A Lesson for Wall Street

It has been a little more than three years since Orange County filed for the biggest municipal bankruptcy in American history, and the shock waves still reverberate. Last week the Securities and Exchange Commission agreed to settle its lawsuit against C.S. First Boston, in which the SEC charged that the investment company and two of its former employees misled investors by failing to disclose the risks of buying Orange County bonds.

First Boston will have to pay $800,000 in fines and agree to an SEC finding that it was negligent. The two former employees must pay $35,000 each. The fines are far larger than the profit the company made in selling the Orange County bonds and should send a message to investment firms that they have to act more responsibly. Rather than take a bond issuer’s assurance that everything is OK, the underwriter will have to do some checking of its own. That should not be too difficult.

The SEC noted that First Boston could have recognized problems from news accounts and the county’s own financial statement. First Boston offered $320 million in Orange County bonds for sale in September 1994, after a number of warnings that steadily increasing interest rates were eroding the county’s investment fund. The bankruptcy came three months later, with the collapse of the $1.7-billion fund.

The SEC lawsuit was the only federal action against a brokerage stemming from the bankruptcy. Orange County last year dropped its criminal lawsuit against Merrill Lynch after the company agreed to pay the county $30 million. The county still has several civil lawsuits pending, including one against Merrill Lynch. The SEC has not ruled out lawsuits against other investment firms as well.

The federal regulators are right to tighten the rules on investment firms. Wall Street has competed fiercely for the lucrative business of underwriting municipal bonds. It should expend some energy in telling those who buy the bonds about the risks, rather than relying on the simple “buyer beware.”