FOR IMMEDIATE RELEASE 99-151 BT Alex. Brown Incorporated to Pay $15.3 Million to Settle Fraud Charges in Municipal Bond "Yield Burning" Case Former Head of Public Finance at Alex. Brown Charged with Fraud Fund Raiser and Adviser to Former Pennsylvania State Treasurer To Be Enjoined Seven Others Settle Related Charges Arising From Pennsylvania Bond Refundings Washington, DC, November 17, 1999 -- The Securities and Exchange Commission today announced that BT Alex. Brown Incorporated, a broker-dealer based in Baltimore, Maryland, has agreed to pay $15.3 million to settle fraud charges arising out of the Commission's investigation into the unlawful practice in municipal bond transactions known as "yield burning." In a related civil matter, the United States Attorney for the Southern District of New York today announced that the United States had intervened in, and settled, a lawsuit alleging "yield burning" filed against BT Alex. Brown's predecessor, Alex. Brown & Sons Incorporated ("Alex. Brown") under the federal False Claims Act. The SEC's settlement with BT Alex. Brown was one of seven actions the Commission brought today against a total of 10 individuals and entities for fraud and other securities violations in connection with two 1994 Commonwealth of Pennsylvania refunding bond offerings. BT Alex. Brown has consented to an SEC administrative order finding that Alex. Brown defrauded Pennsylvania in a March 1994 $494 million refunding bond offering. The Commission found that Alex. Brown misrepresented the size of the markups on U.S. Treasury securities that the firm sold to the Commonwealth for the transaction, charged excessive, undisclosed markups, and failed to disclose fully its fee-splitting arrangement with the financial adviser for the offering, Arthurs Lestrange & Company, Inc., a Pittsburgh-based broker-dealer. Kevin G. Quinn, the former head of Alex. Brown's Public Finance Department, was also charged with fraud in the Pennsylvania bond offering in a separate administrative proceeding. In a related action, the Commission charged Patrick H. McCarthy, a Philadelphia attorney and senior adviser and fund raiser for the Pennsylvania Treasurer at the time of the bond offering, with securities fraud as a result of his law firm's receipt of undisclosed payments from a third party (not related to Alex. Brown) after McCarthy used his influence to obtain the bond business for Alex. Brown. McCarthy consented to a federal court injunction and will pay a $100,000 penalty. Seven other persons and entities, including Arthurs Lestrange, Michael P. Bova (then the head of Municipal Finance at Arthurs Lestrange), Douglas E. Carter (Quinn's successor as head of Alex. Brown's Public Finance Department), and Dennis E. Thiemann and John M. Seidman (both associates of McCarthy), consented to Commission administrative cease-and-desist orders, and will pay disgorgement or penalties as a result of their actions in the March 1994 bond offering and a companion offering in June of the same year. Under the SEC settlement, BT Alex. Brown will pay approximately $15.3 million to the United States Treasury and to certain issuers of municipal bonds to settle claims related to "yield burning" in municipal bond transactions. This payment includes $15,177,572 to be paid to the United States to resolve Alex. Brown's False Claims Act liability for specified municipal refunding bond transactions as well as to resolve related claims of the Internal Revenue Service. As a result, no payment will be required of any issuer of municipal bonds covered by the settlement and the tax-exempt status of those bonds will be preserved. Certain municipal issuers to which Alex. Brown sold Treasury securities for refundings will receive payments totaling $127,674 directly from BT Alex. Brown. The $15.3 million payment relates to the practice commonly known as "yield burning." As the Commission's order explains, when state and local issuers wish to refinance their outstanding bonds, they often engage in an advance refunding. In an advance refunding, the issuer issues new "refunding" bonds and invests the proceeds in a portfolio of U.S. Treasury securities structured to pay the obligations on the old bonds. To prevent abuse of the benefit the federal government gives issuers by not taxing interest paid on their bonds, federal law limits the yield the issuer can earn on Treasury securities bought for refundings. A dealer that overcharges the issuer for Treasury securities diverts money to itself at the expense of the U.S. Treasury (or, sometimes, at the expense of the issuer). This diversion of money away from the Treasury is known as "yield burning" because, by overcharging for the Treasury securities, the dealer artificially reduces or "burns" their investment yield. If yield burning occurs, holders of the new refunding bonds can be required to pay federal income tax on the bond interest they receive. The fraud findings against BT Alex. Brown The Commission's order against BT Alex. Brown finds that in late 1993, Pennsylvania was considering bond refundings totaling over $1 billion. The Pennsylvania Treasurer's office was responsible for selecting a broker-dealer