SEC to call for Calif. IOUs treated as securities

The recipients of billions of dollars in IOUs being issued by California soon may have a regulated market where they could sell them.

Some of the nation’s largest banks say that, starting Friday, they will no longer accept the IOUs. The banks want to pressure the state to end its budget impasse, but their action could leave many businesses and families with fewer options for getting their money.

The Securities and Exchange Commission is going to recommend that the IOUs, which carry an annual interest rate of 3.75 percent, be regulated by the Municipal Securities Rulemaking Board as a form of municipal debt. The guidance could come as soon as Thursday, according to two people familiar with the matter who spoke on condition of anonymity because the SEC hasn’t yet acted.

A regulated market for the IOUs would make it easier for individuals holding them to sell them at a fair price, analysts said.

The SEC oversees rules set by the nongovernment MSRB. SEC spokesman John Nester declined to comment Thursday.

With JPMorgan Chase & Co., Bank of America Corp., Wells Fargo and Citigroup Inc. and some regional banks in the state saying they won’t accept the IOUs for payment after Friday, attention has turned to the possibility of a secondary market to buy up the notes.

“A safe conclusion would be to consider them securities,” said Paul Maco, an attorney at Vinson & Elkins in Washington who was a director of the SEC’s Office of Municipal Securities.

A regulated market for the IOUs “makes it even more advantageous” for individuals holding them, who could sell them at a fair price, Maco said. The price they receive may be discounted in accordance with the market’s perception of the risk of the state repaying the notes, but it would be an orderly market price, he said.

SecondMarket, which creates marketplaces for the trading of illiquid assets, has received “decent interest” from hedge funds, municipal bond and distressed asset investors as potential buyers of the IOUs, Jeremy Smith, the New York-based company’s chief strategy officer, said this week.

As California legislators haggle over how to close a $26.3 billion budget deficit, the state is expected to send out $3.3 billion in IOUs this month to an array of individuals, small businesses and local governments.

It marks the first time since 1992, and only the second time since the Great Depression, that California has sent out notes promising repayment at a later date instead of paying its bills on time.

The IOUs are referred to as registered warrants.

“The California registered warrants have the hallmarks of securities, and if they are securities, they are pretty clearly municipal securities,” MSRB General Counsel Ernesto Lanza said. “To the extent that municipal securities dealers are involved in the sale and trading of the warrants, our rules would apply. We would be especially concerned about dealers’ obligations to customers with respect to fair pricing.”

Copyright 2009 The Associated Press.