Kentucky's Henderson County Settles Charges with IRS Over $63M Issue

WASHINGTON - Henderson County, Ky., has settled tax law charges with the Internal Revenue Service over $62.78 million of Series 2000A pooled bonds, using an unidentified third party's payment to fund the settlement and protect the tax-exempt status of the bonds.

The county disclosed the settlement in a material event notice filed yesterday with the nationally recognized municipal securities information repositories. Neither the notice, nor individuals connected with the transaction, would disclose the third party or the amount it paid under the settlement.

The variable-rate demand revenue bond transaction, which was to finance hospital projects under the Kentucky Hospital Association's health facilities loan program, is one of several similar hospital pool deals underwritten by George K. Baum & Co. that have been or are currently being investigated by the IRS.

In each of these transactions, the IRS has charged that the underwriter rigged bids for the guaranteed investment contract, in which the bond proceeds were invested, in an attempt to divert arbitrage. The material event notice issued yesterday said the IRS claimed some of that arbitrage was used to pay issuance costs.

Peck, Shaffer & Williams LLP of Cincinnati was tax counsel and Bank of America NA provided the GIC in the Henderson County deal, according to sources.

When pooled bonds are issued, a municipality normally invests the proceeds in a GIC until the funds are needed. A GIC provider is typically selected via a competitive bidding process.

The material event notice said the IRS determined that "certain aspects of the bidding process for the [GIC] ... appeared to facilitate the issuance of arbitrage bonds."

"Specifically, the IRS has informed the county that it believes that actions by the persons involved in the bidding (excluding the county) served to divert arbitrage normally rebated to the government to the underwriter to be used in part to fund issuance costs," the notice stated.

In similar pooled bond audits, the IRS contended that a winning, below-market GIC bid essentially diverts arbitrage to the GIC provider. By overpaying for other investment or remarketing fees in "separate" transactions with the underwriter, the GIC provider can share the profits with other deal participants, according to the IRS.

In this case, the Henderson County bonds were all either retired or refunded by Dec. 31, 2002, but the notice stated that the tax-exempt status of several subsequent refunding bonds has also been reaffirmed by the IRS as part of the agreement.

Bradley S. Waterman, the tax controversy attorney representing the county, declined to discuss the settlement yesterday.

Other recent settlements of pooled bond deals involving George K. Baum & Co. include one disclosed in June revolving around $140 million of bonds issued by the West Virginia Hospital Finance Authority. In 2005 the Knox County, Tenn., Health, Educational, and Housing Facility Board disclosed a similar agreement in connection with $250 million of Series 1999 pooled bonds. q

For reprint and licensing requests for this article, click here.
MORE FROM BOND BUYER