Nov. 16 (Bloomberg) -- U.S. law enforcement agents seized documents from three brokers and subpoenaed companies including bond insurers and General Electric Co. in a criminal investigation of whether banks and financial firms conspired to rig bids for investment deals with local governments.

The probe by the U.S. Justice Department centers on guaranteed investment contracts, which municipalities buy to hold bond money until funds are needed to pay for projects. The contracts are what banks and brokers used to invest at least $7 billion of proceeds from bonds issued by local governments across the U.S.; that money was never spent to benefit the public, according to an Oct. 4 Bloomberg News report.

``There's a lack of transparency in the whole market,'' said Dan Veres, executive vice president of Grant Street Group, a Pittsburgh-based firm that conducts guaranteed investment contract auctions on its Web site. ``It is ripe for abuse, the whole process.''

Federal Bureau of Investigation agents searched CDR Financial Products of Beverly Hills, California, yesterday, said Laura Eimiller, a spokeswoman for the FBI in Los Angeles, without providing further details.

CDR had a secret agreement with the provider of a guaranteed investment contract for bonds issued in 1999 by an authority in Gulf Breeze, Florida, Bloomberg News reported on Oct. 4. The deal allowed CDR to increase its fees if none of $220 million in bond proceeds was used for its intended purpose -- affordable housing.

Cooperating With Investigators

In an e-mailed statement, CDR confirmed it was asked to provide documents to the Justice Department. The firm, which says it has handled almost $160 billion of transactions including guaranteed investment contracts as a financial adviser and a broker, said it is cooperating fully with investigators.

``We want to underscore that CDR is open for business and will continue to serve the needs of our municipal and financial institution clients as this process continues,'' said CDR founder and Chief Executive Officer David Rubin. Rubin said he believes the firm has acted appropriately in all of the deals under review in the investigation, which he said was an outgrowth of three-year old probe by the U.S. Internal revenue Service.

Insurer Subpoenas

Financial Security Assurance Holdings Ltd., a unit of Brussels-based financial services company Dexia SA, yesterday said it was subpoenaed by the Justice Department.

FGIC Corp., a New York-based bond insurer, also received a Justice Department subpoena, Brian Moore, a spokesman for the company, said today. Moore said FGIC, a former unit of Fairfield, Connecticut-based General Electric, had exited the guaranteed investment contract business in 2003 when GE sold the company. The outstanding contracts remained with GE.

Moore said FGIC was unaware of any specific issues and the company is cooperating fully. GE also received a subpoena as part of the U.S. probe, said GE spokesman Russell Wilkerson. He said GE, the world's second-biggest company by market value, is cooperating fully with the request.

Security Capital Assurance Ltd., a Bermuda-based bond insurance unit of XL Capital Ltd., today said a unit received a grand jury subpoena from the antitrust division of the U.S. Attorney's Office for the Southern District of New York. XL Capital also said a unit received a subpoena from the U.S. Securities and Exchange Commission related to a probe of guaranteed investment contract brokers, without specifying the subsidiary.

Documents Taken

Federal investigators took documents yesterday from Investment Management Advisory Group Inc., a broker of guaranteed investment contracts and a municipal derivatives adviser based in Pottstown, Pennsylvania, said Gene Grabowski, a spokesman for the firm, known as IMAGE.

``IMAGE received a subpoena from the antitrust division of the U.S. Department of Justice and the company is cooperating fully with the authorities,'' the firm said in written statement last night. ``It is our understanding that subpoenas have been issued to numerous other firms and that the investigation is industry wide. We are confident that our business practices and employees will be fully vindicated as this investigation continues.''

Third Broker

Today, a third guaranteed investment contract broker, Eden Prairie, Minnesota-based Sound Capital Management Inc., said federal investigators seized documents from the firm and also served a subpoena for more documents.

``SCM and its employees are not aware of any charges or claims against them,'' said Sound Capital President Johan Rosenberg in an e-mailed statement. ``SCM cooperated in furnishing requested information, our business continues uninterrupted.''

Sound Capital has retained the Minneapolis, Minnesota law firm of Fredrikson & Byron, P.A. to advise concerning the justice department investigation. The firm includes a former U.S. attorney.

The actions by the Justice Department show that an investigation into how banks compete for the right to reinvest money raised in the $2 trillion tax-exempt bond market has expanded beyond the IRS. The IRS has been looking into whether brokers awarded the work to favored banks, potentially boosting the cost of the investment agreements and depriving the federal government of tax revenue.

