Since 1913, investing in tax-free municipal bonds had been an effective way for high-income individuals to protect their assets. Fifty years later, inflation and “bracket creep” encouraged growing ranks of Americans to buy tax-free municipal issues. Most of them did so more out of general faith in the market than particular knowledge of the purchase. At the time, only a few thousand official statements were printed; sales staff and institutions sometimes got them, but individual investors seldom did.
The less affluent got into the secondary market. That could be risky; if stocks were all the same, nearly every bond was unique. Even within the same issues, the “coupon” or interest payment, the “maturity” or date at which full repayment would be made, and the rating might be different. Each of these factors affected the yield of a municipal bond, so it was difficult for amateurs to value their asset, even if they had sufficient information, which they seldom did. A private company published the Blue List of Municipal Offerings on the secondary market, but coverage was uneven and information incomplete. By the 1960s, unscrupulous dealers had seized the opportunity to prey on unwary, and hardly affluent, investors.
The ploy of choice was the “boiler room,” a makeshift office stocked with telephones and high-pressure sales staff. Bond dealers such as Paragon Securities in New Jersey, R.J. Allen in Florida and Charles A. Morris in Memphis all set up boiler rooms during the 1960s. In fall 1972, the U.S. Securities and Exchange Commission brought civil proceedings under Section 10b of the 1934 Exchange Act against Charles A. Morris, and the phrase “Memphis Bond Daddies” burst into the headlines. In 1974, R.J. Allen was found to have unloaded worthless paper on returning Vietnam prisoners of war. Congress, which had assumed that participants in the municipal securities industry could take care of themselves, discovered widows and orphans by another name. Regulation was not far behind.
Legitimate underwriters and broker-dealers joined with skeptical customers to support better disclosure. By 1973, the Securities Industry Association had developed plans for a self-regulatory organization along the lines of the National Association of Securities Dealers (NASD). U.S. Senator Harrison Williams (D-New Jersey), chair of the Securities Subcommittee of the Senate Committee on Banking, Housing, and Urban Affairs, obtained from the SEC draft legislation which would have revoked the municipal securities exemption. The Dealer Bank Association agreed to the supervision of broker-dealers, but under the purview of existing bank regulators. In the hearings that followed, only the issuers held out against regulation which they assumed would devolve, either directly or indirectly, upon them. The product of two years of compromise was signed into law with the Securities Acts Amendments of 1975.
