CHICAGO — Should municipal bond issuers be discouraged from disclosing voluntary settlements of tax disputes with the Internal Revenue Service, for fear the Securities and Exchange Commission will notice the disclosures and then take enforcement action against the issuer for securities fraud violations?
This question was debated by bond lawyers on two panels at the National Association of Bond Lawyers' Bond Attorneys' Workshop this week.
The debate stemmed from a recent case involving South Miami, Fla., a town with a population of 11,000 in Miami-Dade County.
In August 2011, South Miami entered into two voluntary closing agreements with the IRS to settle tax law violations made in connection with bonds sold in 2002 and 2006 to finance construction of a public parking garage in a commercial district.
Under those agreements, which were negotiated after the city voluntarily alerted the IRS to tax law violations, the city paid $260,345 and defeased a portion of the two prior bond offerings at a cost of $1.16 million.
Then in May of this year, the Securities and Exchange Commission charged the city with defrauding investors by negligently making misstatements and failing to disclose that actions it took that jeopardized the tax-exempt status of the $12 million of bonds.
The city settled the SEC charges by agreeing to a cease and desist order barring it from any future securities fraud violations.
It also agreed to retain an independent, third-party consultant to conduct annual reviews over three years of its policies, procedures, and internal controls for municipal bond disclosures.
The city agreed to follow through and implement all recommendations made by the consultant.
During a discussion of IRS examinations by panelists at NABL's meeting, Chas Cardall, a partner at Orrick, Herrington & Sutcliffe LLP in San Francisco, said he was "fascinated between this interplay" of the city's disclosure of the IRS settlements and the SEC's enforcement action.
"My guess is the SEC would have only known about this case when the issuer disclosed that it went through the voluntary agreement program," he said.
Brad Waterman, another panelist said, "I guess the answer is that fixing the IRS problem doesn't fix the SEC problem."
Later, during a panel discussion of "hot topics" in the securities law area, John Cross, director of the SEC's municipal securities office, was asked whether issuers should fear disclosure of VCAP settlements will prompt SEC enforcement action.
"I think that would be an unfortunate action," Cross said.
"I would push back against the notion that the SEC would just pile on if an issuer entered into a VCAP," he said.
Rebecca Olsen, who works with Cross and was also a panelist, said South Miami was "a unique case" that involved the city's failure to disclose key information to investors and transaction participants, including the Florida Municipal Loan Council, which issued the 2006 bonds.
The city also made misrepresentations to the bond counsel, representing the project was eligible for tax-exempt status in bond documents, the SEC said.
The city triggered the tax law violations when it impermissibly loaned $2.5 million of the 2002 bond proceeds, one month after issuance of those bonds, to the private developer of the project. It failed to disclose that information to the FMLC or any other third party.
The city also did not disclose that it restructured its lease agreement with the developer in 2005 to lease the entire project to the developer, rather than just the retail space.
These actions created private use and payments and caused the bonds to be taxable private activity bonds.
The SEC found that, at the time the 2002 bonds were sold, bond counsel received a copy of the city's lease agreement with the developer, and made clear to the city's then-finance director, that no bond proceeds could be used to finance the retail portion of the structure.
However, subsequent city finance directors were unaware of the warning. The SEC said the city did not file a material event notice disclosing the adverse impact of its actions until July 2010.