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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 is subject to federal anti-fraud statutes.
The SEC's decision means that 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
As expected, the Securities and Exchange Commission late today decided that California's IOUs are "securities" under the agency’s definition.
The SEC’s move won't have any effect on the state's ability to issue the IOUs, because the agency has no jurisdiction over state governments.
Rather, the decision is aimed at limiting the potential for recipients of the IOUs to be defrauded by individuals or companies that offer to buy the scrip, which cash-strapped California is issuing to pay certain of its bills. The state says the IOUs will accrue tax-free interest at a 3.75% annualized rate and will be redeemed for cash on Oct. 2.
"As securities, the IOUs are subject to the antifraud provisions of the securities laws," the SEC said in a statement. "As a result, buyers and sellers will have certain rights and remedies for fraud, and the Commission will be able to take action against any person committing fraud in connection with the purchase or sale of an IOU."
 What would constitute fraud? Say an individual decides to act as a dealer, buying IOUs from people who are stuck with them. This individual tells a potential seller, "I have it on good authority that the state won’t repay these IOUs as promised on Oct. 2. You’d be smart to take 85 cents on the dollar right now."
Assuming the state has said nothing about delaying repayment, the would-be dealer could be charged with misrepresentation under federal securities laws.
So the SEC’s move might keep some of the sharks at bay. But there’s a reason why sharks are at the top of the food chain: They’re good at going for the kill.
"If you hold an IOU and wish to sell it prior to maturity you should consider whether you think you are getting a fair price," the SEC says. But how will you know what’s fair? That’s the problem.
Some independent electronic marketplaces, such as SecondMarket.com, have expressed interest in acting as intermediaries to bring buyers and sellers together. But there won’t be a central market for the IOUs similar to the New York Stock Exchange or Nasdaq for stocks.
And the idea of doing business with someone who has just popped up on the Internet to buy IOUs has caveat venditor written all over it.
The problem for IOU recipients who need immediate cash will become much bigger after Friday, which is the final day that major banks, including Bank of America and Wells Fargo, say they’ll redeem IOUs for customers. California credit unions may be the best alternative: Many say they'll continue to redeem IOUs in full -- if you're a member. Go here for a listing.
Californians wouldn’t have to worry about any of this if Sacramento would just pass a fiscal 2010 balanced budget. But the stalemate continues.
Too bad the SEC can’t charge the Legislature and governor with misrepresenting themselves as responsible public servants.
-- Tom Petruno
Photo: A California IOU. Credit: Rich Pedroncelli / Associated Press
The Securities and Exchange Commission soon may step into the fray over the IOUs California is issuing to pay certain debts.
The SEC could decide today that the IOUs are securities, according to a source familiar with the matter. The Municipal Securities Rulemaking Board, which regulates trading in muni bond debt, was leaning in that direction earlier this week.
A move by the SEC would be an attempt to provide some fraud protection for recipients of the IOUs. Any person or firm offering to make a market in the IOUs -- bringing buyers and sellers together -- could have to register as a broker-dealer and would be subject to federal anti-fraud rules.
Recipients of the IOUs still would be free to sell them or cash them anywhere they’d like. The SEC would be trying to ensure that some orderly markets develop for the scrip, given that major banks, including Bank of America and Wells Fargo, say they won't cash the IOUs after Friday.
The state says it intends to pay off the IOUs on Oct. 2, with interest. The IOUs are earning a 3.75% annualized interest return, which is exempt from federal and state income tax.
The Associated Press reports today that SecondMarket, which creates markets for illiquid assets, has received "decent interest" from hedge funds, municipal bond investors and distressed asset investors as potential buyers of the IOUs, according to Jeremy Smith, the New York company's chief strategy officer.
Also from AP, echoing what my colleague W.J. Hennigan reported earlier this week:
The IOUs "have the hallmarks of securities, and if they are securities, they are pretty clearly municipal securities," MSRB General Counsel Ernesto Lanza said. "To the extent that municipal securities dealers are involved in the sale and trading of the warrants, our rules would apply. We would be especially concerned about dealers' obligations to customers with respect to fair pricing."
-- Tom Petruno
The Bernie Madoff scandal may have helped claim another head at the Securities and Exchange Commission.
Lori Richards, the 49-year-old chief of the SEC’s division that inspects money managers, said Wednesday that she would resign.
Richards has lead the Office of Compliance Inspections and Examinations since it was created in 1995.
Congress earlier this year skewered Richards, former Enforcement Director Linda Thomsen and other SEC officials for failing to uncover Madoff’s $65-billion Ponzi scheme. Thomsen resigned in February.
