Alex. Brown overcharge case settled

$15.3 million to end claims involving bond underwritings

SEC `very pleased'

Deutsche Bank glad to see the end of `an old matter'

SEC settlement

November 18, 1999|By Bill Atkinson | Bill Atkinson,SUN STAFF

In the largest settlement of its kind, Deutsche Banc Alex. Brown agreed yesterday to pay $15.3 million to settle claims by federal investigators that it overcharged the state of Pennsylvania and other local jurisdictions in bond underwriting offerings in the early 1990s.

In an administrative order released yesterday, the Securities and Exchange Commission said that in March 1994, Baltimore-based Alex. Brown Inc. illegally marked up $494 million in U.S. Treasury bonds that it sold to the state of Pennsylvania, which was replacing higher yielding tax-exempt bonds with lower yielding securities.

Alex. Brown also resolved probes into whether it overcharged other cities and local agencies -- including Montgomery County and the Washington Suburban Sanitary Commission -- on 69 bond transactions for more than $5 billion between 1991 and 1995.

"We are very pleased with the result," said Brian Ochs, assistant director of the SEC's enforcement division. "I think this was a particularly egregious series of transactions with these bond offerings. I think there are some very strong results here against the perpetrators."

Under the settlement, Deutsche Banc Alex. Brown will pay $15.177 million to the U.S. government to resolve its False Claims Act liability and related Internal Revenue Service claims.

Alex. Brown was acquired by Bankers Trust Corp. in September 1997, and subsequently by Germany's Deutsche Bank AG. It neither admitted nor denied the findings in the order.

"This is an old matter that we are pleased to have behind us," said Macy Egerton, a Deutsche Bank spokeswoman.

The SEC and the IRS have been investigating a number of firms over the last four years to find out whether they have engaged in "yield burning."

In the early 1990s, many municipalities refinanced bonds to take advantage of lower interest rates, just as many homeowners refinanced their mortgages.

A state might replace its tax-exempt bonds paying 6 percent interest with bonds paying 5 percent. The proceeds from the newly issued bonds were generally invested by the investment bankers in U.S. Treasury securities and placed in escrow.

Municipalities face restrictions against making money on their tax-exempt transactions, so the securities in escrow can yield only the same amount as the interest paid on the new bonds; any additional interest earned has to be sent to the federal government. For example, if the securities in escrow yielded 6.5 percent, and the new bonds the funds were purchased with paid 5 percent, the extra 1.5 percent yield was supposed to have gone to the federal government.

But investment bankers allegedly inflated the price of the Treasury securities they sold to the municipalities, kept the profit and drove down, or "burned" the yield to the acceptable 5 percent level. When a bond's price rises, its yield, or interest paid to the bond holder, falls.

Alex. Brown has since closed its municipal bond division, because, it said, it was losing money.

The SEC's enforcement division also charged Kevin G. Quinn, the head of Alex. Brown's public finance department at the time of the Pennsylvania bond refinancing, with securities fraud in a separately filed administrative proceeding.

Quinn was the lead Alex. Brown banker responsible for the Pennsylvania transaction, according to the order.

The agency alleges that Quinn "misrepresented the size of the markup on the Treasury securities which Alex. Brown sold" in the refinancing, and that he "failed to disclose the nature, purpose and extent" of a fee-splitting arrangement with the state's financial adviser.

William Donnelly, an attorney representing Quinn, said that his client "does not believe that he engaged in any conduct in this manner that violated the federal securities laws."

"We intend to vigorously defend this proceeding on Mr. Quinn's behalf, and he looks forward to the opportunity to vindicate himself," Donnelly said in a statement.

The Alex. Brown settlement is the SEC's third in recent years. It comes on the heels of a settlement with Lazard Freres & Co., which agreed to settle similar charges in April by paying $11 million. CoreStates Financial Corp. agreed to pay $3.7 million in April 1998.

Bloomberg News contributed to this article.

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