More Individual Municipal Bond Shenanigans [Edward Jones SEC overcharge settlement]

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Rick Ferri
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More Individual Municipal Bond Shenanigans [Edward Jones SEC overcharge settlement]

Post by Rick Ferri »

Here is another reason I like municipal bond funds. Bond dealers take advantage of retail investors:

Edward Jones to Pay $20 Million for Overcharging Retail Customers in Municipal Bond Underwritings

"The Securities and Exchange Commission today announced that St. Louis-based brokerage firm Edward Jones and the former head of its municipal underwriting desk have agreed to settle charges that they overcharged customers in new municipal bonds sales.... An SEC investigation found that instead of offering bonds to customers at the initial offering price, Edward Jones and Stina R. Wishman took new bonds into Edward Jones’ own inventory and improperly offered them to customers at higher prices."

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Re: More Individual Municipal Bond Shenanigans

Post by mptfan »

That is also another reason not to trust Edward Jones.
trybogle
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Edward Jones fined for overcharging muni bond customers

Post by trybogle »

[Thread merged into here, see below. --admin LadyGeek]

Thought this may help folks that are with Edward Jones... selling bonds at a premium..

http://www.usatoday.com/story/money/201 ... /31618309/
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Re: Edward Jones fined for overcharging muni bond customers

Post by TareNeko »

I was just about to post this.

Disgusting.
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Re: Edward Jones fined for overcharging muni bond customers

Post by Clever_Username »

Surprisingly useful information, actually -- might help folks convince others out of going to EJ. What's been the biggest regulatory controversy with Vanguard? I think once they were investigated for charging too little. Far better than being fined for overcharging :-)
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Re: More Individual Municipal Bond Shenanigans

Post by abuss368 »

Hi Rick,

Indeed! I will stay the course with our very lost cost Vanguard Intermediate Term Tax Exempt Bond Fund.

Thanks!
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Re: More Individual Municipal Bond Shenanigans

Post by afan »

Rick,

Since you bring it up:

What do you think of financial advisors putting their clients into individual bonds rather than funds. I have always assumed that funds would be better for almost everyone. At least until they had bond portfolios the size of funds and full time people checking bid and ask constantly. Even with, say $1M in fixed income, is that enough for an individual investor to have in bonds, rather than funds?
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Re: More Individual Municipal Bond Shenanigans

Post by skepticalobserver »

The muni bond and antique markets have a lot in common: no two items are the same resulting in little or no liquidity or transparency.

Munis are sold, not bought.
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Re: More Individual Municipal Bond Shenanigans

Post by Rick Ferri »

afan wrote:Rick,

Since you bring it up:

What do you think of financial advisors putting their clients into individual bonds rather than funds.
My company was managing over $300 mm in individual municipal bonds at one time. Now we only use low-cost municipal bond funds. You can't beat them for their diversification. It overwhelms any tax benefit from state specific individual bonds.

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Re: More Individual Municipal Bond Shenanigans

Post by LadyGeek »

FYI - I merged trybogle's thread into here. The software sorts posts by time, Rick Ferri was first.
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Re: More Individual Municipal Bond Shenanigans

Post by larryswedroe »

You can't beat them for their diversification. It overwhelms any tax benefit from state specific individual bonds.
I would agree with the quote if you are talking about lower quality bonds.
The kind of quality we buy (AAA/AA and only GO and essential services) have almost no history of credit losses. In buying bonds now for almost 20 years I believe Buckingham has not experienced a single dollar of credit loss (no guarantee that will be the case of course) and even in Great Depression the bonds had losses of just a few basis points. So with the highest quality you don't need anywhere near the diversification you need with lower quality.

In addition to the state specific issue you have the issue of different parts of the curve will lead often to different types of bonds to be most tax efficient (highest AT return)> So for example for much of recent past even for the highest bracket investors secondary CDs have had higher AT yield at maturities of up to even 5 years at times. Of course a muni fund won't buy taxable. And of course buying the individual bonds saves the mutual fund's expense ratio as well.

Larry
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Re: Edward Jones fined for overcharging muni bond customers

Post by alex_686 »

Clever_Username wrote:Surprisingly useful information, actually -- might help folks convince others out of going to EJ. What's been the biggest regulatory controversy with Vanguard? I think once they were investigated for charging too little. Far better than being fined for overcharging :-)
I doubt that Vanguard will every be fined for manipulating new issue of municipal bonds. I also assume that Vanguard will never be fined for having exploding fuel tanks in their cars. Mainly because Vanguard is in neither business. I am fine at taking shots at other players, but at least try to compare apples to apples and be somewhat fair.

