WASHINGTON — The official statement for a bond issue should disclose if there is a material risk that the bonds might be taxable, even if the Internal Revenue Service never investigates, a Securities and Exchange Commission official said yesterday.
William Baker, an assistant director of the SEC's enforcement division, made the remark at a National Association of Bond Lawyers meeting here, at a time when lawyers have become increasingly concerned about SEC enforcement activities that revolve around tax issues.
"If you are taking a fairly aggressive tax stance and you are aware that there is a danger the IRS might view it differently, that could give rise to a disclosure issue and it may be something that investors are entitled to know before they invest in the bonds," Baker told a reporter after a panel session in which he was asked about the issue.
Several bond lawyers at the meeting said the SEC's stance could spell trouble for bond lawyers who have taken aggressive tax law positions in numerous bond transactions.
Baker told the lawyers that the SEC found in a recent enforcement action against Derryl Peden, a bond counsel with Stennett, Wilkinson & Peden in Jackson, Miss., that the risk of taxability had to be disclosed. The commission charged that Peden failed to disclose the interest on bonds in seven multifamily housing transactions might not be tax-exempt because of alleged tax law violations.
The SEC settled the securities fraud charges against Peden, but has similar charges pending in an SEC administrative proceeding against Thorn, Alvis, Welch Inc., now Thorn Welch & Co., the broker-dealer in the deals, and John E. Thorn Jr., the firm's president.
Thorn and his firm have denied the charges and claim the SEC has no right to pursue charges that hinge on tax law issues never decided by the IRS. They also contend they should not be charged because they relied on Peden with regard to the tax law issues.
Baker said there is precedent for the SEC taking action in cases involving tax issues such as tax shelter cases.
Asked about the underwriter's ability to rely on counsel, Baker said such reliance depends on whether the counsel's advice was rendered in good faith, the party relying on the advice gave counsel all relevant facts, and counsel fulfilled its obligations. Baker said an underwriter can not claim reliance on counsel and then assert attorney/client privilege.
Paul Maco, director of the SEC's Office of Municipal Securities, said "a straight-face test" always applies, meaning the underwriter can not abrograte its responsibilities or knowingly violate the law because of counsel.
Baker said the SEC has almost two dozen municipal bond-related investigations underway that could result in enforcement action.
These investigations, he said, "focus on all aspects of the (municipal) market" including conflicts of interest among participants of a deal, financial advisers who may not be providing appropriate services, affiliated transactions in which third parties are providing compensation that is not disclosed, the use of consultants who control selection of a deal's participants or access to the issuer, and the failure to meet primary and secondary market disclosure obligations.
The conflict of interest investigations include pay-to-play situations or the payment of financial benefits, such as a swap provider payment to an underwriter or an escrow provider payment to a financial adviser, Baker said. The disclosure investigations, he said, include whether there was timely disclosure of bankruptcy, financial troubles, or problems with an underlying project; and, an inquiry from a governmental agency like the IRS.
In addition, the SEC is looking at broker-dealers that may have engaged in book and recordkeeping violations, excessive markups, and illegal sales practices, he said.
Baker said that Terry Busbee, a former Escambia County, Fla., Utilities Authority board member, and Preston Bynum, an investment banker with Stephens Inc., will be sentenced by a federal court in Pensacola next week in a conflict of interest case involving bonds.
In a luncheon speech, Christopher Taylor, executive director of the Municipal Securities Rulemaking Board, complained about a recent newspaper report that suggested broker-dealers are making charitable and other contributions to circumvent the board's Rule G-37, which is designed to curb pay-to-play practices. Taylor said the rule "has had a dramatic and very beneficial effect on this industry" and that firms have always given to charitable causes.
Taylor conceded the board's proposed Rule G-38, which is aimed at requiring dealers to disclose information about consultants, could treat bond lawyers as consultants if they are providing a dealer bidding on a deal with a tax analysis of that deal. He urged the lawyers to let the MSRB know if the rule's definition of consultant is too broad. Taylor said the board has no current plans to revise suitability rules.
In a session on disclosure, SEC officials expressed concerns about issuers disclosing their accounting practices in an official statement and then changing them later, even if they disclose the change, unless it is to improve practices or meet a new state requirement. They urged issuers put core finanical information and operating data in an official statement and then update a "mirror" of that in succeeding years so investors have a frame of reference.
Robert Colby, deputy director of the SEC's division of market regulation, told the lawyers the SEC is not likely to bring enforcement cases over technical violations of the new disclosure rules. The SEC, he said, is more likely to deal with disclosure issues in cases involving securities fraud. Colby urged lawyers who are fussing about some ambiguities in the new rules to remember the rules are vague in some instances because the market wanted them to be flexible.
"We have a new venture here," said Colby. "It has to be applied according to its spirit as opposed to a roadmap. It's going to be working- out process and its up to you and other participants to make it work efficiently."
