The Allegheny County, Pa., Sanitary Authority has agreed to pay $70,000 to settle Internal Revenue Service charges that it violated yield restriction requirements on an advance refunding escrow for $260.3 million of bonds issued in 2005.

The authority disclosed the settlement, or closing agreement as it called, in an event notice filed on the Municipal Securities Rulemaking Board's online EMMA system. The settlement will preserve the tax-exempt status of the sewer revenue refunding bonds.

The bonds were issued in part to advance refund some bonds that had been issued in 1997 and 2000, according to the official statement.

CDR Financial Products brokered the bid for escrow securities, which were to be open-market Treasury securities. Bidders were asked to either bid the lowest price, or if the lowest price would take the investment yield above the bond yield, then instead bid a price that, along with a shorter term for the escrow and rolling the longest bond into a zero coupon bond, would take the investment yield down to the bond yield, said Perry Israel, a bond lawyer representing ALCOSAN.

JPMorgan put forth a nonconforming bid that would satisfy both requests instead of one or the other. Its bid was accepted because it offered the lowest price on the escrow securities. ALCOSAN decided to adjust the bid to just go with that lowest price. However the IRS took the position that ALCOSAN had no right to adjust the nonconforming bid and it had to take both parts of it, which made the investment yield higher than the bond yield and in violation of yield restriction requirements, Israel said.

"The service conducted an examination of the bonds and concluded that [ALCOSAN] failed to meet the requirements of Section 103 [of the Internal Revenue Code] because [it] failed to determine the fair-market value of the investments in the advance refunding escrow in accordance with Section 1.148-5(d)" of the Treasury rules, ALCOSAN said in the notice. "As a result, the service concluded that the issuer failed to properly restrict the yield on these investments in accordance with 1.148-2 causing the bonds to be arbitrage bonds under Section 148."

"The issuer does not necessarily agree that the investments were valued incorrectly," the notice added.

William Inks, the authority's director of finance and administration, said ALCOSAN decided to make the payment because it would be cheaper than the cost of fighting the IRS.

ALCOSAN's notice said that the IRS had not formally asserted any claims against it or sought to tax any of the bondholders' interest earnings.

The terms of the settlement were arrived at by negotiation between the issuer and the IRS and "may differ from the terms of settlement of other bond issues examined or to be examined by the service," the notice said. It added that the agreement "may not be cited or relied upon by any person or entity whatsoever as precedent in the disposition of any other case."

The agreement stipulated that neither party "shall endeavor by litigation or other means to attack [its] validity" and that the case "may be reopened in the event of fraud, malfeasance or misrepresentation of a material fact."

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