I doubt that Vanguard will every be fined for much. They are selling a low cost one size fits all commodity. Most firms run afoul when offering complex customized products. Or when their employees are on a "eat what you kill" compensation plan. In either case the damage tends to be limited to just that product. If Vanguard was every found fiddling around, it might be with one of their bigger products. If that were the case the fine would be far larger than 20m.
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Re: More Individual Municipal Bond Shenanigans

Post by wshang »

afan wrote:Even with, say $1M in fixed income, is that enough for an individual investor to have in bonds, rather than funds?
There is so much exists about this on BH on archived threads. If you don't care to get some extra money for some work, sure, go the muni mutual fund route. But $1M is above the threshold.
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Re: More Individual Municipal Bond Shenanigans

Post by ogd »

wshang wrote:
afan wrote:Even with, say $1M in fixed income, is that enough for an individual investor to have in bonds, rather than funds?
There is so much exists about this on BH on archived threads. If you don't care to get some extra money for some work, sure, go the muni mutual fund route. But $1M is above the threshold.
There is no threshold. $10K is fine is fine, $1M is fine, and Rick's $300M is especially fine.

The only thing a larger portfolio does is it makes it possible to have some amount of diversification. Still, the fund is better at it than you: far more diversified, cheaper if you account for time, more liquid than possible in a realistic portfolio and avoids the pitfalls that (in my belief) are the norm rather than the exception in the small to medium muni investor crowd.
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Re: More Individual Municipal Bond Shenanigans

Post by patrick013 »

Medium grade muni's can default. Puerto Rico a recent example.
Waiting to see what the end result of that isn't the best investment
idea.

AAA General Obligation Muni Escrowed to Maturity, certainly a better idea.
Or let the fund diversify the risk then with just a few lower rated bonds
in the portfolio.

Can be avoided except some exposure to high tax rate people. Large
funds exist, money markets, etc..
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Re: More Individual Municipal Bond Shenanigans

Post by afan »

I would think a large enough portfolio also gives you the attention of someone who checks to see whether your bond ratings have fallen to the point that you would no longer want to hold them. That could be accomplished by DIY individuals with enough time on their hands, by a fund, or by a money manager running a series of separate accounts for clients. But given the low transparency of the muni market, the poor compliance of issuers, the huge number of different issues, keeping on top of this sounds like a lot of work, especially for someone doing it part time and without a lot of subscription access to pricing and information services. Hence my assumption that one needed a large amount of fixed income under management.

All of the above is independent of the diversification question. The large manager might run many individual accounts, most of which are not diversified. The manager would still have the person power to keep on top of all the issues about changes in credit quality.

Larry says that high rated munis have such low default rates that one need not worry about diversification. That may be true, but does that look at the bonds only when issued, or assuming dropping any bonds whose rating falls? Given the historical problems in the muni market, can you count on issuers now telling everyone when their financial conditions deteriorate? Can you count on the ratings agencies to pay enough attention to cut the ratings when municipalities run into financial trouble?

With the low fees that Vanguard charges, there is not much room for a portfolio of individual bonds to save money. As I understand Larry, the advantage is not cost, but the ability to customize holdings to client's tax rate and state of residence. Again, a lot of work, and unclear whether the difference would be worth it for a DIY, unless I suppose you are retired.
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Re: More Individual Municipal Bond Shenanigans

Post by Artsdoctor »

Geez. We all know that munis on the secondary market can be a bear to get a fair price on, but being cheated on an initial offering? Well, that's just criminal. Clearly, the SEC agrees!
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Re: More Individual Municipal Bond Shenanigans

Post by patrick013 »

BTW, you can login to Moody's and check bond ratings. That's
the best info there is. Some people buy muni's just for the sake
of diversification - it is another asset class. A few percent or
a few million. :D

My own bonds are individual bonds. Not hard at all. Not unhappy
at all. The books cannot do better. Never a 4% loss or a zero return
due to bond duration. Always buy up to the next best bond or CD.
It's easy. Depending on maturity of the bond(s) and the term premium
it could be much easier. Just my personal preference. Indexing stocks
is great.
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Re: More Individual Municipal Bond Shenanigans

Post by afan »

patrick013 wrote:you can login to Moody's and check bond ratings.
The last time I paid attention to this issue, there were two problems with that.

1. The ratings agencies saw little reason to update their ratings on individual issues. They got paid when they generated their original rating. They did not get paid for following the bonds and changing the ratings when the creditworthiness of the issuer changed. They would issue a rating and never look back at that bond.

