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Issuers Can Temporarily Buy ARS

WASHINGTON - Governmental issuers can purchase their own auction-rate bonds on a temporary basis without running afoul of any tax laws or extinguishing the debt, the Treasury Department said in a notice issued yesterday.

"This notice is intended to provide greater certainty and flexibility to address certain potential federal tax issues that have arisen in the tax-exempt bond market as a result of recent rating agency downgrades of major municipal bond insurers and failures of auctions in the auction-rate bond sector of the tax-exempt bond market," the 21-page document stated.

Notice 2008-41 comes on the heels of the Securities and Exchange Commission's determination earlier this month that issuers may bid on and purchase their own auction-rate securities to avoid a failed auction, without triggering SEC enforcement action, if certain information is disclosed. The notice modifies, adds to, and supersedes the Treasury's previous guidance on reissuance and auction-rate bonds, Notice 2008-27, which was widely praised by members of the muni community.

The major change between the two notices is the addition of a section permitting governmental issuers to purchase their own auction-rate bonds temporarily in an effort to preserve liquidity. According to the notice, issuers may purchase and hold their own bonds for 180 days without retiring the bonds, provided the bonds were purchased prior to Oct. 1, 2008.

In addition, an issuer may refund a bond while owning it with a refunding bond if there is a failed auction or remarketing.

The guidance also clarifies that conduit borrowers or other third parties involved with auction-rate bonds may purchase the bonds without being subject to the 180 day limit. Under the notice, a governmental issuer, as long as it is making its best effort to remarket the bonds, may hold the debt for 179 days, then resell it to the third party and still be compliant with tax laws.

Several technical questions raised by muni members regarding the original notice are addressed in the new notice, including those asked by members of the National Association of Bond Lawyers during their Tax and Securities Law Institute, which took place in San Francisco a few days after the release of the initial notice.

For example, during a panel session at the conference, NABL members asked John J. Cross 3d, an attorney with the Treasury's office of tax policy, about the stipulation that said any bonds converted to an interest rate mode must be resold at par, except for when the bonds are converted to a fixed rate for the remaining maturity, at which time they can be sold for a premium.

The lawyers wanted to know how the premium should be accounted for in the bonds, and at the time Cross said the matter had not been considered yet. The new notice specifically states that a premium from such a sale should be considered as additional sales proceeds for arbitrage purposes.

Bruce Serchuk, an attorney with Nixon Peabody LLP in Washington, D.C., said yesterday that he found helpful not only the notice's content, but also the speed with which it was produced.

"For the IRS and Treasury to put guidance out, get informal comments, and then this quickly turn around and address some of those issues in a new piece of guidance, is both unheard of and incredibly impressive," he said. "The pace of [Treasury's] action speaks volumes as to how much they appreciate what's going on in the market."

He added that the specific details new to the notice will require further analysis from muni market participants, but that overall the notice should "make people's lives easier in terms of dealing with their auction-rate problems."

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