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SEC: California IOUs are Securities; What Can You Do With Them Now?

By Brian Kumnick on July 14, 2009 | Last updated on March 21, 2019
The state of California, mired in a months-long budget stalemate, finally began issuing IOUs instead of cash for some of its obligations earlier this month. The IOUs, officially known as "registered warrants," will mature later this year, and in the meantime will accrue tax-free interest. Many major banks in California are now declining to accept the warrants, leaving many warrant-holders in a temporary cash crunch, looking for ways to trade or sell their warrants now in exchange for cash.

Now comes word that the federal government has stepped in to regulate warrant trading. The Municipal Securities Rulemaking Board, an entity overseen by the Securities and Exhcange Commission, stated its opinion late last week that the California warrants are "municipal securities" subject to certain federal securities laws.
So if your firm is holding California IOUs, or if your clients have IOUs and want to know what they can do with them now that their bank won't accept them, what does this development mean? Here are several things to think about:

Warrants will be subject to federal securities-fraud laws. "Holders of these IOUs and those who may purchase them are protected by the provisions of the federal securities laws that prohibit fraud in the purchase or sale of securities," according to the SEC's statement. Make sure to be aware of all registration, disclosure, and documentation requirements before effecting a warrant sale.

Brokering a warrant transaction will require registration. The MSRB opinion says that "persons acting as intermediaries between buyers and sellers of the warrants may need to register as brokers, dealers or municipal securities dealers." Undoubtedly a few unscrupulous "brokers" will appear this summer offering to buy warrants at deep discounts. So if you or a client wish to sell your warrants to a dealer or broker, do your due diligence: ensure that the buyer is aware of the MSRB rules and is properly registered as a municipal securities borker or dealer.

Beware the pitfalls of the inefficient market. Some sort of a marketplace for California registered warrants will undoubtedly spring up, and while the MSRB's decision is meant to ensure some level of fairness in that marketplace, the efficiencies and the transparency of a large, liquid market like a major stock exchange will not exist to the same degree. Make sure you shop around carefully, inquiring as to prices and fees, before agreeing to a sale.

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