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Wachovia Settles Charges of Fraudulent Bid-Rigging in Municipal Investment Proceeds

Thursday, December 15, 2011

Tatiana Rodriguez | Bloomberg LawSEC Press Release No. PR-2011-257 (Dec. 8, 2011); SEC Litigation Release No. LR-22183 (Dec. 8, 2011); SEC v. Wachovia Bank, N. A., No. 11-CV-07135 (D.N.J. filed Dec. 8, 2011); DOJ Press Release No. 11-597 (Dec. 8, 2011) The fourth in a series of coordinated efforts by federal and state agencies and attorneys, Wachovia N.A. (Wachovia), now Wells Fargo N.A., settled charges with the authorities regarding alleged misconduct in connection with municipal securities proceeds. Wachovia allegedly engaged in fraudulent and anticompetitive bidding practices by providing kickbacks to bidding agents in order to win contracts for temporary municipal investment proceeds and to underwrite the municipal securities. Wachovia agreed to pay $148 million and take certain remedial measures to resolve the allegations.

Investment of Municipal Securities Proceeds

Municipalities often raise funds to finance projects by publicly offering and selling tax-exempt bonds and notes. Following the sale of municipal securities, some of the proceeds typically are not spent immediately but rather are invested in certain types of derivatives intended to meet the municipalities' specific collateral and spend-down needs. Municipalities receive bids on the instruments in connection with the sale of the underlying municipal securities. To preserve the tax-exempt status of the municipal securities underlying the reinvestment contracts, they must be sold at fair market value which may be established through a competitive bidding process prescribed by tax regulations. Failure to comply with the governing regulations creates a rebuttable presumption that a fair market value was not obtained and compromises the tax-exempt status of the underlying securities.

SEC Action Alleging Fraudulent Conduct

According to the SEC, from 1997 through at least 2005, Wachovia engaged in 58 transactions involving fraudulent practices that affected the prices of reinvestment instruments and deprived municipalities of a conclusive presumption that their reinvestment instruments were purchased at fair market value, all of which jeopardized the tax-exempt status of the underlying securities. Without admitting or denying the SEC's allegations, Wachovia consented to the entry of an order enjoining it from future violations of Section 17(a) of the Securities Act of 1933, which prohibits fraudulent conduct, and agreed to pay $46 million to the SEC. The SEC alleged that members of Wachovia's Municipal Derivatives Market Group submitted rigged bids to bidding agents for the municipalities. The submissions allegedly were rigged to win based on (1) advanced information on the amount other providers bid, and (2) set-ups in advance of the bidding, assuring non-bidding wins from other providers. Further, Wachovia's employees also allegedly submitted non-winning bids to rig the bidding for other providers. In exchange for preferential treatments, Wachovia steered additional business towards bidding agents and participated in providing non-winning bids to enable other firms to win. Wachovia also allegedly falsely represented or certified in its bid submissions and Provider's Certificates that, among other things (1) bids were conducted at arm’s length, (2) it had not consulted with any other potential providers about its bids, (3) the bids were determined without regard to any other formal or informal agreement that it had with a municipality or any other person, and (4) the bids were not submitted solely as a courtesy to the municipality or any other person. This deprived municipalities of a "conclusive presumption that their reinvestment instruments were purchased at fair market value, and/or jeopardized the tax-exempt status of the underlying securities." Robert Khuzami, the Director of the SEC Division of Enforcement, summarized the allegations by stating: "Wachovia won bids by playing an elaborate game of 'you scratch my back and I'll scratch yours,' rather than engaging in legitimate competition to win municipalities’ business."

DOJ Action Alleging Anticompetitive Practices

Wachovia also entered into an agreement with the Department of Justice (DOJ) for its anticompetitive activity with municipal reinvestment proceeds. The DOJ's charges were limited to Wachovia's conduct from 1998 to 2004. It also focused on certain former Wachovia employees at municipal derivatives trading desks who allegedly entered into unlawful agreements to manipulate the bidding process and rig bids on municipal investment and related products.

Related Actions by Other Federal and State Authorities

In addition to settlements with the SEC and the DOJ, Wachovia also resolved charges brought by the Office of the Comptroller of the Currency (OCC), the Internal Revenue Service, and 26 state attorneys general. Federal and state authorities also have settled actions involving bid rigging to obtain municipal reinvestment proceeds, with the following firms:
  • In December 2010, Bank of America Securities LLC (BOA) entered into settlements with federal and state authorities, under which the firm is to pay $137 million in penalties and restitution.
  • In May 2011, federal and state authorities entered into settlements with UBS Financial Services Inc., under which the firm is to pay $160 million in penalties and restitution.
  • In July, 2011, federal and state authorities entered into settlements with J.P. Morgan Securities, under which the firm will pay $228 million in disgorgement and penalties.
Suggesting other cases may be filed, Sharis A. Pozen, the acting assisting attorney general stated, "We are committed to ensuring competition in the financial markets and our investigation into anticompetitive conduct in the municipal bond derivatives industry continues." DisclaimerThis document and any discussions set forth herein are for informational purposes only, and should not be construed as legal advice, which has to be addressed to particular facts and circumstances involved in any given situation. Review or use of the document and any discussions does not create an attorney-client relationship with the author or publisher. To the extent that this document may contain suggested provisions, they will require modification to suit a particular transaction, jurisdiction or situation. Please consult with an attorney with the appropriate level of experience if you have any questions. Any tax information contained in the document or discussions is not intended to be used, and cannot be used, for purposes of avoiding penalties imposed under the United States Internal Revenue Code. Any opinions expressed are those of the author. The Bureau of National Affairs, Inc. and its affiliated entities do not take responsibility for the content in this document or discussions and do not make any representation or warranty as to their completeness or accuracy.©2014 The Bureau of National Affairs, Inc. All rights reserved. Bloomberg Law Reports ® is a registered trademark and service mark of The Bureau of National Affairs, Inc.

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