Securities industry regulators are investigating municipal bond underwriters over excessive expenses in entertaining officials of credit rating agencies, bond issuers and their families to drum up business.

Financial Industry Regulatory Authority Chief Executive Richard Ketchum, in disclosing the probe on Monday, did not name specific firms but cited expensive meals and tickets to sporting events and Broadway plays as examples of the excesses.

The municipal market has been plagued for years by pay-to-play scandals involving broker-dealers, but they rarely involved rating agencies.

This is the first time I'm aware that these allegations have been made in relation to a rating agency, said Ernesto Lanza, general counsel of the Municipal Securities Rulemaking Board, the municipal bond regulator that writes the rules that FINRA and the SEC enforce.

The inappropriate behavior he cited is similar to Securities and Exchange Commission probes in 2009 cases against firms that flew issuer officials and some family members to New York in prior cases. for the kinds of events cited by Ketchum.

We have seen examples of excessive expenses for the entertainment of issuer officials and rating agency officials, which are then charged to the municipalities' cost of issuance, he said at FINRA's annual fixed-income conference in New York.

The effect is that underwriters get reimbursed for their entertainment from bond proceeds, he said.

MSRB rules bar bond dealers from giving gifts in connection with municipal securities activities, according to Lanza. The definition is so broad that it encompasses many market participants, even bond trustees, he said.

Moody's Investors Service and Standard and Poor's Ratings, the two largest rating agencies, said they strictly enforce the prohibition.

While we are not aware of this investigation, Moody's has implemented strict policies for our analysts that reinforce SEC rules, which clearly prohibit the type of conduct alleged, said Michael Adler, a spokesman.

One of the large U.S. credit rating agencies, Standard & Poor's, said it does not allow its employees to accept gifts in exchange for business.

S&P spokesman Chris Atkins said the firm's code of conduct expressly prohibits our analysts from soliciting or accepting gifts or entertainment. We don't permit it.

The investigation has also found payments to political action committees listed as line items in new bond underwriting expenses, as well as false representations of services never performed by dealers, he said.

These issues raise serious noncompliance issues and a breach of ethics that we are continuing to investigate, Ketchum said.

FINRA's focus on underwriting expenses follows a move by California's treasurer on February 1 to bar underwriters from using bond proceeds to pay fees to their lobbying group, the Securities Industry and Financial Markets Association.

The investigation comes as the MSRB is considering extending its pay to play rules for dealers to municipal advisers. The self-regulatory group also has asked to SEC to approve new rules that would force Wall Street firms to disclose their political action committee membership lists and contributions.

Regulators for years have worked to bring more openness and price visibility to fixed-income markets that, unlike equities, have no central marketplace for price discovery.

I wouldn't be surprised if it has been going on for more than a little while, said Jacob Alpert, an executive vice president at M.R. Beal, a municipal bond dealer in New York. People don't know where that line in the sand is (but) there is a line definitely.

Ketchum also said Monday that FINRA wants fixed-income research analysts to be subject to the same conflict-of-interest rules as equity analysts.

Turning to customer disclosure, he said that brokerages and their advisers need to be sure that customers understand the credit and other risks of increasingly complex debt securities.

He pointed to rising demand by individual investors for high-yield bonds as an area of greater focus, since investors and possibly many brokers do not fully understand the instruments' credit and interest-rate risks.

In another example of the regulatory group's attention to misdeeds in the muni community, FINRA said Monday that it fined SWS Group Inc's Southwest Securities unit $500,000 for paying former Texas municipal officials and others to solicit underwriting assignments in violation of MSRB rules.

The Dallas-based brokerage from October 2006 through April 2009 paid five individuals, including three former Texas municipal officials, more than $200,000 for the services, FINRA said. Southwest neither admitted nor denied the charges.

(Additional reporting by Joan Gralla and Lisa Lambert in Washington, editing by Jed Horowitz and Chip Barnett)