The Wall Street Journal - 13.09.2019

THE WALL STREET JOURNAL. Friday, September 13, 2019 |A

A California district sold municipal bonds to raise money to upgrade schools such as the John F. Kennedy High School in Richmond.

BRIAN L. FRANK FOR THE WALL STREET JOURNAL

Bond Flips

Hit School

Districts

FROM PAGE ONE

combat roles. Western militar-
ies of late have been pressed to
allow facial hair on religious
grounds, which the RAF al-
ready permitted.
The RAF said allowing
beards across the service
would help “promote inclusiv-
ity,” as well as attract and re-
tain more aviators. It’s no free-
for-all: The beards must be
uniform—no longer than 25
mm, about an inch. Airmen can
only have full beards with mus-
tache; no goatee, Vandyke or
mutton chops. And a com-
manding officer must grant
permission to grow.
The beard ban end has

ContinuedfromPageOne

drawn volleys of derision on in-

ternet chat sites used by service

members. “Man buns next?”

one conversation was titled.

Traditionalists say shaving

is as much a part of the mili-

tary as saluting and marching.

Anyone who can’t suffer a bit

of personal sacrifice probably

doesn’t belong in uniform, one

military officer said.

Hirsute supporters counter

with British military history.

Soldiers returned victorious in

1856 from the Crimean War

with long, bushy beards grown

to protect against the cold and

wind. Beards became de ri-

gueur, “symbols of the heroic

male,” according to Alun

Withey, senior lecturer at the

U.K.’s University of Exeter and

an expert on the history of fa-

cial hair.

A mustache requirement

was eventually written into the

King’s Regulations for the

army, leaving a bare upper lip

grounds for a court-martial.

At the start of the 20th cen-

the unsightly bristles to which

I had for years been con-

demned by obedience to regu-

lations,” he wrote.

Fashion has again tipped in

the bearded back and forth. A

2017 survey by U.K. pollster

YouGov found that 61% of men

ages 18 to 39 had some facial

hair, compared with 43% in

2011.

Thomas Coney, a 27-year-

old former British army engi-

neer, said he quit in 2017, in

part, because he wasn’t al-

lowed to wear a beard: “I was

taking back my own freedom.”

Mr. Coney, who now sports a

long beard and runs an online

bookstore, said rules on tattoos

were overlooked, but “beards

have been persecuted.”

Canada last year welcomed

beards in its armed forces, say-

ing “greater control over per-

sonal appearance enhances or-

ganizational morale.”

A German court this year

fired back at the trend of relax-

ing appearance standards. It

rejected a complaint from

a Goth soldier over rules that

permit only women to wear

their hair long. The trooper

had argued the practice dis-

criminated against men.

While forbidding beards, the

Royal Marines and RAF have

long allowed mustaches, a style

liberty that caused a dust-up

with allies in Afghanistan.

A British airman attached

to the U.S. Air Force in 2008

was told to trim his handlebar

mustache. American airmen

aren’t allowed facial hair

stretching below the top lip,

the Brit successfully argued

that he was subject only to the

Queen’s Regulations. [The

King’s and Queen’s regulations

are identical, and the name

used depends only on who is

monarch.]

The U.K.’s Royal Navy allows

beards, in the tradition of leg-

endary seafarers. Still, it keeps

a strict code. “Designer stub-

ble,” less than 25 mm, and

“hipster beards” are out. If

there is any doubt, according

to the Queen’s Regulations,

commanders “define an accept-

able appearance of a beard, as

much depends on the features

of the individual.”

The British army appears

disinclined to change, though

there are exceptions beyond re-

ligious and health reasons.

Prince Harry, a former army of-

ficer no longer in the service,

wore both a beard and his old

uniform at his wedding.

The British army allows

beards for handful of ranks

that carry ceremonial roles, in-

cluding pioneer sergeants. His-

torically, they performed iron-

work and were allowed a beard

to protect their faces from the

heat of forges. They still parade

in bushy beards, toting axes.