2. The muni market was opaque. There were relatively few rules about disclosure of the financial state of municipalities on an ongoing basis. What few rules existed were commonly ignored. So even if you had a ratings agency that was trying to update its rating, it may well have no information to use to do so.

Yes, you could look up a rating of a bond, but it could have been based on information that was years old. No one may have updated the information and if they did, no one at the ratings agency may have noticed or cared.
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Re: More Individual Municipal Bond Shenanigans

Post by patrick013 »

Well there should be some annual recalc there.

Illinois bonds were recently downgraded so some annual
reporting must have been done. Bigger issues no doubt
get closer attention.
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Re: More Individual Municipal Bond Shenanigans

Post by Johno »

afan wrote:
patrick013 wrote:you can login to Moody's and check bond ratings.
The last time I paid attention to this issue, there were two problems with that.

1. The ratings agencies saw little reason to update their ratings on individual issues. They got paid when they generated their original rating. They did not get paid for following the bonds and changing the ratings when the creditworthiness of the issuer changed. They would issue a rating and never look back at that bond.

2. The muni market was opaque. There were relatively few rules about disclosure of the financial state of municipalities on an ongoing basis. What few rules existed were commonly ignored. So even if you had a ratings agency that was trying to update its rating, it may well have no information to use to do so.

Yes, you could look up a rating of a bond, but it could have been based on information that was years old. No one may have updated the information and if they did, no one at the ratings agency may have noticed or cared.
1. is not true. When engaged to make a rating the agencies have to be paid to continue to rate or else the issue becomes 'non rated'. So also last sentence is not true. The information reflected in the current rating will be reasonably timely, though not real time and things can change fast, which is a genuine shortcoming of ratings. Also there's no evidence IMO to say the rating agencies 'don't care' about the accuracy of their ratings. That might be populist political themes about the 2008-9 meltdown seeping into serious discussion of investing, where they don't belong. There are valid criticisms of rating agency policy toward 'synthetic' credits (AAA CMO tranches etc), and in general, but that's not evdience the rating agencies 'don't care'.

Otherwise though it's true there's reason to view rating agency ratings as less than the whole story. Besides not being a real time information source (compared to market prices of bonds), the ratings are based on required info provided to the agencies they can't gtee is accurate. Also by the same token that ratings are not 'one and done', it means a bond you buy when rated say A, a pretty good rating, could later be lower rated. Bonds seldom default directly from high IG range ratings (though it's happened) but more often get downgraded to a lower rating first. The DIY credit risky bond portfolio constructor needs to keep track and decide accordingly whether to keep downgraded bonds (though it's not free to get rid of them, their prices will have deteriorated also).

In general though I doubt when people say they've done as well with individual muni issues as a fund, apples to apples. The main reason is poor price execution by DIY relative to what the fund's traders can get. That outweighs the ER of a cheap fund. The DIY portfolio needn't be particularly riskier, and the amount of diversification needed depends how much money is in muni's (eg. if only 10% of your money is in muni's, the other 90% diversifies you a lot and you needn't have dozens or 100's of muni issues).
Last edited by Johno on Fri Aug 14, 2015 3:58 pm, edited 1 time in total.
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Re: More Individual Municipal Bond Shenanigans

Post by afan »

I think Illinois is a great example. The agencies had to respond because they have been so much in the news. This was a case where everyone knew about the problems long before the agencies woke up. That seems to be common. If the problems are not in the news, if learning of them would require tedious poring through financial reports (assuming they were ever created), then I don't have much confidence the raters would do their jobs.

Johno,

The problems I am talking about with both rating agency attention to changing credit quality, particularly in the muni market, have been so well documented, I don't think it is debatable. You are citing what they are supposed to do. I am talking about what has actually happened. Similarly, many of the municipalities simply never bothered to issue the required financial reports. They were never forced to do so. In theory, the market might punish an issuer that was way behind. In reality, many bonds are issued so rarely that this did not supply much discipline.

I am not making this up. Look up the issue and you will see what I mean.
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Re: More Individual Municipal Bond Shenanigans

Post by Johno »

afan wrote:1. I think Illinois is a great example. The agencies had to respond because they have been so much in the news. This was a case where everyone knew about the problems long before the agencies woke up.

