less visible services. Finally, the government is targeting allegations that brokers are hired on a “pay-to-play” basis. This investigation is in its early stages; it is potentially massive. False Representations Various people involved in selling $20 million in municipal bonds for a small sewer district located on Whidbey Island, Wash., were recently charged with fraud. The bond proceeds were supposed to finance a portion of a private office complex. The promoters of the bonds � including the developer and investors in the project � falsely claimed that the proceeds would be used to acquire land, misrepresented that a prominent investment bank had provided financing for the project, falsely claimed that the buildings were fully leased to highly rated companies, and failed to disclose kickbacks to several promoters. No substantial work was ever done on the office complex, and the bonds quickly went into default. The federal government has filed criminal fraud charges against the developer of the project, his attorney and two investors in the project. Those changes remain pending. Closer to home, the SEC brought charges against the underwriter and financial advisor for Dauphin County General Authority’s issuance of $75 million in bonds to finance the purchase of an office building and parking lot in Harrisburg. The SEC claimed that the defendants misled prospective investors and failed to disclose that a major tenant in the building was about to terminate its lease. (The authors represented the financial advisor, who was exonerated at trial.) The underwriter was found liable and ordered to disgorge his fee of just under $500,000, and to pay a fine of the same amount. Fraudulent Bond Auctions Municipal bonds are often sold at auction. In a few recent cases, auction houses have engaged in various fraudulent practices. For example, Regional Brokers secretly placed its own bids even though it had no intention of purchasing the bonds. These phony bids made it look like Regional was conducting a competitive auction. Regional also collusively accepted late bids with knowledge that the late bid was the highest, and therefore winning, bid in the auction. This allowed the late bidder to purchase the bond for just over the next highest bid. Discount Muni-Brokers similarly disseminated false bids to misrepresent that auctions were more competitive than they really were, and to meet minimum auction requirements. The SEC imposed a $100,000 penalty on Regional and required it to certify that it has implemented new compliance procedures. It also imposed on Regional’s CEO a $50,000 civil money penalty and a permanent ban on serving as a supervisor in the securities industry. The SEC revoked Discount’s license and imposed a $15,000 civil money penalty and five-year supervisory ban on Discount’s CEO. Conclusion The federal government is gearing up to significantly increase its oversight and enforcement of the municipal bond market. Industry participants should be wary and should redouble their efforts to ensure full compliance. Attorneys who represent such industry participants should actively advise their clients on how to avoid trouble and be prepared to rebut allegations of wrongdoing. Joshua U. Metz is a partner at Dilworth Paxson, where he is a member of the corporate investigations & white collar group. His areas of practice include white collar criminal defense and related litigation, as well as internal corporate investigations. He has defended a number of political and business figures. He can be reached at 717-236-4812 or [email protected]. David M. Laigaie , a partner with the firm, heads the corporate investigations and white collar group. His areas of practice include health care fraud, securities fraud, tax fraud, export violations, pharmaceutical marketing fraud, municipal corruption, defense procurement fraud and public finance fraud. He regularly conducts internal corporate investigations. He can be reached at 215-575-7168 or [email protected].

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