Deutsche Banc Alex. Brown to Pay Over $15 Million to Settle Yield-Burning Suit

Alex Brown agreed to pay $15.177 million directly to the government and to pay $127,674 to several municipal governments.
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Securities firm

Deutsche Banc Alex. Brown

has agreed to pay more than $15 million to settle a lawsuit charging that the firm defrauded the government through a financing practice known as yield burning.

The charges represent only a small fraction of the many claims filed under seal against a range of securities firms. Michael Lissack, a former managing director of

Smith Barney

who identified the arcane and complex practice, originally filed the suit.


Justice Department

, through the

U.S. Attorney for the Southern District of New York

, intervened in the suit Wednesday. Concurrently, Alex. Brown agreed to pay $15.177 million directly to the government and to pay $127,674 to several municipal governments.

Since Lissack, who also sued Smith Barney for dismissing him, brought the practice to its attention in March 1995, the government, led by the IRS, has spent the last five years attempting to determine how to pursue yield-burning allegations.

Lissack himself could make up to $25 million for his role in exposing the activity,

The Wall Street Journal

has reported.

Deutsche Banc Alex. Brown, of Baltimore, is a subsidiary of

Deutsche Bank AG

, of Germany. It was called

Alex. Brown & Sons

at the time of the alleged activity. The company had no immediate comment.

As recently as 1996, the Department of Justice had not definitively decided that yield burning falls under the federal

False Claims Act


Municipal issuers typically use Treasuries to refinance outstanding debt. Those issuers are not allowed to make money on their tax-exempt bond transactions. Underwriters raised the price, or "burned down'' the yield, on those securities to the level that municipalities were allowed to earn, pocketing the difference.

By overcharging the issuer, a securities firm can snatch up the money the federal government could have made from taxes.

The government's had difficulty pursuing allegations of yield burning because the bond issuers are often unaware of the price gouging, as it can be done without affecting the issuer's savings on the refunding.

For example, the lawsuit alleges that Alex Brown secretly charged the state of Pennsylvania a markup of 4.5 basis points instead of 0.45 basis points in a $494 million bond offering in March 1994. The federal government was defrauded, according to the IRS, because it could have collected taxes on the profits if the lower amount was charged.


Securities and Exchange Commission

also charged a Philadelphia lawyer and several others involved in the deal with failing to disclose a fee-splitting arrangement. Alex. Brown was offered the contract to refinance the bonds on the condition that it split its revenues with another company.

In the early 1990s, when interest rates for Treasury bonds were low, local and state governments issued more than $360 billion to refund bonds in advance. Securities firms were often bidding competitively for the right to underwrite the bonds, often making up the difference by overcharging the issuers.

The IRS first said it would investigate whether the issuers paid market value for the T-bonds in 1993, and the SEC in 1995 asked dealers for information about the rates. Since then, the government has settled similar cases with

Meridian Securities


Lazard Freres