The same privilege is af-

forded Goat Majors, who are

assigned to tend a regimental

mascot. Nature cut short one

serviceman’s tenure, Mr. Hill

recalled. The major couldn’t

grow a decent beard.

tury, the fashion pendulum

swung. Lt. Gen. Nevil Mac-

ready, a senior British army of-

ficer, recalled in his memoirs

how an officer complained that

a mustache would hinder his

postwar career in acting.

At Lt. Gen. Macready’s rec-

ommendation, King George V

authorized the army in 1916 to

allow the removal of mus-

taches. The next evening, Lt.

Gen. Macready got a shave. “I

was only too glad to be rid of

newly issued bonds in negoti-
ated offerings between 2013
and 2017 were sold to custom-
ers who turned around and
sold them to dealers within a
single day of the initial offer-
ing, usually for a profit, the
Journal found.
Prices on those flipped
bonds were then marked up
further as they were sold to
longer-term investors, bringing
the total market-adjusted prof-
its to more than $900 million.
The Journal’s investigation
found that those profiting from
the flipping often include the
banks hired to price and sell
the bonds.
Piper Jaffray, which was
paid about $500,000 to act as
the lead underwriter, said in a
written statement that the Cal-
ifornia school-district bonds
were priced “fairly and suc-
cessfully.” It said: “Our second-
ary market trading was a small
fraction of the total trading
volume.”
The district’s financial ad-
viser, Blake Boehm of munici-
pal advisory firm KNN Public
Finance, briefed the school
board not long after the bond
sale, deeming it “very success-
ful.” After the Journal shared
its findings about post-offering
trading with the West Contra
Costa district, then-Associate
Superintendent John al-Amin
said that those findings “are
deeply concerning and would
undermine the faith bond issu-
ers have in the municipal mar-
ket.”
Although underwriters often
make money by reselling
flipped bonds, that doesn’t ap-
pear to be their primary mo-
tive.
Underwriters are obligated
to purchase any bonds they
can’t place with customers,
which ties up cash and exposes
them to risk. So they have an
incentive to price the bonds to
move—and, if necessary, to sell
them to customers who have
no intention of holding them
for long. When those custom-

ers want to sell, the under-
writer often will step in to buy.
Under federal rules, under-
writers have a duty to set
prices that are “fair and rea-
sonable” taking into consider-
ation all relevant factors, in-
cluding their “best judgment”
of the fair market value. In re-
cent years, the Securities and
Exchange Commission has be-
gun enforcement efforts aimed
at protecting issuers during
the pricing and sale of bonds.
In June, the SEC announced
a settlement with an under-
writer for selling bonds for the
public library in Harvey, Ill.,
“at a price which was below
market price for comparable
bonds.” The SEC said the un-
derwriter, IFS Securities, failed
to make a sufficient effort to
market and place the debt. The
settlement marked the first
time the SEC has determined
that underwriter pricing be-
havior violated the fair dealing
standard, even though there
was no fraud or misrepresenta-
tion. IFS, which didn’t admit or

ContinuedfromPageOne

deny the findings, didn’t re-

spond to requests for com-

ment.

The identity of buyers and

sellers of municipal bonds isn’t

public information. The Jour-

nal identified some using regu-

latory reports insurers file

with the National Association

of Insurance Commissioners,

or NAIC.

During the period of the

Journal’s analysis, insurers

bought and quickly sold $3.

billion of newly issued munici-

pal bonds, the filings show. Of

that total, $2.6 billion, or 70%,

was sold back to the under-

writer that had just priced and

sold the bonds. The under-

writer paid the insurer more

than the initial price 88% of

the time.

When cities and school dis-

tricts decide to sell municipal

bonds, they engage securities

firms to underwrite them. Gen-

erally, the public entities have

two options. They can put the

bonds up for competitive bids

and award them to the securi-

ties firms that price them with

the lowest interest cost. Or

they can choose an under-

writer in what is known as a

negotiated offering. Negotiated

offerings account for about

75% of the money raised in

bond offerings.

