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Municipal Securities Market Lacks Oversight, Says GAO

Sec

First Posted: 01/18/12 06:21 PM ET Updated: 01/18/12 06:21 PM ET

Government oversight of the $3.7 trillion market for municipal securities, wracked by several high-profile cases of fraud and bid-rigging, is inadequate, according to a report by the Government Accountability Office.

The securities, used by state and local governments to finance transportation projects and the construction of housing, hospitals, and schools, have been the subject of a five-year federal investigation into the reinvestment of proceeds of municipal bond sales. Most recently, General Electric Co.agreed to pay more than $70 million to settle a criminal probe for conspiring to overcharge 44 states on municipal-bond deals.

The Securities and Exchange Commission enforces the rules written by two self-regulatory organizations with oversight of the market -- the Municipal Securities Rulemaking Board and the Financial Industry Regulatory Authority. But because of huge staff cuts at the SEC inspection arm -- from 62 inspectors in 2005 to 38 in 2011 -- it has checked neither the MSRB nor FINRA's fixed-income surveillance programs since 2005.

The SEC's last inspection "predated the financial crisis -- and its ensuing volatility in the municipal market," the report says. Without such oversight, "the SEC may be unable to identify and act on regulatory problems in a timely manner."

The SEC recently began to look at FINRA's program, including municipal trade reporting and markup reviews. It has not begun a fresh review of MSRB.

In addition, the report found that the market favors institutional investors over individuals with better information and prices.

Some Regulators Make Wall Street's Case On Volcker Rule

One of the top arguments made by Wall Street executives and congressional Republicans against the Volcker Rule, which bans firms from trading with their own funds, is that the rule would reduce bank profit and liquidity -- essentially the cash available in the financial system to make trades and loans.

The rule, an essential part of the Dodd-Frank financial overhaul, is due to be in place by July 21.

On Wednesday, at a contentious hearing before the House Financial Services Committee, regulators defended the rule as necessary to prevent the type of risky trading that hobbled the financial system in 2008.

But some helped make Wall Street's case. Acting Comptroller of the Currency John Walsh said U.S. banks "will operate at a competitive disadvantage" with foreign banks. Federal Reserve Governor Daniel Tarullo acknowledged that the rule will be difficult to implement, since both banks and regulators will have a tough time distinguishing between permissible market-making and prohibited profit-making trading.

Rep. Barney Frank (D-Mass.) blamed the financial industry and its demands for the complexity of the 300-page rule, saying "a very simple rule could have been formulated, but it would not have accommodated the concerns you have of the financial institutions. So to some degree they are complaining about you having accommodated them."

Meanwhile, regulators are sure to earn the wrath of reform groups by proposing to extend an exemption that would allow U.S. banks to engage in proprietary trading of not just U.S. government bonds, but those of foreign countries too. "That benefit is not extended to the government securities of other countries," Martin Gruenberg, the Federal Deposit Insurance Corp. acting chairman, told lawmakers, according to MarketWatch. "We are going to get comments on this and this will be one of the issues we will be looking at."

Citigroup Fined Over Conflicts of Interest

Citigroup Global Markets was fined $725,000 today by the Financial Industry Regulatory Authority, a bank self-regulatory organization, for failing to disclose conflicts of interest in its research reports and research analysts' public appearances.

Those conflicts related to research reports on companies published from January 2007 to March 2010. Citigroup failed to disclose that the firm did business with those same companies -- either managing public securities offerings or engaging in investment banking for them. Citigroup anaylsts also failed to mention those relationships when discussing the companies in public appearances.

"Firms need to provide investors with full and accurate information so they will be able to take it into consideration before making an investment decision," said Brad Bennett, FINRA executive vice president and chief of enforcement.

Credit-Rating Agency's Conflicts of Interest Ignored

Though credit-rating agencies that rubber-stamped subprime mortgage securities played a major role in fueling the housing bubble, there has been little progress by regulators or lawmakers to increase incentives for the agencies to produce more reliable ratings, according to a new Government Accountability Office report. A main concern has been that Standard and Poor's, Moody's and Fitch are paid by the Wall Street firms that create the securities the agencies are being asked to rate.

Though there are at least seven alternative compensation models that would reduce that conflict of interest, they have received scant attention from either Congress or regulators, says the GAO. "For example, these authors noted that SEC had not reached out to them to further discuss these models as part of its ongoing study of alternative compensation models for credit rating agencies."

Blame Game Over Drug Shortage

Many parents have been up in arms over the past year because drugs, including Ritalin and Adderall, to treat childrens' attention deficit hyperactivity disorder have been in short supply. And two federal agencies are pointing fingers at each other for the problem, reports the Pharmalot blog.

The Drug Enforcement Administration sets overly strict quotas for the drugs, causing the shortage, say the regulators at the Food and Drug Administration. But the DEA says the supply is fine, suggesting drugmakers regulated by the FDA are to blame for pushing high-priced brand-name versions instead of the cheaper generics. Now, some members of Congress are demanding answers, sending letters to the DEA and big drugmakers including Novartis and Shire. One letter implies drugmakers favor profits over consumers' needs.

Pollution Regs Won't Cause Power Outages, Says Congressional Research Service

Despite the claims of Republican lawmakers and energy industry giants, new Environmental Protection Agency rules that limit toxic air pollution from power plants will not cause power outages, according to a new report by the Congressional Research Service (h/t The Hill).

There is plenty of capacity in the electrical system to make up for the impact of coal and oil-fired plants forced to close after installing costly technology to reduce pollution, says the report, adding that it is "unlikely that electric reliability will be harmed by the rule."

Today's Must-Reads

* SEC enforcement director Robert Khuzami forcefully defends the agency's track record for financial-crisis-related cases, telling HuffPost's Ben Hallman, "Our record in financial crisis cases is characterized by aggressive and broad-based enforcement activity" against companies and individuals who hid exposure to bad mortgage loans from investors.

* Three federal investigations are underway into major problems plaguing the $12.3 billion cleanup of America's most radioactive site. (USA Today)

* Who really caused the financial crisis in 2008? China, of course, argues Foreign Policy's Heleen Mees.

* The 10 most-common workplace safety violations, which declined overall to 3.1 million reported incidents in 2010 from 3.3 million in 2009.

* AirTran Airways ordered to hire back and pay over $1 million in back wages to awhistleblower pilot, who was fired after reporting mechanical concerns.

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Filed by Marcus Baram  |