- BOND TRUSTEES
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- The basic function of the municipal bond trustee (which is typically a department of a commercial bank) is to carry out the administrative functions required under the conditions of the bond. Among these are:
- establishing the accounts related to the bond;
- invoicing the issuer for debt service payments and holding funds until dispersed;
- maintaining a list of bondholders;
- making interest (and ultimately principal) payments to bondholders; and
- representing the interests of bondholders in the event of a default.
- In other words, the trustee acts in a fiduciary capacity with regard to bondholders. In the event of a default, the obligations—and the authority—of trustees increase considerably. The trustee takes on a more discretionary role and is subject to a higher legal norm (the “prudent person” standard). For example, in a default situation the trustee has to decide when and how to use debt-service reserve funds. Trustees have often been accused of being too cautious in such situations.
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- Under normal (non-default) circumstances, the fees paid to trustees are modest—often less than $5,000 a year. Those fees usually increase if a default has occurred.
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- IT STARTED WITH RAILROAD SCAMS
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- The need for bond trustees is said to have originated in the mid-19th Century as a result of railroad bond scams. Swindlers would travel to small towns in the Midwest and West and pose as railroad representatives who were deciding where the line would run. Townspeople were told that the odds that the railroad would pass through their town would be greatly improved if they invested in the project. Residents would readily hand over their hard-earned savings to buy railroad bonds that turned out to be bogus. This helped give bonds a bad reputation that legitimate issuers sought to counteract by bringing in independent parties to protect the rights of investors.
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- In the decades that followed, however, there was a great deal of inconsistency in the performance of trustees, which was in part a reflection of ambiguity in the law. In 1936 the U.S. Securities and Exchange Commission published a detailed report on trustees that recommended the enactment of clearer and stricter rules. Congress used the report as the basis for the Trust Indenture Act of 1939. The Act affirmed the duty of trustees (which were now required to be corporations) to protect the interest of bondholders and to provide ongoing information about the financial condition of the issuer. Congress did not, however, set a strict requirement that trustees monitor that condition. All of this applied only to corporate bonds, but it had influence on trustees for muni bonds.
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Trustees are subject
to the anti-fraud
provisions of
federal securities
laws. A trustee who
helped an issuer put
out false or
misleading
information could
face fraud charges
brought in a
private suit or by
the SEC. They are
also susceptible to
charges of
mismanagement. Two
of the major cases
involved Bank of
America's trustee
business.
In November 1998 BofA agreed to pay $187.5 million to settle charges by state and local governments in California that it had mishandled bond payments and systematically retained unclaimed bondholder payments that should have been returned to the appropriate authorities between 1978 and 1995. In July 2001 BofA agreed to pay $35.6 million to the state of Alaska to settle allegations that the bank overcharged bond issuers for trustee services, mishandled unclaimed funds owed to bondholders and maintained faulty records. The Alaska allegations involved 30 bond issuers and about 900 debt offerings from 1958 to 1995.
- There remains some degree of confusion about the extent of the trustee’s disclosure responsibilities. When the SEC amended Rule 15c2-12 in 1994 to require underwriters to get issuers to provide annual financial updates, the Commission did not state a clear role for trustees in collecting or distributing that information. This is in line with the limited scope of federal municipal bond regulation, which focuses mainly on underwriters and dealers. (See section on
regulation.)
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THE
HOLMES HARBOR CASE
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- The most significant trustee legal dispute in many years has been taking place in Washington State. U.S. Trust Co. found itself one of the targets of a class action lawsuit there in connection with $20 million in bonds issued by the Holmes Harbor Sewer District in October 2000. The state auditor’s office and the state attorney general later concluded that the bonds were invalid because they were issued for a project located outside the sewer district. There was also a question about the legitimacy of U.S. Trust’s being hired as a trustee, given that state law bars water and sewer districts from hiring private trustees except in cases of revenue bonds. (For non-revenue bonds, the districts are supposed to use the county treasurer as trustee.) Though the Holmes Harbor Sewer District and its bond counsel claimed the securities were revenue bonds, others have argued that this was not the case, given that no revenues of the district were pledged as security.
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- In 2003 a state court judge denied U.S. Trust’s motion to dismiss investor charges that it made reckless or negligent misrepresentations in connection with the bonds. In August 2003 the U.S. Justice Department and the SEC each filed charges against the developer, the underwriter, the bond counsel and other parties involved with the Holmes Harbor offering, but not U.S. Trust. The civil suit against U.S. Trust was postponed until August 2004 while the federal criminal case against the other parties proceeded.
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- For the vast majority of bonds, the responsibilities of the trustee are routine and prosaic. In that small minority of cases that involve corruption or financial distress, the role of the trustee suddenly becomes more prominent and potentially much more controversial.
- TOP TEN TRUSTEES FOR LONG-TERM MUNICIPAL
NEW ISSUES IN 2003
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- Ranked by the number of new issues
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- 1. US Bank......................................................................... 832
- 2. Bank of New York............................................................ 810
- 3. Wells Fargo Bank............................................................ 509
- 4. Wachovia Bank................................................................ 361
- 5. J.P. Morgan Chase........................................................... 319
- 6. Bank One........................................................................ 233
- 7. SunTrust Bank................................................................. 144
- 8. Fifth Third Bank................................................................ 135
- 9. UMB Bank....................................................................... 125
- 10. National City Bank.......................................................... 118
- TOP TEN TOTAL............................................................... 3,586
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- NATIONAL TOTAL........................................................... 14,584
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- Source:
Thomson Financial
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