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Issuers Should Track BABs

WASHINGTON — The Internal Revenue Service, concerned that some Build America Bonds are being sold to investors at prices that are too high, is urging municipal issuers to track the trading of their BABs through the Electronic Municipal Market Access system and to question underwriters about the pricing.

“The IRS is troubled when we see an upward trend in prices and that some apparently public purchasers are buying bonds at prices in excess of the initial offering price in what appears to be the primary market,” George E. Gurrola, an IRS tax law specialist in the agency’s tax-exempt bond office, told bond lawyers during a teleconference yesterday. “If this is indicated in the trading record for your BAB issue, an explanation should be sought.”

Gurrola also suggested that issuers check their BAB trading data on the Municipal Securities Rulemaking Board’s EMMA site as well as other information to determine whether the underwriter’s certification of issue price is accurate.

The American Recovery and Reinvestment Act of 2009 that created BABs includes a provision stating that they cannot be sold at more than a de minimis amount of premium, with the implication that if the sales premiums were too high issuers’ bonds would not qualify as BABs and then would not qualify to receive subsidy payments.

“We strongly encourage issuers to protect their interests and to perform due diligence in accepting the underwriter’s certification through pre-sale discussions with the underwriter, reviewing comparable and recently sold issues, and access all available information on their bond issues, including information available through EMMA,” Gurrola said during the teleconference, which was sponsored by the National Association of Bond Lawyers.

Gurrola’s remarks appear to stir the controversy about BAB pricing and what steps issuers should take to avoid an IRS audit of their bonds at a time when the Obama Administration and Democrats in Congress are pushing an extension of BABs.

As of early May, more than $97 billion of BABs have been issued and the IRS is expected this week to pass the $1 billion threshold in the amount of subsidy payments it has made to BAB issuers, Steven Chamberlin, manager of TEB’s compliance and program management section, said during the teleconference.

“It’s regrettable both from the standpoint of bond lawyers and I assume the standpoint of the service to have a problem that is interfering with the smooth delivery of BABs, one of the great successes of the modern era in public finance legislation,” Frederic Ballard, a partner at Ballard Spahr Andrews & Ingersoll LLP, said after the call.

Gurrola said that 70.4% of BAB issuers who responded to IRS compliance check questionnaires said they had written procedures for determining whether their BABs stayed within the de minimis premium restriction. Most of them said they rely on the certificate provided by the underwriter or initial purchaser of the bonds to determine compliance. While 71.4% knew their BAB trading data was available on EMMA, only 11.2% of them had reviewed it.

Gurrola cited the certification that is routinely given by underwriters with respect to substantially identical bonds: “The bonds were offered to the public excluding bond houses, brokers or similar persons or organizations acting in the capacity of underwriters or wholesalers at a price equal to the initial offering price.”

That certification is critical to determining the issue price, he said.  However, he said a review of BAB trading data on EMMA suggests that many BABs are not sold at the initial offering price.

Gurrola gave three examples of situations that he said should raise questions.

In the first example, after a negotiated sale, EMMA trade data showed that a portion of a maturity had been purchased by some customers at the initial offering price and other portions by customers at prices in excess of the initial offering price.

“It is appropriate to ask the underwriter if it is holding back some portion of the maturity for initial sales at prices in excess of the initial offering price,” Gurrola said. “If the IRS sees this fact pattern in the course of an audit we will ask whether the entire maturity was offered to the public at the initial offering price.

In the second example, EMMA trade data after a negotiated sale showed an upward trend in prices and that some portion of a maturity was sold directly or indirectly to the underwriter, affiliates of the underwriter or related accounts of the underwriter. Even if those sales were shown as customer sales on EMMA, if public orders were unfilled or customers were buying bonds at prices in excess of the stated initial offering price, Gurrola said: “It is appropriate to question whether the entire maturity has been offered to the public at the initial offering price.”

“The IRS will ask this question if the bond is audited and EMMA trading data shows an upward trend in prices,” he said.

In the third example, EMMA trade data showed after a negotiated sale that the dealers were the purchasers of all or a portion of a maturity at the initial offering price and then offered those bonds to customers at prices in excess of the initial offering price.

“It is appropriate to question whether the entire maturity has been offered to the public and not just to the dealers at the initial offering price,” Gurrola said. “If the IRS sees this fact pattern in the course of an audit, we will ask whether the entire maturity was offered to the public at the initial offering price.”

However, bond lawyers do not necessarily agree with the IRS’ stance.

They claim rules state that the issue price of bonds that are publicly offered is the first price at which a substantial amount, 10%, of the bonds are sold to the public. They contend the rule states that “the issue price does not change if part of the issue is later sold at a different price.”

Further, it says that the issue price of bonds for which a bona fide public offering is made is determined as of the sale date based on reasonable expectations regarding the initial public offering price.”

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