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Top firms fined $120M
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April 6, 2000: 6:05 p.m. ET
Seventeen top-notch investment houses pay fines to settle yield burning case
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NEW YORK (CNNfn) - Seventeen top-notch investment houses, including Goldman Sachs & Co., Lehman Bros. and Morgan Stanley Dean Witter, will pay the U.S. government $120 million in fines after being charged with a practice called yield burning; in which brokerages selling federal and municipal bonds overcharge their clients, the Securities and Exchange Commission said Thursday.
The settlement, announced by the SEC, the U.S. Attorney for the Southern District of New York and NASD Regulation Inc. -- the regulatory arm of the National Association of Securities Dealers - resolves civil fraud charges filed by regulators against a total of 21 firms under the False Claims Act. The settlement also resolves claims by the Internal Revenue Service that certain bonds the firms sold between 1990 and 1996 were tax-exempt.
A veritable Who's Who of Wall Street firms were involved in the settlement, including: the Salomon Smith Barney unit of Citigroup (C: Research, Estimates), which will pay $38 million in penalties -- the largest portion of the settlement; PaineWebber (PWJ: Research, Estimates) which will pay about $21.6 million; Dain Rauscher Inc. (DRC: Research, Estimates), which will pay about $11.2 million; and Warburg Dillon Read LLC, which will pay about $6.3 million.
However, none of the firms admitted to any wrongdoing in the case.
The resolution requires the firms to pay a grand total of more than $139 million. Including the actions announced today, more than $172 million will have been paid by 21 firms to resolve charges of yield burning and related claims, the SEC said.
A PaineWebber spokesman said, "We are pleased with this industry-wide settlement. It covers municipal reinvestment transactions done throughout the industry from 1990 through 1994 and resolves any uncertainty regarding tax liability for the affected municipal bond issuers and bondholders."
A complicated transaction
When municipalities wish to refinance their outstanding debt, they often engage in a municipal securities offering known as an advance refunding. In such an offering, a municipality sells new "refunding" bonds and invests the proceeds in a portfolio of U.S. Treasury securities structured to pay the obligations on the old bonds, lowering its interest expense.
To prevent abuse of the benefit the federal government gives municipalities by not taxing interest paid on municipal bonds, federal law limits the yield that the municipality can earn on the portfolio of Treasury securities purchased for an advance refunding.
A brokerage firm that overcharges a municipality for Treasury securities purchased with the proceeds of an advance refunding diverts money to itself at the expense of the U.S. Treasury, or in certain instances, at the expense of the municipality. When money is diverted from the U.S. Treasury it's known as "yield burning" because the overcharge illegally "burns" the yield down to a level that appears to comply with federal law, but doesn't.
Any government or corporation issuing bonds -- which are essentially chunks of debt the issuer is prepared to sell to an investor and pay interest on -- typically wants to sell the securities with the lowest possible yield, keeping the interest they pay to the holders of those securities low.
No more yield burning
"This settlement demonstrates the continuing resolve of the government as a whole to address the problem of yield burning and to ensure the integrity of financial markets," said Mary Jo White, the U.S. Attorney for the Southern District of New York. "The government is pleased that it was able to reach this settlement without causing issuers or holders of municipal bonds to suffer adverse tax consequences."
 SEC Chairman Arthur Levitt echoed White's remarks, remarking the settlement is "a milestone in the federal government's effort to resolve the problem of yield burning in a way that protects innocent municipalities and bondholders."
Other investment firms included in the settlement were: Prudential Securities Inc.; Pierce, Fenner & Smith Inc.; William R. Hough & Co. A.G.; Edwards & Sons Inc.; CS First Boston Corporation; J.C. Bradford Co. Inc.; Piper Jaffray Inc.; Raymond James & Associates Inc.; Southwest Securities Inc.; and Wheat First Securities Inc. 
--Reuters contributed to this report.
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