 Richards, a 24-year veteran of the SEC who worked in enforcement in the Los Angeles office in the early 1990s, told Bloomberg News that it was "completely my decision" to step down.
"I’m excited about taking on new challenges," she said, without revealing her plans. "I’ve been thinking about doing something different for some time."
U.S. lawmakers were livid that the SEC could have missed Madoff’s long-running Ponzi scheme, despite evidence it was given by a whistle-blower.
As Bloomberg notes:
"Perhaps most shocking" about the case is that Richards’ unit never conducted an inspection of the money-management side of Madoff’s business after he registered it with the SEC in September 2006, U.S. Rep. Paul Kanjorski said at a January hearing.
Kanjorski said the SEC overlooked "red flags" such as the inability of investors to duplicate Madoff’s returns and his use of "an auditor the size of a mouse" to review a fund "the size of an elephant."
Richards’ defense was that the SEC had about 400 staff members to inspect more than 11,000 money managers.
She told Congress in January that the agency had to "prioritize registrants for examination, and to assign examination staff to those advisors and funds that appear to present the greatest potential for having an adverse impact on investors."
Richards said the process was "a form of triage, to help match available staff resources to the most pressing risks."
But if the process missed Bernie Madoff, it obviously wasn’t very good at identifying "pressing risks."
-- Tom Petruno
Photo: Lori Richards. Credit: Associated Press
Money market mutual funds, already paying near-zero yields, could see those payouts fall further under proposed new rules to boost the safety of the portfolios.
The Securities and Exchange Commission today proposed tightening restrictions on money funds’ investments, hoping to avoid a repeat of the sudden demise of the $60-billion Reserve Primary fund last September.
Money funds, which hold a total of $3.6-trillion in investors’ savings, would have to hold more of their assets in only the most liquid securities, so that they have ready cash to pay off investors who want out.
The most liquid assets also typically pay the least, so owning more such securities probably would put more downward pressure on fund yields. The average taxable money fund’s annualized yield now is a mere 0.13%, according to iMoneyNet Inc.
 Money funds already are designed to allow investors to get in or out at will, at a constant $1-a-share asset value. But when investors deluged the Reserve Primary fund with redemption notices in September it was unable to meet all of those requests.
That triggered a run on other money funds, forcing the U.S. Treasury to step in and guarantee fund assets to stem investor panic.
SEC commissioners today proposed that funds serving individual investors would have to hold at least 5% of their assets in cash, Treasury securities or other investments that could be sold in one day. At least 15% of assets would have to be in securities that could be sold within a week.
Those percentages would be doubled for funds that serve institutional investors.
The SEC also proposed that the maximum average maturity of fund holdings be cut to 60 days from the current 90 days, which also would likely depress portfolio yields further. . . .
Read on »
The use of "toxic" to describe high-risk mortgages has been de rigueur for the last two years. Now it looks like Countrywide Financial Corp. founder Angelo R. Mozilo might have coined the term.
In the Securities and Exchange Commission’s civil fraud case filed today against Mozilo, the agency includes excerpts from e-mails Mozilo wrote in spring 2006 to other Countrywide executives, describing his concerns about some of the lender’s unconventional mortgages.
 He uses "toxic" twice in these emails -- long before word became the mortgage-market adjective of choice on Wall Street.
In March 2006, Mozilo wrote that the lender’s program of granting subprime loans for 100% of the value of a borrower’s home was "the most dangerous product in existence and there can be nothing more toxic and therefore requires that no deviation from [underwriting] guidelines be permitted irrespective of the circumstances."
In April 2006, Mozilo wrote about those loans, "In all my years in the business I have never seen a more toxic prduct [sic]."
But when Countrywide’s risk-management department in April 2006 recommended increasing minimum credit scores for the loans, echoing Mozilo’s criticisms, the idea allegedly was opposed by David Sambol, who then headed the lender’s production units (and who also is a defendant in the SEC’s case).
Sambol "noted that such an increase would make Countrywide uncompetitive with subprime lenders such as New Century, Option One, and Argent," the SEC says.
-- Tom Petruno
Photo credit: Gerry Broome / Associated Press
The Securities and Exchange Commission's civil fraud case against Angelo R. Mozilo and two other former senior executives of Countrywide Financial Corp. centers on allegations that they knew the lender was making increasingly dangerous mortgages from 2005 through 2007, but pretended to Countrywide’s investors that the loans were high quality.
The agency zeros in specifically on so-called pay-option adjustable-rate loans, which allowed borrowers to pay so little each month that their loan balance increased.