The Justice Department is conducting an ``investigation of anticompetitive practices in the municipal bond industry,'' said spokeswoman Kathleen Blomquist.

The IRS's office of tax-exempt bonds said in January 2005 that it found pervasive bid-rigging for guaranteed investment contracts.

Diverting Profits

The IRS is looking into possible improper bidding that may have diverted to banks and brokers money that should have been paid in taxes. U.S. tax law prevents local governments from profiting by selling municipal bonds and reinvesting the money at higher rates. Such earnings, known as arbitrage, must be paid to the U.S. government.

Regulators are concerned that unfair bidding caused local governments to pay too much for their investment contracts, much like they did during the so-called yield burning scandals of the 1990s when Wall Street banks sold them overpriced Treasury bonds. Wall Street banks paid more than $170 million to end the Securities and Exchange Commission's investigation of that practice.

Never Used

At least $7 billion of bond proceeds were never put to public use over the past 10 years and were invested in guaranteed investment contracts, benefiting banks and advisers while doing nothing for the taxpayer, according to the Oct. 4 Bloomberg report.

CDR's handling of investment bids for the city of Atlanta has already come under scrutiny. The IRS last year told officials from Atlanta that the city may have overpaid for a $453 million guaranteed investment contract from Bank of America Corp. in an auction run by CDR. The contract was for money raised by a 1999 water and sewer bond.

A Bank of America employee who bid for the Atlanta bond work, Doug Campbell, was fired after disclosing that he paid $57,393 to CDR for transactions in which it played no role.

The employee said in internal e-mails that the payments were made to bolster his relationship with CDR. Campbell also wrote that he made similar payments to another broker of guaranteed investment contracts, Los Angeles-based Winters & Co., and PaineWebber Inc., now a unit of Zurich-based UBS AG and a rival bidder for investment contracts.

No Charges

Campbell, who now works at Minneapolis-based Piper Jaffray Cos., declined to comment today about whether he has been subpoenaed in the investigation. Susan Beatty, a Piper Jaffray spokeswoman, said Campbell hadn't been subpoenaed, nor had he been charged criminally in connection with the Department of Justice investigation.

Bank of America spokeswoman Shirley Norton had no comment on whether the Charlotte, North Carolina-based bank has been contacted by the Justice Department. Christopher Winters, head of Winters & Co., didn't return a phone call yesterday. Doug Morris, a spokesman for UBS, had no comment.

Blomquist at the Justice Department wouldn't say whether other firms had received subpoenas or who else was under investigation.

`Baffled'

George Majors, a managing director of Los Angeles-based financial advisory firm Bond Logistix LLC, said he would be surprised if bankers risked their careers -- and possibly jail - - to conspire to win municipal investment contracts at a time when probes of the financial industry have made firms more cautious.

``I'm baffled,'' Majors said. ``Why would you do that?''

Majors said his firm hasn't been contacted by investigators.

Charles Anderson, manager of field operations for the IRS's tax-exempt bond division, told bond lawyers in May that the agency is investigating cases where providers of guaranteed investment contracts paid kickbacks to the brokers who evaluated their bids for the agreements. Anderson didn't name the parties involved.

Arizona County

The IRS has scrutinized a $27 million bond sold by Pima County, Arizona's Industrial Development Authority to help individuals buy homes. According to documents obtained from the authority, the IRS said it was concerned about quarterly payments made by Paris-based Societe Generale, France's third- biggest bank, to CDR, which structured the transaction and evaluated bids for the investment agreement.

New York-based Financial Security Assurance was one of the four that bid for that contract, the records show.

Societe Generale spokesman Jim Galvin declined to comment about whether the firm was contacted by the Justice Department.

On Nov. 10, George K. Baum & Co., a Kansas City, Missouri- based investment bank settled allegations with the IRS that it diverted profits on municipal bond deals. In one instance the IRS alleged that bidding was rigged in the selection of a guaranteed investment contract provider for a $150 million loan pool underwritten by Baum in 1999 and issued by the Illinois Development Finance Authority.

The Illinois authority spent less than 1 percent of the $150 million offering to finance computers for schools and libraries. The IRS concluded the deal was a ``sham.'' The authority paid the IRS to keep the bonds exempt from taxes.

The IRS settlement with Baum covered more than $2 billion of such deals between 1997 and 2001. Baum, which agreed to pay the IRS an undisclosed amount, didn't admit or deny wrongdoing.

To contact the reporter on this story: William Selway in San Francisco at wselway@bloomberg.net.

Last Updated: November 16, 2006 17:11 EST