Alex Brown pays $15 million to settle yield-burning case

Largest amount paid by an investment bank so far for a qui tam case

Nov. 17, 1999 -- Investment bank BT Alex. Brown Inc. has agreed to pay more than $15 million to settle charges that it had defrauded the federal government in the municipal bond market through a practice known as "yield burning."

It is the largest amount paid by an investment bank so far to settle allegations that it had engaged in yield burning by overcharging municipalities for U.S. Treasury securities.

"Alex. Brown and other investment banks took advantage of their positions as trusted financial advisors and deal managers to enrich themselves at taxpayers' expense," said Erika A. Kelton, an attorney with Phillips & Cohen LLP, a Washington, D.C., firm which represents the whistleblower who initiated the case. "The Treasury lost hundreds of millions of dollars because of yield-burning schemes."

Today's settlement covers transactions from 1990 through 1995 where Alex. Brown & Sons Inc. — the predecessor to BT Alex. Brown — had been a financial advisor or financial manager to municipalities, counties and agencies in:

  • Pennsylvania
  • Maryland (Montgomery County, Prince George's County, Calvert County, Frederick County, St. Mary's County, Charles County, Carroll County, Cecil County, Ocean City, city of Cumberland, Maryland Transportation Authority and the Maryland Health and Higher Education Facilities Authority);
  • North Carolina (cities of Charlotte, Asheville, Goldsboro and Fayetteville and Mecklenberg County);
  • Louisiana (city of New Orleans);
  • Virginia (city of Leesburg and Virginia College Building Authority); and
  • Washington, D.C. metro area (Washington Suburban Sanitary District)

The Justice Department, the Securities and Exchange Commission and the Internal Revenue Service agreed to a global settlement of potential False Claims Act, security law and IRS liabilities against BT Alex. Brown, which has been acquired by Deutsche Bank.

The government investigated the practices of Alex. Brown and other investment banks in the municipal bond market as a result of a "qui tam" (whistleblower) lawsuit filed by Michael Lissack, a former managing director of Smith Barney. Out of the total settlement, BT Alex. Brown is paying $15.17 million to settle charges made by Lissack.

"Municipal bond sales are arcane and complex transactions," said attorney John R. Phillips of Phillips & Cohen. "Without the help of an insider, the government may never have become aware that Wall Street was defrauding the Treasury of hundred of millions of dollars."

Two other investment banks previously settled qui tam cases brought by Lissack. Alex. Brown's settlement brings the total to about $39 million that banks have paid so far as a result of Lissack's decision to blow the whistle on Wall Street using the False Claims Act.

Lazard Freres & Co. agreed to pay the federal government a total of $11 million last April to settle federal yield-burning charges. In November 1998 Lazard agreed to pay the Los Angeles County Metropolitan Transportation Authority $9 million to settle charges brought under the California False Claims Act that the investment bank fraudulently overpriced securities by $3 million on a single municipal refinancing transaction. (Phillips & Cohen also served as counsel to the LAMTA in the case.)

A separate qui tam case brought by Lissack resulted in Meridian Securities (now CoreStates Financial Corp.) paying the Justice Department $3.8 million in April 1998 to settle yield-burning charges.

Yield burning occurs when banks improperly inflate the price of securities above their fair market value. The excessive mark-ups lower — or "burn" — the securities' yield. In the case of municipal debt refinancings known as "advance refundings," underwriters pocketed profits that should have gone to the federal government.

Phillips & Cohen's empirical study of pricing practices in the municipal bond market found that when banks sold securities competitively, they charged average mark-ups of just 25 cents per $1,000 bond. But when they sold clients the same securities on a sole-source basis, the banks added about a $5 mark-up per bond. The profits made on non-competitive sales were on average 20 times higher than those made on competitive deals.

Lissack's false claims lawsuit against Alex. Brown was filed in 1995 in the southern district of New York (Manhattan). It was brought under the False Claims Act, which permits individuals with knowledge of fraud against the government to file suit on its behalf.

For more information about this case, see the following news stories:

  • "BT Alex. Brown agrees to pay $15.3 million in bond case," David Barboza, The New York Times, 11/18/99.
  • "U.S. near sweeping pact on 'yield burning,'" Charles Gasparino and John Connor, The Wall Street Journal, 11/18/99.
  • "Alex. Brown overcharge case settled," Bill Atkinson, Baltimore Sun, 11/18/99.
  • "Broker to pay for Pa. markups," Tom Cahill, The Philadelphia Inquirer, 11/18/99.
  • "SEC fines, censures lawyer, two investment firms for gouging state," Ken Zapinski and Frank Reeves, Pittsburgh Post-Gazette, 11/18/99.