Suppose a town needs to

raise $20 million to build a

new town hall. The securities

firm it selects as lead under-

writer examines the town’s fi-

nances, as well as interest

rates for U.S. Treasurys and

other municipal bonds. Then it

gauges investor appetite for

the town’s bonds at different

interest rates and maturity

dates.

The underwriter, after con-

sulting with the issuer, slices

the total amount to be raised

into a series of bonds with dif-

ferent interest rates and matu-

rity dates, then buys the bonds

at a discount to their offering

prices—typically less than half

a percentage point. The differ-

ence between the discounted

price and what the underwriter

sells them for is the under-

writer’s pay.

Obvious conflict

The underwriting process

sets up an obvious conflict.

The municipal issuer wants to

pay the lowest possible inter-

est rate. The underwriter

wants to ensure the bonds will

be attractive enough to easily

resell to investors and bond

dealers. The Municipal Securi-

ties Rulemaking Board, or

MSRB, which writes rules for

underwriters, requires them to

disclose that they have “finan-

cial and other interests that

differ from those of the issuer.”

Many issuers engage advis-

ers to help navigate the pro-

cess and monitor the under-

writers.

Prairie-Hills Elementary

School District 144, which

serves pre-kindergartners

through eighth-graders in Chi-

cago’s economically struggling

south suburbs, didn’t hire an

adviser when it issued bonds

in 2016. It needed money to

add vestibules to school en-

trances so its staff could see

and talk with visitors before

buzzing them in, the superin-

tendent said. An elementary-

school roof needed to be re-

placed. School board members

were eager to add air condi-

tioning to classrooms.

The district hired Oppen-

heimer & Co., which priced and

sold about $20 million of mu-

nicipal bonds on March 22,

2016. By the end of the first
      trading day, one-quarter of the
      bonds had been flipped, some
      of them back to Oppenheimer
      itself, according to the Jour-
      nal’s analysis.

Oppenheimer, a unit of Op-

penheimer Holdings Inc.,

bought back about $1.6 million

in bonds it had sold to insurer

Contintental Casualty Co. just

hours earlier, then resold them

foraprofitof$10,969,NAIC

and MSRB trading records

show. Continental made

$10,530.

Trading in the first 10 days

after the offering netted Op-

penheimer and traders at other

firms nearly $700,000, or

about $540,000 when adjusted

to account for movements in

the broader market.

Continental Casualty flipped

bonds with underwriters 845

times between 2013 and 2017,

the most of any insurer ap-

pearing in the Journal’s analy-

sis. A spokesman declined to

discuss those trades, saying by

email: “We are not going to

share any insights into this

practice at this time.”

The trading profits suggest

the bonds were underpriced,

meaning taxpayers will wind

up spending additional money

for interest payments.

Oppenheimer said in written

statements it had followed its

standard protocol and is “con-

fident that the pricing of the

bonds was fair, reasonable and

equitable to the district.”

It said 2016 was a difficult

financial year for Illinois and

Cook County, and there was

“significant uncertainty as to

whether state aid would be

available to fund the district’s

budget.”

The district’s bonds, how-

ever, were somewhat insulated

from those concerns because

they were insured, earning

them a rating of AA by Stan-

dard & Poor’s, now S&P Global.

Oppenheimer said that while it

“sought buy-and-hold market

participants, traditional buyers

except for one, did not partici-

pate.”

District Superintendent Ki-

mako Patterson said the Jour-

nal’s analysis “is of intense in-

terest and concern. Districts

pretty much depend on compa-

nies like Oppenheimer to be

honest and do what’s in our

best interest.”

The MSRB, a self-regulatory

organization overseen by the

SEC, established the rule say-

ing that underwriters have a

duty to set “fair and reason-

able” prices, but its rules also

say the underwriter isn’t re-

quired to “exert its best efforts

to obtain the ‘most favorable’

pricing” unless it tells the is-

suer it will do that.

