Yield Burning

Yield burning is the illegal practice of underwriters marking up the prices on bonds for the purpose of reducing the yield on the bond.

Yield burning is attempted in order to reduce the amount of tax that is incurred on fixed-income investments. However, this practice violates federal tax laws. It is illegal for an investor to earn a given yield on a fixed-income investment and use yield-burning activities to evade the full extent of the tax obligations incurred on that investment.

This practice, also referred to as "burning the yield," is done after the bond is placed in escrow for an investor who is awaiting repayment. 

Several regulating and government enforcement bodies, such as the Securities and Exchange Commission (SEC) and the Internal Revenue Service, view the practice of yield burning as unethical and illegal. Parties that engage in these practices risk incurring major penalties, fines and other forms of punishment from the federal government, specifically the IRS, and other agencies or entities with relevant jurisdiction.

One of the most well-known cases of publicly-revealed yield burning involved a man named Michael Lissack, who worked as an investment banker for Smith Barney. He would later become known as a yield burning whistleblower. He filed a qui tam lawsuit, which is a type of whistleblower lawsuit that relates to actions covered under the False Claims Act. Lissack’s suit against more than 20 Wall Street banking firms alleged that the firms engaged in yield burning by selling securities at prices above fair market value to state and local agencies and entities, and then keeping money that should have been paid in liabilities to the federal government. This meant lots of big profits, possibly obtained illegally, for the investment firms, but also represent significant lost revenues for the Treasury Department and the IRS.

Lissack claimed that after objecting to this practice and refusing to play a role in the prohibited tactics, he was fired from his job.

Many of the securities firms named in the lawsuit eventually agreed to a hefty settlement announced in April 2000, in which they paid significant damages and penalties to the U.S, Treasury and the entities that issued the municipal bonds. Lissack was reportedly entitled to receive millions of dollars for his role in initiating the lawsuit, although he said at the time that he had planned to donate a large chunk of it to charity.