SEC may put California IOUs under fraud-protection rules


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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