‘Fair price’

In an interview, MSRB se-

nior adviser and former gen-

eral counsel Michael Post said:

“We have longstanding rules

that require underwriters to

treat issuers fairly and to pur-

chase the bonds in an under-

writing at a fair price.” He de-

clined to comment on specific

trades in the Journal’s analy-

sis.

In 2017, the Washington

Economic Development Fi-

nance Authority sold $134 mil-

lion of tax-exempt bonds on

behalf of a private company

building a facility that would

convert farm waste to paper

pulp. The company, Columbia

Pulp I LLC, paid Goldman

Sachs & Co. $3.8 million, or

about 2.9% of the money

raised, to underwrite the

bonds.

The unit of Goldman Sachs

Group Inc. set prices so the

bonds would generate annual

interest of 7.75% for buyers—a

high yield indicative of the

speculative nature of the com-

pany’s new technology. Gold-

man sold the bonds in 25

trades, all at 11 a.m. on July

25, 2017.

A little more than an hour

later, some of the original buy-

ers sold $10.75 million of the

bonds to dealers at 5.3% more

than they had just paid, gener-

ating profits of $571,000.

Later that day, according to

NAIC filings, Goldman bought

back $6.6 million of bonds it

had sold to insurers for

$376,000 more than the buy-

ers had paid. Trading records

show Goldman then resold

those bonds for a $42,

profit.

Within 10 trading days of

the initial sale, $32 million of

the bonds were flipped by ini-

tial buyers, the Journal analy-

sis showed. Goldman and the

dealers and customers who

bought and resold them made

market-adjusted profits total-

ing $2.2 million.

Columbia Pulp declined to

comment. In a written state-

ment, the Economic Develop-

ment Finance Authority said it

“does not assume responsibil-

ity for or monitor secondary

market trading in its bond is-

sues.”

After the West Contra Costa

bond offering in 2016, the un-

derwriter, Piper Jaffray, said in

a report to the school district

that 23 financial firms and 16

smaller investors had bought

$180 million of the $191 million

in bonds. The report identified

those firms as “going-away”

buyers.

The district’s financial ad-

viser, Mr. Boehm, later told the

school board: “The term ‘going

away’ means that...these are

true buyers. These are not

dealers looking to just buy the

bonds for purposes of putting

[them] in the trading inven-

tory.”

A Piper Jaffray spokes-

woman said the firm didn’t in-

tend to give school officials the

impression that the $180 mil-

lion worth of bonds wouldn’t

be resold.

20 40 60 80 100 120

Offerprice

98

99

100

101

102% of face value

97

Onthefirstdayoftrading,

theleadunderwriter,Piper

Jaffrey,soldallofthebond

infivetradesatthe

offeringpriceof97.735.

Twoofthecustomerswho

boughtatotalof$2.

millioninbondsintwo

tradessold,or'flipped,'

thebondswithinaday.

Oneofthosecustomers,

insurerSafetyNational

Casualty,solditsbonds

backtoPiperJaffrayata

priceof98.650,givingita

profitof$10,065.

PiperJaffraythensoldthe

sameamounttoanother

dealeratapriceof98.750,

foraprofitof$1,100.

Dealersthatboughtfrom

PiperJaffrayalsoresold

thebondsathigherprices.

Attheendofninedaysof

trading,mostofthebonds

wereownedbylong-term

investors,whopaidon

average2.8%morethan

theofferingprice.

1

1

3

2

2

3

3

4

4

TRADE NUMBER

AnatomyofaBondSale

In2016,theWestContraCostaschooldistrictsolda$3.7millionbondaspartof

alargeroffering.Eachdotisatradeofthatbond.

Note: Trade sequences may be slightly out of order due to reporting lags.

Source: Municipal Securities Rulemaking Board; National Association of Insurance Commissioners

$0.1million

$1million

Beards

Invade the

Military

‘That’s not the way

it’s supposed to go,’

said an adviser to

local governments.

Back in style.