WASHINGTON – A group of lawyers is urging tax regulators to make some revisions and clarifications to proposed issue price rules to avoid confusion and make the rules more workable.
The tax-exempt financing committee of the American Bar Association's Taxation Section made the recommendations in a letter and 20-page document sent to Treasury Department and Internal Revenue Service officials this week.
Overall, the issue price rules that were proposed in June "set forth a practical, administrable and theoretically sound approach to issue price determinations," the committee said.
But modifications should be made to the definition of "underwriter," diligence and documentation issues, potential yield restriction problems arising from advance refundings, and timing issues, it said.
Darren McHugh, a shareholder with Stradling who played a major role in developing the comments said the committee wants to make sure that the rules are "as clear and concise as possible to limit the risk that they could be applied in any ambiguous fashion."
Issue price is important because it is used to help determine the yield on bonds and whether an issuer is complying with arbitrage rebate or yield restriction requirements, as well as whether federal subsidy payments for direct-pay bonds such as Build America Bonds are correct.
Under existing rules, the issue price of each maturity of bonds that is publicly offered is generally the first price at which a substantial amount, defined as 10%, are reasonably expected to be sold to the public.
But tax regulators became concerned that some dealers were "flipping" bonds -- selling then to another dealer or institutional investor who then sold them again almost simultaneously, with the prices continually rising before the bonds were eventually sold to retail investors.
The Treasury and the IRS tried to tighten the rules in 2013 by proposing new ones that replaced the "reasonable expectations" standard with actual sales and increased the definition of "substantial amount" to 25% instead of 10%. Those rules drew so many complaints that they were scrapped and replaced with new proposed rules in June.
Under the new proposed rules, the issue price of a maturity would generally be the price at which the first 10% of the bonds are actually sold to the public.
The rules would provide an alternative method for determining issue price If 10% of a maturity hasn't been sold by the sale date. In that case, the issue price would be the initial offering price of the bonds sold to the public, as long as the lead underwriter certifies to the issuer that no underwriter filled an order from the public after the sale date and before the closing date at a higher price than the initial offering price. An exception can be made if the market moved after the sale date, but the underwriter must document any market movements.
The committee asked the tax regulators to clarify the definition of underwriter in the proposed rules. It wants regulators to clearly state in the rules that when bonds are sold or privately placed with a bank, the bank will not be considered an underwriter.
The issue prices rules would still apply. The bank could certify the purchase price, which would be the issue price, to the issuer.
While the preamble to the rules states that anyone who purchases bonds for investment purposes should not be treated as an underwriter, the group wants clarity on the definition of underwriter with regard to banks in private placements because "this has become such a material part of the municipal market," McHugh said.
The committee also wants the regulators to clarify that firms are only underwriters if they take on underwriting or capital risk. Typically when broker-dealers purchase bonds to sell to customers they have those customers already lined up and don't plan on holding the bonds, McHugh said.
"We're just asking that they clarify for us that a broker-dealer that purchases from the underwriter, but is not really putting their capital at risk or taking on underwriting risk, is not going to be treated as an underwriter," he explained.
The committee also asked the regulators for revisions related to the alternative method for determining issue price when 10% of maturity hasn't been sold to the public. It wants the regulators to shorten the so-called lock-up period during which bonds can't be sold at prices above the initial offering price. The shorter period would be six business days after the sale date, instead of the entire period between the sale and closing date.
"Part of the rational for that is expediency and the sort of convenience of closing," said McHugh. "The nature of modern markets is that almost, by definition, you're going to have a market change within six days so you're almost always going to be able to justify that. The idea is that after the end of six business days the underwriter could sell the bonds at prices higher than the initial offering price, even without having to prove any market change."
McHugh noted that an official statement typically is deemed final on the seventh day after pricing.
The committee also asked regulators to consider other factors than just changes in interest rates to justify market changes, such as currency devaluations of major world economies or lower oil prices, among other things.
In other revisions requested with regard to the alternative method for determining issue price, the lawyers suggested the regulators establish three safe harbors under which issuers could meet their due diligence requirements on the underwriter's certification that bonds were not sold above the initial offering price for a period of time.
The first safe harbor would be if the bonds are sold competitively and three bids for them are received. The second would be if the issuer has a post-sale consultation with the lead underwriter regarding pricing and asks questions such as those recommended by the Government Finance Officers Association in its recommended practice on Pricing Bonds in a Negotiated Sale. The third would be if the issuer has a post-sale consultation with the financial advisor and gets a certification from the FA that he or she reviewed the pricing and determined that the bonds were sold at fair market value.
The committee also asked the regulators to finalize rules proposed in 2007 that would codify a revenue procedure regarding advance refundings. Under those rules, if the window for selling state and local government series securities is closed and issuers can't buy open-market Treasuries for advance refunding escrows that match the underlying bond maturities, issuers can make yield reduction payments to avoid violating yield restriction requirements.