The SEC, obviously going for the biggest shock effect in presenting its case, is playing up excerpts from a series of e-mails it pulled from Countrywide’s computers.
 As the setup for one of the e-mails, the SEC quotes from a speech Mozilo gave on May 31, 2006, in which he said that "Pay-Option loans represent the best whole loan type available for portfolio investment from an overall risk and return perspective," that the "performance profile of this product is well understood because of its twenty-year history, which includes stress tests in difficult environments[,]" and that Countrywide "actively manages credit risk through prudent program guidelines … and sound underwriting."
Yet just one day later, on June 1, 2006, the SEC says, Mozilo sent an e-mail to other Countrywide executives "in which he expressed concern that the majority of the Pay-Option ARM loans were originated based upon stated income, and that there was evidence of borrowers misrepresenting their income. Mozilo viewed stated income as a factor that increased credit risk and the risk of default."
In the e-mail, the SEC says, Mozilo also "reiterated his concern that in an environment of rising interest rates, [loan] resets were going to occur much sooner than scheduled, and because at least 20% of the Pay-Option borrowers had FICO scores less than 700, borrowers ‘are going to experience a payment shock which is going to be difficult if not impossible for them to manage.’ "
As for what Countrywide’s investors were told, the SEC complaint says:
On April 27, 2006, Mozilo stated in an earnings call that Countrywide’s "pay-option loan quality remains extremely high" and that Countrywide’s "origination activities [we]re such that, the consumer is underwritten at the fully adjusted rate of the mortgage and is capable of making a higher payment, should that be required, when they reach their reset period."
Could Mozilo’s views have changed that dramatically between April 27 and June 1?
-- Tom Petruno
Photo: Angelo R. Mozilo. Credit: Jay Mallin / Bloomberg News
Angelo Mozilo has come to symbolize the wretched excess of mortgage lending during the housing boom.
He also became a symbol of excess on another level: executive compensation.
The case the Securities and Exchange Commission has been pursuing against the Countrywide Financial Corp. founder ties into both of those emotionally charged issues: Countrywide's aggressive lending generated Mozilo's fabulous wealth.
The SEC’s job is to protect investors, not subprime mortgage borrowers. So it isn’t directly concerned with whether Countrywide made loans to people who had little chance of repaying them.
 Rather, the SEC cares whether Countrywide’s shareholders were misled about the company’s finances as the mortgage market deteriorated, and whether Mozilo’s heavy personal stock sales violated federal rules against insider trading.
Indirectly, of course, the SEC’s case is about Countrywide’s voracious lending. As the company grew to become the nation’s biggest mortgage provider, its earnings ballooned to $2.7 billion in 2006 from less than $500 million in 2001.
The company’s stock soared to a record high of $45.03 in February 2007 from $10.24 at the end of 2001, a 340% gain. In the same period the average financial-services stock in the Standard & Poor’s 500 index rose a modest 41%.
Mozilo reaped huge sums by selling personal stock into that price surge. He took home $160 million in 2005 and $120 million in 2006, including pay and profit on exercised stock options.
The SEC has been investigating whether Mozilo accelerated his stock sales because he knew something that other shareholders didn’t know -- for example, that Countrywide’s loan portfolio was a time bomb.
In a statement today, Mozilo’s attorney, David Siegel, had this to say:
"All of Mr. Mozilo's stock sales were made in compliance with properly prepared and approved trading plans and reflected recommendations by his financial advisor over a long period of time.
"The persistent innuendo in the media and political circles that Mr. Mozilo was selling Countrywide stock because he was aware of some supposedly ‘secret’ adverse information about the company is scandalous and inconsistent with even a cursory examination of the facts surrounding the history of his stock holdings."
Mozilo sold stock regularly under trading plans that were commonly used by many executives during the bull market as a way to avoid the appearance of selling on inside information. The plans entailed a commitment to sell a set amount of stock at regular intervals – say, monthly.
But as a Los Angeles Times story noted in September 2007, "Most executives adopt a plan and stick with it, compensation and securities experts say. Mozilo didn't."
From the story (and I urge reading the entire piece):
Mozilo shifted course twice in late 2006 and early 2007, according to regulatory filings, amid mounting signs of trouble in the housing and mortgage industries.
Mozilo adopted a new trading plan, added a second and then revised it, allowing him to unload hundreds of thousands of additional shares before Countrywide stock went into a tailspin.