to sell the U.S. Treasury securities to the Commonwealth for the refundings. McCarthy, who had strong influence in the Treasurer's office, approached Alex. Brown about selling the Treasury securities. Since 1991, McCarthy had directed public finance engagements to Alex. Brown in exchange for having a percentage of the revenues paid to his law firms. McCarthy also had Alex. Brown appointed as financial adviser to the Pennsylvania Treasurer earlier in 1993. McCarthy proposed that Alex. Brown could be appointed to sell the Treasury securities if the firm would agree to pool its revenues with the Commonwealth's financial adviser for the refundings, Arthurs Lestrange, and allocate 60 percent of the total revenues to Arthurs Lestrange. Alex. Brown agreed and received the appointment from the Treasurer's office. Alex. Brown thereafter agreed with the Treasurer's office that it would sell the Treasury securities to the Commonwealth for a markup of 4.5 basis points (.045 percent) over the price Alex. Brown paid for the securities. Instead, Alex. Brown marked up the portfolio 45 basis points (.45 percent). The Commission's order finds that Alex. Brown violated the antifraud provisions of the federal securities laws by misrepresenting the size of the markup, and by charging excessive, undisclosed markups. The Commission's order also finds that Alex. Brown committed securities fraud by failing to disclose fully its fee-splitting arrangement with Arthurs Lestrange. Alex. Brown's revenues on the refunding were approximately $2.4 million, and Arthurs Lestrange's financial advisory fee was $210,000. After pooling and allocating fees pursuant to their agreement, Alex. Brown received approximately $1 million and Arthurs Lestange received over $1.5 million. Michael Bova of Arthurs Lestrange sent a letter to Commonwealth officials which disclosed the fact that the two firms were pooling their fees (but not the percentage split) and attributed the fee split to the firms' "inextricably integrated" efforts and "close professional cooperation." However, Alex. Brown knew and failed to disclose to the Commonwealth that Arthurs Lestrange was being disproportionately compensated from the pooled revenues, and that Alex. Brown had agreed to the fee split because McCarthy had indicated that Alex. Brown needed to do so in order to obtain the assignment to sell the Treasury securities. Without admitting or denying the findings in the Commission's order, BT Alex. Brown agreed to be censured, to cease and desist from future violations of the antifraud provisions, and to make the payments described above. Securities fraud charges against Kevin G. Quinn The Commission's Division of Enforcement has also charged Kevin G. Quinn, the head of Alex. Brown's Public Finance Department at the time of the Pennsylvania bond refunding, with securities fraud in a separately filed administrative proceeding. Quinn was the lead Alex. Brown banker responsible for the Pennsylvania transaction; his conduct forms the basis of the Commission's order against Alex. Brown. In the proceeding against Quinn, the Division alleges that he misrepresented the size of the markup on the Treasury securities which Alex. Brown sold in the Pennsylvania refunding, and that he failed to disclose the nature, purpose, and extent of Alex. Brown's fee- splitting arrangement with Arthurs Lestrange. The case will be heard by an administrative law judge. Patrick H. McCarthy to be enjoined for securities fraud In a complaint filed in the United States District Court for the Middle District of Pennsylvania, the Commission also charged McCarthy, the attorney and former adviser to the Pennsylvania Treasurer who put Alex. Brown into the refundings, with securities fraud. The complaint alleges that, although not a Commonwealth employee, McCarthy was viewed by senior staff as the most powerful person in the Treasurer's office after the Treasurer and the Executive Deputy Treasurer, and that he used his position and influence to promote Alex. Brown in the refundings without disclosing his receipt of fees to the Treasurer's office or the Commonwealth. Specifically, the Commission's complaint alleges that Dennis E. Thiemann, then a longtime consultant to Arthurs Lestrange through his firm, HDI, Inc., believed that the sale of Treasury securities to an issuer for a refunding bond offering could be lucrative for a broker-dealer. Thiemann obtained Michael Bova's agreement that Arthurs Lestrange would pay Thiemann one-third of its revenues on the bond offering if Thiemann could find a larger broker-dealer which would agree to sell the Treasury securities to the Commonwealth, split its fees with Arthurs Lestrange, and pay 60 percent of the total to Arthurs Lestrange. Thiemann then approached his friend, John M. Seidman, who ran a private consulting firm called JMS Associates, and whom Thiemann believed had contacts within the Treasurer's office. Seidman and Thiemann discussed several firms, including Alex. Brown, which Seidman knew was the financial adviser to the Treasurer's office. Seidman also was a friend of McCarthy, and knew that McCarthy had a long-standing relationship with Alex. Brown's