BOSTON — Bond lawyers need to be realistic and acknowledge that there will be changes to the existing issue price rules, the chair of a panel at a conference here said.
"We're just not putting the toothpaste back in the tube. It's just not happening," Chas Cardall, a partner at Orrick, Herrington & Sutcliffe in San Francisco, said at the National Association of Bond Lawyers' Tax and Securities Law Institute. "I think as soon as all of us are sort of more realistic about where this is going, maybe we have a better conversation," he added.
The IRS and Treasury Department released proposed issue price rules in September, which are substantially different from the existing rules and have drawn widespread criticism from the market. A discussion about issue price at a NABL conference in the fall was heated. Market groups also strongly opposed the proposed rules in written comments and remarks at a public hearing in Washington earlier this year.
Cardall said the purpose of this week's panel was to talk more broadly about the issue price question and hear the perspectives of the regulators and enforcers. The hope was to get a sense of how market participants and regulators may be able to move toward a compromise, he said.
Cardall noted in the first of the two sessions on issue price that there's been "at a minimum, issue price fatigue," as well as "a need to try to get to a place where we feel like there's a good, professional, productive conversation happening around issue price so we can sort-of see our way on some path."
After the second of the sessions, Cardall said that he think it's sunk into the regulators that this is a hard topic.
Issue price is important because it is used to help determine the yield on bonds and whether the issuer is complying with arbitrage rebate or yield restriction requirements, as well as the amount of federal subsidy payments issuers receive for direct-pay bonds such as Build America Bonds. Issue price also plays a role in complying with other muni tax rules such as the 2% limit on issuance costs for private-activity bonds and the size of debt service reserve funds.
Under the current rules, the issue price for each maturity of bonds publicly offered is the first price at which a substantial amount of the bonds is reasonably expected to be sold to the public, with substantial defined as 10%. The issue price is usually determined based on reasonable expectations when the bonds are priced, before the closing of a bond deal.
However, the proposed rules would eliminate the reasonable expectations standard and instead base the determination of issue price on actual sales of the bonds. The proposed rules include a safe harbor under which the issue price would be the price at which the first 25% of the bonds is actually sold to the public. "The public" would be any person other than an underwriter, a term that would be defined as "any person that purchases bonds from the issuer for the purpose of effecting the original distribution of the bonds, or otherwise participates directly or indirectly in the original distribution."
During the sessions, Cardall gave an overview of how and why the proposed regulations came about. Over time, there's been more price visibility and near real-time market data available.. As market participants took a closer look at issue price, they saw that there appeared to be a lot of variation in pricing. Sales to institutional investors during an initial offering were at one price and then sales in smaller chunks of those bonds got sold at higher prices to retail investors, he said.
There are problems with the reasonable expectations standard because it's not exact, Cardall said. And the Internal Revenue Service's tax-exempt bond office was discovering circumstances were they had concerns with pricing. Given the fact that regulators and enforcers focus on the areas in the market where there are perceived abuses, maybe new issue price rules are needed. At a minimum, there are issues with issue price that need to be dealt with, he said.
John Cross, director of the SEC's office of municipal securities, said that bond lawyers have an "uphill battle" fighting the use of an actual sales standard for determining issue price.
Greater price transparency has become a major theme in the capital markets, and is reflected in technological advancements, securities law and policy. But the trend toward increased price transparency "runs head-on into a longstanding reasonable expectations test," Cross said.
He acknowledged that the price data on the Municipal Securities Rulemaking Board's EMMA system is confusing. However, it's hard for issuers to prove reasonable expectations when lots of data is released almost immediately that involves actual prices.
TEB director Rebecca Harrigal said that she heard from TEB staff and others that you have to ask if the existing rules are working if you see that underwriters are quickly turning around bonds at higher prices, sales to underwriters are being treated as sales to the public, and there's more market data available. But issuers are not necessarily verifying that their price is correct given that information.
Vicky Tsilas, Treasury's associate tax legislative counsel, said that Treasury and the IRS received about 20 comments about the proposed rules, including a number from state treasurers. Market groups criticized the use of an actual sales standard, saying that the market data issuers would need to check to make sure they are meeting the safe harbor doesn't currently exist on EMMA. Also, there may be unsold maturities, which could prevent those maturities from meeting the safe harbor on the sale date. Furthermore, groups found the meaning of the terms "underwriter" and "offering period" to be unclear, she said.
Another major critique of the proposed rules is that they don't distinguish between competitive and negotiated sales. "Frankly that is an issue that I would like to acknowledge because there is a difference in the way bonds are sold in a competitive and a negotiated sale" and because sometimes issuers are required to do competitive sales, Tsilas said.
Tsilas would not say what path Treasury and the IRS will take moving forward. One option would be to look back to the existing regulations and possibly provide some safe harbors and clarify terminology there. Another option would be to proceed with an actual sales approach while recognizing market concerns, possibly drawing a distinction between competitive and negotiated sales, clarifying the definition of an underwriter and providing a rule for when there are unsold maturities of bonds.
Cardall said he was appreciative of Tsilas' comments that the revised rules could address the unsold maturity problem.
Ernie Lanza, deputy executive director of the MSRB, said that while he does not have hard numbers yet, there are an "more than a minimal" number of issues where at least 25% of all maturities are sold at a price on the first day of trading, as well as where 25% of at least one maturity is not sold on the first day of trading.