"There is clearly no legal prohibition of altering your plan," said David Priebe, a Bay Area attorney who has helped set up more than 50 of such plans for executives. "But the more that you modify or add to your plan over a short period of time, the more risk that someone will call it into question. I would not say that you cannot do it. I would say there is a risk if you do do it."
By January 2008 Countrywide's stock had crashed to $5 and the loss-ridden company was forced into the arms of Bank of America Corp.
The SEC staff believes there is enough evidence of wrongdoing by Mozilo to charge him with fraud. His lawyers now have the task of talking the SEC out of it, against the post-financial-crash backdrop of the public's desire for vengeance against those who they believe perpetrated the debacle.
At most, however, a successful SEC civil case (i.e., a settlement) would involve a steep fine. The far greater risk for Mozilo would be a federal criminal case, and that is still a much bigger legal question mark.
-- Tom Petruno
Photo: Angelo Mozilo in 2007. Credit: Anne Cusack / Los Angeles Times
Countrywide Financial Corp. founder Angelo Mozilo may be facing federal civil fraud charges, the Wall Street Journal is reporting this afternoon.
From the Journal:
Staff at the Securities and Exchange Commission have decided to recommend filing civil fraud charges against Mozilo, according to people familiar with the investigation.
 The SEC sent a so-called Wells notice to Mr. Mozilo several weeks ago alerting him of the planned charges, the people said. The potential charges include alleged violations of insider-trading laws as well as failing to disclose material information to shareholders, according to one person familiar with the matter.
A Wells notice is a precursor to a civil lawsuit in an SEC investigation. It outlines to an individual or company under investigation what charges might be filed against them and gives a target a chance to respond to the allegations.
Mr. Mozilo's attorneys could still persuade the SEC's commissioners not to bring a case.
David Siegel, an attorney for Mr. Mozilo couldn't immediately be reached for comment. SEC officials also didn't respond to calls for comment.
The SEC began investigating Mozilo after a Los Angeles Times report in September 2007 detailed his sale of $145 million in Countrywide stock in late 2006 and 2007 via automatic trading plans.
From a story by my colleagues Kathy M. Kristof and E. Scott Reckard last August:
Federal law bars a corporate executive from buying or selling the stock of his or her company while in possession of material nonpublic information about the firm, unless the trades are made under automatic plans established in advance.
Mozilo launched such a plan in October 2006. But in the following two months, as problems in the subprime mortgage market mounted, he revised the plan once and launched an additional trading plan. Both moves allowed him to sell more shares.
Countrywide said in 2007 that Mozilo had made the changes without regard to inside information. But legal experts said the modifications raised a red flag.
As its mortgage losses surged, Countrywide's shares plunged from a peak of $45 in February 2007 to $5 by early 2008, when the mortgage giant hastily agreed to a takeover by Bank of America Corp.
-- Tom Petruno
Photo: Angelo Mozilo. Credit: Mark Wilson / Getty Images
The list of possible candidates to chair a federal investigation of the financial-system debacle now includes retired Supreme Court Justice Sandra Day O’Connor, former Federal Reserve Chairman Paul Volcker and former Securities and Exchange Commission Chairman Arthur Levitt, Bloomberg News reports, citing unnamed sources.
Congress wants to name a panel modeled on the one that investigated the cause of the early-1930s market crash that fed the Great Depression. That probe, spearheaded by Senate counsel Ferdinand Pecora in 1933, led to major financial reforms including the creation of the Securities and Exchange Commission. Along the way it also made for great theater as Pecora called in the leading bankers of the era, including Charles E. Mitchell and Albert H. Wiggin, to testify about their roles in the meltdown.
The House and Senate have passed separate bills to create a commission, but still have to reconcile their differences before sending the legislation to President Obama.
From Bloomberg:
Discussions over who will lead the panel, as well as the group’s other members, continue and no decisions have been made, people familiar with the matter said.
The commission is likely to have the power to subpoena witnesses and spend more than a year delving into the issue.
My vote would go to the 81-year-old Volcker, assuming he would be willing to give up his current gig as chairman of Obama’s Economic Recovery Advisory Board and take on something potentially historic in scope and impact.
But in a recent interview on Bloomberg TV, Volcker said his role as an Obama advisor "is as temporary as it can be. I'm conscious of the fact that I’m not leaving enough time for fishing in my old age."
O'Connor is 79; Levitt is 78.
-- Tom Petruno
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Tom Petruno
Tom Petruno has been chronicling financial markets' highs and lows since 1979, and has been the Times' financial columnist since 1990. He writes on markets, corporate finance and the economy, and how it all ties in to individual investors' portfolios.
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