Richard A. Levan & Associates, PC - Wall Street Journal

Friday, May 9,1997

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CREDIT MARKETS

Muni-Bond Probe Turns the Spotlight on Pennsylvania

By CHARLES GASPARINO And JOHN CONNOR
Staff Reporters of THE WALL STREET JOURNAL

The federal government's probe into municipal-bond abuses is turning up the heat in the state of Pennsylvania, where a batch of bond deals, government officials and some major underwriters are coming under intense scrutiny.

While New Jersey and Massachusetts have been focal points for muni-bond abuses, government officials with knowledge of the probes say Pennsylvania now is one of the major hotspots in their four-year probe of the S1.3 trillion municipal-bond business.

The Securities and Exchange Commission is conducting intensive probes into a number of bond deals sold in the state. The Internal Revenue Service has also expressed interest in the matter. The examinations are focusing on top muni-bond underwriters, including Prudential Insurance Co. of America's Prudential Securities Inc. and Alex. Brown Inc.'s Alex. Brown & Sons, the Baltimore-based investment-banking firm about to be acquired by Bankers Trust New York Corp. Several state officials, including former State Treasurer Catherine Baker Knoll, as well as numerous lobbyists, lawyers and others associated with state financial issues are being questioned by federal regulators.

The deals under scrutiny appear to have predated the elections of the current top officials running the state. Richard Levan, the lawyer for Ms. Baker Knoll, says in defense of his client that "the SEC has been looking at a number of municipal-bond deals for some time, but has brought surprising few cases." That said, the bond examination is getting so serious that the current state government, under the leadership of Republican Gov. Tom Ridge, is eyeing what to do next if regulators take the most drastic action and void the tax-exempt status of some of the state's muni debt now under scrutiny. State officials won't comment on the matter, but people with knowledge of the issue say high-ranking state officials are discussing a possible monetary settlement with the federal government to preserve the tax-exemption of bonds that could be declared taxable if the investigations turn up something improper.

"Everyone is watching and waiting," says Joseph Carduff, a political consultant based in Harrisburg, Pa., the state capital. "People are pretty worried. This thing is reaching the top levels of government and finance around here."

According to people familiar with the matter, the SEC is examining more than a dozen bond deals in the state, totaling more than SI billion of debt. One underwriter involved in the inquiry, Alex. Brown, said in a statement: "We have responded to SEC inquiries concerning a variety of [bond issues] over the last 21 months. While we cooperate with SEC inquiries, we customarily do not comment on them." The scope of the inquiry includes one of the biggest muni-bond deals in state history: The S762 million issue sold in 1993 to refund debt sold to build state prisons.

The transaction, underwritten by Prudential Securities, has been under scrutiny for a number of years and from a number of standpoints. The SEC is looking at the so-called pay-to-play aspects of the deal. Prudential, which served as lead underwriter for the transaction, hired at least one politically connected lobbyist to help win the issue: Dennis "Harvey" Thie-mann, the former chairman of the state's Democratic Party, according to internal Prudential documents. Mr. Thiemann would not comment; his lawyer, George Bochetto, said in an interview that he doesn't believe Mr. Thiemann is under investigation. "He's simply been asked questions in connection with an investigation the SEC is conducting" as part a nationwide inquiry in certain types of muni-bond deals, Mr. Bochetto said.

Regulators have also examined the issue as part of their massive probe into "yield burning" abuses. Yield burning occurs when underwriters create special escrow accounts needed to complete complex bond deals known as advanced refundings. To create the accounts, underwriters must sell municipalities government securities. Now regulators want to know if underwriters overcharged municipalities for the escrow bonds, "burning" down yields on these securities.

The SEC and the IRS refused to comment about the matter. Prudential spokesman Charles Perkins said: "We provided some documents to the SEC in May of last year, and we haven't had any contact with the SEC since."

The wide-ranging inquiry also includes numerous smaller deals sold by municipalities throughout the state. Recently, CoreStates Financial Corp., the holding company for CoreStates Capital Markets, made waves when it announced that it may repay municipalities harmed by potential yield-burning improprieties committed by Meridian Capital Markets, which it acquired in 1996. People close to the matter say the SEC is investigating as many as a dozen Meridian deals.

Separately, in another legal matter in the muni world, the Justice Department yesterday asked a federal appeals court to rehear a decision overturning the criminal conviction of former municipal-bond executive Robert Cochran. Mr. Cochran, formerly with the Oklahoma City office of Stifel, Nicolaus & Co., was convicted by a federal jury in Oklahoma City last spring of wire fraud and related offenses in connection with muni transactions. Earlier this year, a three-judge panel of the federal appeals court in Denver overturned the conviction.

In overturning the conviction, the three-judge panel said in part that "this is a case about greed, and not only that of defendant. That said, greed and criminal liability are not necessarily synonymous." The SEC said in an amicus siding with federal prosecutors that a rehearing "is warranted because the panel's decision threatens to undermine the efforts of both the United States and the Commission to combat fraud in the securities markets." The ruling overturning Mr. Cochran's conviction, "if widely accepted, would strike at the heart of the commission's enforcement and antifraud efforts," the agency said.