NASD Eying Tobacco Debt Trade Prices

NASD officials refused to comment about whether any investigation is underway, but sources said the association is closely scrutinizing tobacco bond trades as part of its routine surveillance of municipal bond trade pricing data.

The Municipal Securities Rulemaking Board provides the NASD each day with pricing and other data from municipal bonds that traded two or more times the previous day. The board also sends the association daily reports containing data for all trades, with a one-week lag time. Those rolling daily reports contain corrections of errors in the other daily reports on frequently traded bonds.

The NASD routinely surveys the data for pricing abuses and has brought enforcement cases against a few dealers during the past two years alleging they charged customers excessive markups and markdowns on muni bond purchases and sales. None of these cases has involved tobacco bonds.

But market participants pointed to the huge spreads in tobacco bond prices that have occurred in recent days in the aftermath of the court decision against Philip Morris, which has spawned numerous credit rating downgrades.

An Illinois judge last month ruled that Altria Inc., the nation's largest tobacco manufacturer and the parent of Philip Morris, had to pay smokers of Marlboro Lights and Cambridge Lights $10.1 billion in a case in which the smokers claimed they were duped into believing the light cigarettes were healthier than regular ones. Under state law, the firm has to post a $12 billion bond to appeal the decision. That led Philip Morris to warn that it might have to file for bankruptcy and that it might be unable to make an April 15, 2003, payment under the 1998 national settlement between the tobacco companies and states. Then on Thursday a panel of Illinois lawmakers refused to approve a proposal that would have allowed Philip Morris to post only a small portion of the bond while appealing.

These actions spawned a series of rating downgrades and created turmoil in this sector of the market.

The NASD, sources said, is reviewing the trade data for potential abuses. Typically, the association questions dealer firms when they see such possible abuses, the sources said. The trade data the MSRB sends to its subscribers does not specify which dealers or customers are involved in muni bond trades. But the data the board sends the NASD is complete and this information is included, the sources said.

"No one provides the identities of dealers in public transparency reports for any public market," Christopher Taylor, the MSRB's executive director said yesterday.

Kevin Olson, a self-described investor advocate, who sponsors a Web site - www.municipalbonds.com - that contains pricing information, posts daily reports showing the widest pricing spreads in the muni market. The reports have been dominated by the spreads for tobacco bond trades in recent days. His April 3 report showed the highest spread between the lowest price a customer sold bonds for and the highest price a customer purchased bonds for that day was 18 points for some South Carolina bonds with a 6.375% coupon and a maturity date of June 15, 2028.

Regulators have refused to adopt any "bright line" rule specifying what percentages of markups and markdowns are excessive, preferring instead to rely on the prevailing prices of the market and the circumstances surrounding purchases and sales. But spreads of more than 5% typically are considered excessive for non-high yield bonds and some of the NASD's enforcement cases have involved lower spreads.

Some market participants criticize Olson's data, claiming it is misleading because it reports spreads from aggregate trade data for individual bonds during the day without taking into account the timing or any events that might have occurred that could affect the bonds' prices. They also claim the data, which comes from the MSRB daily reports, sometimes contains errors that are not corrected after the MSRB has posted the corrections, and does not take into account other factors such as the size of the trade.

But other market participants said Olson's reports should not be discounted and contain some seemingly damning information against dealers, particularly when checked against The Bond Market Association's Web site containing pricing information, www.investinginbonds.com. TBMA's site does not show the summary information on the widest spreads. But it does detail the trades that occurred in each bond issue that traded two or more times the previous day. Both Olson's and TBMA's data comes from the MSRB.

According to TBMA's data, a customer sold $1.735 million of the South Carolina bonds for $91.65 per $100 of bonds at 9:44 a.m. on April 3. At that exact same time, dealers traded the same amount of the bonds for the same price. Five minutes later, a customer bought $5,000 of the bonds at par. The transaction was smaller, but does the smaller size justify a spread of 8.35 points, which was 9.2% or $460 more than the price of the transaction that occurred a few minutes before? Some market sources said no. At 4:45 p.m., a customer bought $5,000 of the South Carolina bonds for $89.94 per $100. Fitch Ratings did not announce its downgrades until after the market closed and news of the Illinois legislative panel's decision not to reduce the bond did not run on most wires until later.

"But there may have been a buzz about these things," one source said. "Bad news results in price volatility."

"The question is, how much volatility is legitimate?" another source said.