2. The problems I am talking about with both rating agency attention to changing credit quality, particularly in the muni market, have been so well documented, I don't think it is debatable.
1. That's a very typical example of where ratings changes follow market price changes. That isn't debatable, shown by many studies. So if the straw man we're supposed to be knocking over is the argument that ratings changes will warn you of impended credit deterioration before the bond price reacts, yeah lets beat the heck out of him! :D

2. This OTOH refers to charge made by two 'whisteblowers' at Moody's in the immediate wake of the 2009 crash about non review of small cobweb encrusted issues by small municipal issuers, not a 'well documented' general fact about municipal ratings as you seemed to state it. If a DIY portfolio constructor just buys a few small old issues of obscure issuers of course there's a generally higher level of uncertainty about the credits. If the person is buying major issuers or is referencing say the rating of the state of the issuer, or a new issue, that info is not going to be years out of date.

The whole tangent launched off somebody saying 'you can look up Moodys ratings'. They didn't actually say what exactly that would achieve. They didn't say what other filters (size of issuer, how seasoned the issue, how many issues) would be applied. I guess the implication might have been taken as 'and this makes it easy to avoid any credit problem', which if that was what was meant is exaggerated. But your response as phrased was also exaggerated.

It's a definitely well documented historical fact that default rates of initially highly rated muni bonds have been very low, lower than the rate even for initially similarly highly rated corporations. Again, I would say that assuming common sense in constructing the portfolio credit wise, the main drawback to DIY muni portfolio v fund is the better prices the fund is going to get on the bonds, net of ER.
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Re: More Individual Municipal Bond Shenanigans

Post by afan »

Johno,

For example
WASHINGTON - More than half the municipal bonds sold between 1996 and 2005 have been delinquent in filing financial disclosures, showing the secondary market disclosure system for the municipal market is flawed, mostly because there are "no consequences for not filing," Peter J. Schmitt, president of DPC Data Inc., said yesterday about a new study released by his firm.


...
more than 25% are in chronic delinquency, missing three or more years of disclosures.

...
over 42,000 borrowers brought one or more issues to market during that period, only about 33,000 borrowers filed annual disclosure documents
...

The SEC has never taken action against a broker-dealer for underwriting the bonds of an issuer that failed to file its annual financial disclosures.

...

"There is virtually no enforcement in the secondary market, it's not taken seriously," he said. "There are no consequences for not filing and what you get is bad disclosure behavior."

http://www.bondbuyer.com/issues/117_168/-294051-1.html
“The findings indicated that in any given year, it would be impossible to analyze credit risk or find any warning of default from officially filed disclosure data on significantly more than half the issues studied,” Mr. Schmitt said. “For people attempting to make good investment decisions or protect themselves from potential default, this is not good news.”

http://www.investmentnews.com/article/2 ... disclosure
although certain public disclosures, including fnancial statements, are
contractually mandated in this market, enforcement is weak and regulatory oversight is limited to
the anti-fraud provisions of the Securities Acts. Consistent with the notion that issuers withhold
information to avoid incurring regulatory or reputational costs, I fnd disclosure decreases when
a local economic shock increases risk.

https://www.google.com/url?sa=t&rct=j&q ... LA&cad=rja
And so on.

The SEC did eventually wake up and ask issuers to file notices indicating that they had not filed necessary disclosures and eventually brought a complaint against one issuer that had, falsely, claimed in a notice that it was not delinquent.

One can take heart in the low historic rate of defaults for GO bonds. But all GO's are not created equal and some have stronger backing than others. But looking up a rating in Moody's is not a particularly reassuring source of information.
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Re: More Individual Municipal Bond Shenanigans

Post by Johno »

afan wrote:Johno,

For example
WASHINGTON - More than half the municipal bonds sold between 1996 and 2005
What % of $ amount? I think you'd find it very much lower. Which directly related to 'lack of enforcement in the secondary market' where $'s are what counts.
Last edited by Johno on Fri Aug 14, 2015 5:06 pm, edited 1 time in total.
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Re: More Individual Municipal Bond Shenanigans

Post by afan »

Perhaps. So what?
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Re: More Individual Municipal Bond Shenanigans

Post by Johno »

afan wrote:Perhaps. So what?
So it's presumably a tiny % of the $'s, and thus not very relevant to a common sense DIY investor who wouldn't concentrate a lot of his/her $'s in tiny (volume) issuers, let alone *old* issues of tiny issuers.
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Re: More Individual Municipal Bond Shenanigans

Post by patrick013 »

It's a shame when so many muni's default, Moody's is unreliable,
plus yields are super low. Can't have triple-A insured if there
are no insurers left. AAA state GO's with no insurance the top
quality left.
age in bonds, buy-and-hold, 10 year business cycle
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