WASHINGTON - Municipal issuers may be able to bid on their auction-rate securities under certain circumstances, but it is unclear if such moves will violate securities law, according to a notice written by two members of the National Association of Bond Lawyers that was sent to NABL members late Wednesday.
The eight-page notice, written in a question-and-answer format meant to lay out the existing tax and securities legal framework, details concerns NABL members have raised in light of the turmoil in the auction-rate securities market. But it suggests that the municipal market is still unclear on some crucial issues and is eagerly awaiting guidance from the Securities and Exchange Commission.
The notice was written by John McNally of Hawkins Delafield & Wood LLP and Ed Oswald of Orrick, Herrington & Sutcliffe LLP, but it does not reflect the views of NABL, or McNally and Oswald's firms, and it was not meant to be used as legal advice. It comes six days after two groups sent the SEC separate letters asking for assurance that issuer bids on auction-rate bonds would not trigger securities law violations. Sources said yesterday that multiple divisions within the SEC are still reviewing the letters, and have not yet decided if or how the commission will respond.
Meanwhile, NABL plans to hold a teleconference at 1 p.m. Eastern Standard Time Thursday to discuss its notice. The teleconference will include John J. Cross 3d, an attorney with the Treasury's office of tax policy, Martha Mahan Haines, the SEC's municipal securities chief, J. Foster Clark, NABL's president and a partner at Balch & Bingham in Birmingham, as well as McNally and Oswald.
NABL's notice essentially says that counsel should determine whether underlying bond documents allow issuers to purchase their own bonds and whether the possibility of such purchases is already disclosed in the bond's offering statement or could be "cured" by new disclosure.
Still, the notice warns that SEC officials have expressed concerns that if an issuer or conduit borrower enters a buy order in a primary-market auction, it may be affecting the price that would otherwise occur, which may constitute "market manipulation."
Bond attorneys and commission officials have said that such transactions could expose issuers to possible violations of the SEC's broad 10b-5 anti-fraud rule. The NABL notice says that such transactions may also fall under Section 15(c)(1) and Rule 15c1-2 of the 1934 Securities Exchange Act, which apply to broker-dealers.
NABL's notice comes about six days after a group of 14 hospitals in Massachusetts and California urged the commission to allow issuers to provide "interim, short-term self liquidity" to support auctions and avoid the widespread auction failures that have led to double-digit interest rates. That letter, authored by an attorney at Ropes & Gray LLP in Boston and disclosed publicly last week, outlines specific circumstances in which issuers would bid in their own auctions, including that they would disclose in advance their intent to bid on their own bonds and the rate at which they plan to bid.
Meanwhile, a second letter sent to the SEC by the Securities Industry and Financial Markets Association, which has not been released, asks the commission staff to advise the market that the purchase by an issuer or conduit borrower of auction-rate bonds in the secondary market - after an auction has established the rate and the bonds are between auction dates - would not result in the staff recommending an enforcement action, according to the NABL notice.
"The issuer or obligor could then determine to either sell or to hold the purchased bonds on the next auction date, but once again could not purchase additional bonds in a primary auction market," NABL said, referring to the SIFMA letter.
As the SEC considers how to respond, bond attorneys appear divided on what to do. Some attorneys believe that the "market manipulation" argument falls flat if there is no real "market" - one in which there are willing sellers of the auction-rate securities but no buyers.
In such an environment, issuers ought to be able to bid on their own securities, assuming adequate disclosure in advance of any one auction, and if the issuer also offers to redeem the bonds from existing bondholders, said several attorneys, including J. Hobson Presley Jr. of Presley Burton & Collier LLC in Birmingham and Dean Pope of Hunton & Williams in Richmond, who spoke at a NABL conference last week in San Francisco in which issues regarding auction-rate securities consumed the bulk of the securities enforcement and disclosure discussions.
