Looking to sell a California IOU? Read this first

If you've got a California IOU you'd like to cash today, your options are much more limited than they were last week.

Major banks including Bank of America, Wells Fargo, Chase and Union Bank no longer will take the state's scrip from customers.

However, as my colleague Tiffany Hsu wrote on Saturday, Citibank says it will accept the IOUs (from customers) through Friday. Bank of the West says it plans to allow customers to deposit the paper indefinitely. Some smaller banks, and many credit unions, also continue to redeem the IOUs from members for full cash value.

If you're tempted to try to sell an IOU to someone (say, online) to get cash before the state plans to pay off the paper on Oct. 2, you should at least know your rights. The Securities and Exchange Commission last week decided that the IOUs (officially known as registered warrants) are securities under U.S. law -- which means that someone acting as a dealer and trading the paper, as opposed to just buying and holding, is subject to federal anti-fraud statutes.

The SEC's decision means that someone trading in IOUs is supposed to comply with standards set by the Municipal Securities Rulemaking Board.

Here's what the MSRB said in a statement on Friday:

"The buying, selling and trading of California’s warrants by intermediaries are subject to all MSRB rules of conduct and fair practice," said MSRB General Counsel Ernesto Lanza. "The MSRB is particularly concerned about compliance with obligations with respect to the prices at which such intermediaries buy California warrants from citizens who may be in need of immediate cash,"  Lanza said. "Persons attempting to profit from the buying and selling of municipal securities must price those transactions based on their fair market value, and California’s IOUs are no exception."

MSRB rules require that prices for the purchase and sale of municipal securities, including the California warrants, charged by securities firms and banks must be fair and reasonable based on their best judgment of the securities’ fair market value. These intermediaries would violate this rule if they attempt to take advantage of their customers by offering to purchase warrants at deep discounts that do not reflect fair market value. Advertisements and published quotations for purchases and sales of California warrants also must meet MSRB standards.

In theory, this is supposed to protect cash-needy IOU recipients from ripoff artists. 

But "fairness" in pricing any security is a subjective thing, of course.

If just having rules that call for fair pricing was enough to make it so, no one would ever feel that they got a bum deal buying or selling a thinly traded municipal bond in the broker marketplace. And we know that isn't true.

But by all means, if you're shopping around to sell an IOU, ask potential buyers if they're registered as securities dealers; if they're aware of the MSRB standards; how they're determining that the price they're offering is "fair;" and what fees are involved.

Note that once you sell, the buyer is entitled to the 3.75% annualized tax-free interest return the state says it will pay on the IOUs at maturity.

Photo: Printing IOUs in the state controller's office. Credit: Rich Pedroncelli / Associated Press

Comments

[Michael]

I referred to your blog and your information about the SEC involvement in California IOUs via my Twitter account, mrbarnard1.

My tweet generated an unusually intense and heated response from someone I take to be from Australia who is trying to buy California IOUs.

Here's that exchange. I wonder if his assertions are accurate.

From mrbarnard1: “Do you have a California IOU instead of a check? Here's what you need to know about selling it: http://sn.im/n5uf7”

From @TheTopBloke: “@mrbarnard1 The SEC does not regulate IOU's. That is bulls**t.”

From @mrbarnard1: “@TheTopBloke The SEC last week decided that the IOUs (officially known as registered warrants) are securities under U.S. law.”

From @TheTopBloke: “@mrbarnard1 They are not. There is no regulation, no statute which allows the SEC to regulate them.”

From @mrbarnard1: “@TheTopBloke "They are not...no regulation, no statute which allows the SEC to regulate." Please correct the L.A. Times.http://sn.im/n5uf7”

From @TheTopBloke: “@mrbarnard1 BTW, they said, 'they believe'. It's a scam, see financial times July 6th”

From @TheTopBloke: “@mrbarnard1 I've emailed the SEC and there is nothing more they say than 'they believe' in other words...”

From @TheTopBloke: “@mrbarnard1 If you are to trade in them like stocks, then yes, but if you buy one to hold to maturity, then no.”

From @TheTopBloke: “@mrbarnard1 They do not want a secondary market to be created without allowing Wall Street to cash in.”

From @TheTopBloke: “@mrbarnard1 If you ask the State Treasury Dept, they will tell you, you can purchase, but you need a notarized bill of sale.”

From @TheTopBloke: “@mrbarnard1 Therefore, no, SEC does not regulate, but if you build a site and start trading, and forge them, obviously they will get you.”

From @TheTopBloke: “@mrbarnard1 Either way, if you know someone that wants to part with it, send them my way, I'm buying.”

From @TheTopBloke: “@mrbarnard1 1 more thing. Assuming they are securities, has the State registered the scheme with the SEC, or R they issuing fraudulently?”

This exchange is visible on my Twitter account at mrbarnard1.

[Tom Petruno]

@Michael: SEC has no jurisdiction over the state of California, so the state has no need to register the IOUs. The SEC has jurisdiction over securities and securities dealers. The SEC can't stop anyone from buying an IOU to hold. But if someone starts buying and selling -- acting as a dealer -- that's where the SEC believes it has jurisdiction. It would be interesting to see someone take them to court over this, but I highly doubt anyone would. Certainly, the SEC is not going to get involved with individuals who are just buying IOUs for their own accounts, as private investors.

Tom Petruno