municipal securities business. McCarthy was then approached for his assistance in arranging for Alex. Brown to be appointed to sell the Treasury securities. The complaint alleges that McCarthy then contacted Alex. Brown with the offer that Alex. Brown could be appointed to sell the Treasury securities if it would split fees with Arthurs Lestrange, and that McCarthy used his influence to have Alex. Brown appointed over the objections of the Treasurer's senior staff. After the refunding closed, Arthurs Lestrange paid one- third of its revenues, or $520,891 to Thiemann's firm, HDI, Inc. HDI, in turn, paid $175,250 to JMS Associates and $172,000 to McCarthy's law firm, and retained $173,641. The Commission's actions do not allege that Alex. Brown or Arthurs Lestrange knew about HDI's payments to JMS Associates or to McCarthy's firm. When senior staff in the Treasurer's office became aware and protested that Alex. Brown had overcharged the Commonwealth for the Treasury securities, McCarthy supported Alex. Brown. Alex. Brown later entered into an agreement to retain McCarthy's firm for $20,000 per month, commencing in June 1994, and McCarthy again used his influence to have Alex. Brown selected to sell the Treasury securities for the Pennsylvania's June 1994 refunding over the objections of the Treasurer's staff. The Commission's complaint alleges that, while promoting Alex. Brown's interests in the Treasurer's office in connection with both the March and June 1994 refundings, McCarthy knowingly or recklessly failed to disclose to the Treasurer's office or to the Commonwealth that he had a conflict of interest arising from his payment arrangements with Thiemann and Alex. Brown. Without admitting or denying the Commission's allegations, McCarthy consented to an injunction against future violations of the antifraud provisions and to a $100,000 penalty. McCarthy's law firm voluntarily returned to Pennsylvania the $172,000 obtained from HDI and all of the retainer fees received from Alex. Brown after June 1994, plus interest, and is not the subject of a Commission action. Other SEC actions related to the Pennsylvania refundings Thiemann, HDI, Seidman, and JMS Associates consented to Commission administrative orders finding that they were causes of McCarthy's violations. Without admitting or denying the Commission's findings, they each consented to orders that they cease and desist from committing or causing antifraud violations. The orders also require HDI and JMS Associates to disgorge the sums they obtained from the March 1994 refunding revenues ($173,641 and $175,250 respectively) plus prejudgment interest. The Commission also took action against Arthurs Lestrange and Michael Bova for their role in these transactions. In a settled administrative order, the Commission found that Arthurs Lestrange and Bova, as the Commonwealth's financial adviser, owed duties of complete disclosure. Although Bova informed Commonwealth officials by letter that Arthurs Lestrange and Alex. Brown were pooling fees, Arthurs Lestrange and Bova violated the securities laws by failing to disclose that Arthurs Lestrange would receive the largest portion of the pooled revenues, notwithstanding that its own contribution would be much smaller than that of Alex. Brown. Bova's letter also failed to disclose that Arthurs Lestrange had agreed to pay one-third of its revenues to Thiemann's company for bringing to Arthurs Lestrange a share of the deal revenues generated by Alex. Brown. Without admitting or denying the Commission's findings, Arthurs Lestrange and Bova consented to censures and to orders that they cease and desist from future violations. In addition, Arthurs Lestrange will pay a $100,000 penalty, and Bova will pay a $35,000 penalty. The Commission also took administrative action in connection with the Pennsylvania bond offerings against another former Alex. Brown banker and head of Public Finance, Douglas E. Carter. The Commission's order finds that Carter became the lead banker at Alex. Brown for the June 1994 Pennsylvania refunding; that, in that capacity, he knew or should have known that Alex. Brown had overcharged the Commonwealth 45 basis points instead of the agreed 4.5 basis points on the Treasury portfolio for the prior refunding; and that he violated the securities laws by not disclosing this fact to the Treasurer's office. Without admitting or denying the Commission's findings, Carter consented to be censured, to cease and desist from future violations, and to pay a penalty of $35,000. The Commission thanks the United States Attorney for the Southern District of New York, the Department of Justice, the Department of the Treasury, the Internal Revenue Service, and the Commonwealth of Pennsylvania for their cooperation in this matter. The Commission's investigation into yield burning and related practices by other dealers continues. Details of the Commission's enforcement actions can be found on its website at http://www.sec.gov. For further information, contact: William R. Baker, Associate Director, Division of Enforcement at (202) 942-4570 Brian A. Ochs, Assistant Director, Division of Enforcement, at (202) 942-4740. # # #