Municipal Securities and the So-Called "Real World"

It always amazes me to hear Series 7 classroom instructors tell students that the Series 7 "has nothing to do with the real world."

Nothing could be further from the truth. As you'll see from the link below, the Series 7 material that you're studying about municipal securities is unfolding right across the street from my office. Across the street sits an old brick industrial building that was almost converted into lofts, condos, and townhomes except that the real estate market--as you may have heard--sort of went south before they could sell any of the units. I watched a few work crews install hundreds of windows and sandblast the original wooden beams, but this project never even got off the ground after that. The developers borrowed $15 million with nothing to show for it, and the lenders have sued to foreclose on the property.

A very familiar story playing out across America, isn't it?

What does this have to do with municipal securities? As you'll see from the article at the link below, the local park district now wants to purchase that huge former industrial campus with our tax dollars and use it for office space and recreational facilities. They'll have to borrow a ton of cash to buy the property now in foreclosure, and they'll do so only if we taxpayers vote "yes" in February to let them issue these municipal bonds backed by an increase in our property taxes. If the majority determines that tax payers should pay a few hundred bucks more a year in property taxes in order to expand the park system, the bonds will be issued. If the majority votes "no," the issue will die temporarily, until the politicians can think of another plan. It's kind of shocking to see how the village played their hand on this one. The village dragged out the development of the "Roos building" painfully by requiring all kinds of variances and rejecting round after round of architectural changes . . . by the time the developers got the village council to approve the project, the real estate market had completely turned south and--oopsie--no interested buyers at this time.
Now that the building is in foreclosure, that same local government steps in to buy it at a discount. Then again, this is basically Chicago here. I mean, you can see the Sears Tower by stepping outside and looking to your right. But it seems like some pretty strong-armed tactics for a village government to take just the same.
In any case, if you'd like to see how the same Series 7 material you're studying is unfolding right outside my office window, click on the link below:
http://www.forestparkreview.com/main.asp?SectionID=1&SubSectionID=38&ArticleID=4504

Public Offering Price (POP)

A customer buying a new municipal bond from a syndicate member pays the:
A. ask price, plus a commission
B. public offering price, plus a commission
C. public offering price, plus a reasonable markup
D. public offering price

What the above question is pointing out is that a primary offering of securities has one price called the "public offering price," or "POP." Built into that POP is the compensation to the underwriters and selling agents. This is true whether we're talking about municipal securities, corporate securities, mutual funds, or variable annuities. When securities are traded among investors in the secondary market, broker-dealers step in between and either make commissions or markups-markdowns. But when they act as underwriters on the primary market, their compensation is built into the POP.

ANSWER: d

Insider Trading

It's Friday morning and, as usual, I'm at the FINRA website looking up recent disciplinary actions. Today I find a well-known broker-dealer being fined for insufficient anti-money laundering policies. $600,000 is the fine, but I also know how much it costs to shoot advertisements involving helicopters, let alone running those ads in prime time, so I think their pocketbook will survive.
On the other hand, the individual referenced in the link I'll post below is done. Game over. Forced early retirement. As you'll see, when a broker-dealer is called in for investment banking work, they end up knowing information no one else has, information that can move the price of the company's stock up or down with near certainty. So, investment bankers are fiduciaries who have to keep the information confidential. Don't spread the news, and--for crying out loud--don't try to buy shares of the company's stock so you can dump it when the news becomes public. Tempting, sure. But it's a criminal violation. It leaves you open to all kinds of civil suits. And--as you'll see--it tends to end a registered representative's career permanently.

See what I'm talking about here:
http://www.finra.org/Newsroom/NewsReleases/2009/P120328

Kicking the Series 7's Behind

I'm going to let one of our happy Series 7 customers write this blog post. In case you're thinking that passing the Series 7 is "impossible," see what my man Danny has to say below:

Robert;
I just passed the Series 7 yesterday (Nov 2nd) and I wanted to thank you for your assistance. I've been sitting in on your free Friday webinars and they have been extremely helpful. Perhaps they were the key to me getting a 93% on the test!Your willingness to share your expertise and personal passion for this material is very uplifting, during a period of time when we (the test takers) are stressing out. You bring a level of reality to the material and your practical examples based on your real life experiences is very helpful. Keep it up, I'm off to the 66 now and will continue on the calls, I do enjoy them.