"If you tell the market what you're doing, why you're doing it, and you're playing within the terms and provisions of your documents, how can it be a securities law violation?" said Ken Artin, a partner at Bryant Miller Olive PA in Orlando, whose clients include Florida's Citizens Property Insurance Corp., which has aggressively participated in auctions of its taxable floating-rate debt and as of Monday had purchased about 44% of its outstanding $4.75 billion of taxable auction-rate securities.
"Thomas Lee Hazen, a securities expert and law professor at the University of North Carolina-Chapel Hill School of Law, said that the SEC will look closely at the no-action requests to determine if the reasons issuers cite to buy back their securities are outweighed by some fear of manipulation.
"The SEC might say, 'Based on the facts you've outlined, we will not recommend an enforcement action against you,'" Hazen said."
But a senior public finance partner at a large firm who asked for anonymity said he is skeptical that issuers should be able to bid on their own bonds, even with disclosure.
"You don't expect issuers to be playing around with their own securities," he said. "You're talking about a governmental body, not a corporation that has money that it can play with. Most of these governments are ... worried about deficits" and do not have extra cash lying around.
He added: "This does have the effect of changing the interest rate payable on these bonds and it's hard for me to get over that."
Another concern among several bond attorneys is that private litigation may be brought by bondholders claiming that the issuer's bid prevented the bondholders from receiving a higher rate of interest than they would have otherwise received. Even if the SEC provided some guidance that said the commission would not bring enforcement actions, broker-dealers may request indemnity from private lawsuits, in which the issuer would promise to both pay the costs of the litigation and any potential damages, the senior public finance attorney said.
Meanwhile, the NABL notice warns that the disclosure roles of issuers and underwriters may change in instances in which an issuer converts its auction-rate bonds to variable-rate demand obligations.
If, in such a conversion, there is a current refunding with a new OS, the offering would be treated as a primary-market offering. In that situation, the issuer would be primarily responsible for the content of its disclosure documents and may be held liable under the federal securities laws for misleading disclosure. For the underwriter, if there is a primary offering the underwriter must have a "reasonable basis for belief in the truthfulness and completeness of the key representations made in any disclosure documents used in the offerings," the NABL notice said, citing the SEC's primary-market disclosure rules that were released in 1988.
But if the bonds are being converted from auction-rate securities to VRDOs under the terms of the original bond documents, such a conversion should be considered to be a secondary market transaction and subject to different disclosure requirements, particularly for the firm acting as a remarketing agent.
"If a new disclosure document were prepared, the issuer would have responsibility and attendant liability for such disclosure document used in connection with the secondary market sale," the NABL notice said. "The investment banker, however, may be considered to be wearing the hat of marketing agent rather than of an underwriter, and may not have the attendant responsibilities established in the 1988 release for underwriters."
Turning to tax issues, NABL's letter provides several answers to potential questions arising from Notice 2008-27 on reissuance, which was issued by the Treasury Department earlier this month. The notice was discussed in depth during NABL's conference in San Francisco last week, and NABL provides further guidance on its implications, as several issuers are turning to bond counsel, seeking to convert from auction-rate securities to other interest rate modes.
According to the document, auction-rate bonds are considered qualified tender bonds, meaning they can be converted to another interest mode without triggering a reissuance, as long as that conversion is permitted in the original bond documents. Furthermore, an issuer can remove a credit enhancement like bond insurance from the bonds, and the resulting interest rate change will not constitute a significant modification to the bonds, which would result in their reissued.
The document also addresses the special rules in the notice regarding qualified hedges. Normally, a hedge is considered terminated if it has been significantly modified, but the notice permits minor modifications that would result in a yield change of less than 25 basis points, and-or the yield is adjusted to account for payments and receipts on the modified hedge.
A modification to a credit enhancement will not be considered significantly modified unless the alteration results in a change in the payment expectations of the bonds, meaning there is a substantial enhancement or impairment of the capacity of the bonds to be paid as originally intended.