Danny Williams

The Series 7 Exam

Let's talk about the Series 7 exam itself. First, the basic facts:

• 250 questions (plus 10 experimental)
• 6 hours with a required "half-time" break
• a calculator is provided--bring your photo ID only
• you must be sponsored by a broker-dealer to take the test
• to get a securities salesperson (agent) license from your state, you must also take the 63 or the 66 exam in virtually all states

Now let's dispel a few urban legends regarding the Series 7

• there is no limit to the number of times you can take the test
• however: you must wait 30 days to re-test after the first failed attempt, 30 days to re-test after the second failed attempt, then 6 months after every failed attempt going forward
• the test does not adapt to anything you're doing on the computer
• no one has the "actual Series 7 questions"

How do people perform on this exam?

• on any given day, ~ 66% of those taking the test pass it
• any company claiming to have a "90% pass rate or higher" is pulling a number out of thin air. how could anyone consistently beat the national average by 25+ points, especially when all other vendors have access to each others' materials? there are no secrets in the test prep industry
• the average score is about 73% on the test
• no one has results broken down by "first attempt," "second attempt," etc.

For more information on the Series 7 exam itself, go to YouTube and type in "Series 7 exam" or "What is a Series 7?" and click on our video clip.

Disciplinary Actions

It's Friday morning and, as usual, I'm at the FINRA website looking at recent disciplinary actions. For the month of October there are about 40 pages' worth of infractions, ranging from recordkeeping mishaps to outright bad behavior. I'll place the link below, or you can just go to http://www.finra.org/, then "industry professionals," and then look under "enforcement" for "disciplinary actions." This month you'll find several small fines resulting from sloppy reporting of trades. You'll notice that the same firm often has two or three violations in the same month. And you'll see that Regulation SHO, in which short sales have to be executed very carefully and properly, is a hot topic for the regulators. Reg SHO is all about making sure that when shares are sold short, there actually are shares available. Otherwise, the laws of supply and demand are being manipulated, and market manipulation is the number-one thing that the SEC and FINRA try to prevent. Before executing the short sale, the broker-dealer has to locate the securities and reasonably believe they can be delivered. Of course, the procedures involved to "locate" the securities are new, and it's tough to get the supervisory system in place. Luckily, FINRA is there to help motivate the firms to improve their systems by handing out fines and naming names .
I'll let you take it from here:
http://www.finra.org/web/groups/industry/@ip/@enf/@da/documents/disciplinaryactions/p120231.pdf

Taxation on OID municipal bonds

A Series 7 customer just emailed me to question the tax treatment for original issue discount (OID) municipal bonds. To be honest, I've never felt 100% comfortable teaching on this topic and should have done some research on it a long time ago. So, no matter how dry an email about the veracity of taxation on original issue discount municipal securities might seem, I was actually quite pumped to dive in. Luckily, I've been doing so much searching at http://www.irs.gov/ lately that I was able to find what I needed in less than one minute. And, luckily, all I needed was Publication 550. That, plus a handful of Excedrin, the reading skills of an attorney, and the patience of Job. But, in the end I was rewarded by knowing that the way I teach taxation on discounted municipal bonds is, apparently, exactly right. I also noticed that I do, apparently, provide a useful service for Series 7 candidates by taking nearly incomprehensible English and making sense of it. In my Pass the 7 book, I try to keep it simple. In the book, my job is to tell you that an original issue discount (OID) municipal bond is treated differently from a STRIP. Since the interest on a STRIP is taxable, you have to report some interest income you haven't actually received on 1099-OID each year and pay tax on it. But, a muni is tax-exempt; therefore, you don't have to pay tax on anything and don't have to file anything. If you sell the bond before maturity, you get to step up your cost-basis to help reduce or eliminate a capital gain on the bond. I also then point out that when you buy a tax-exempt (muni) bond at a discount from an investor, things are wholly different. Now, that discount is taxable . . . as ordinary income!
Turns out, that is exactly right, no matter how strange it seems. But what really struck me is how difficult it is to get that all from the orginal bureaucratic, legalistic version. This is how the IRS explains what I just wrote above (From Publication 550) :
Original issue discount. Original issue discount (OID) on tax-exempt state or local government bonds is treated as tax-exempt interest. If the bonds were issued after September 3, 1982, and acquired after March 1, 1984, increase the adjusted basis by your part of the OID to figure gain or loss.
Discounted tax-exempt obligations. OID on tax-exempt obligations is generally not taxable. However, when you dispose of a tax-exempt obligation you must accrue OID on the obligation to determine its adjusted basis. The accrued OID is added to the basis of the obligation to determine your gain or loss.
Market discount. Market discount on a tax-exempt bond is not tax-exempt. If you bought the bond after April 30, 1993, you can choose to accrue the market discount over the period you own the bond and include it in your income currently, as taxable interest. If you do not make that choice, or if you bought the bond before May 1, 1993, any gain from market discount is taxable.

I guess what also struck me was how much I enjoyed reading Publication 550 and how much I, apparently, need to find myself a hobby.