WASHINGTON - The yield-burning controversy has been very damaging to the municipal market and should be settled if possible, the incoming president of the National Association of Bond Lawyers said in a recent interview.
"I would be all in favor of some sort of settlement," said 43-year old Floyd C. Newton 3d, a partner with King & Spalding in Atlanta who will be inaugurated as NABL's 20th president tonight at the group's 23d annual bond attorneys workshop in Chicago. "I think it's always desirable to get rid of a controversy."
"It's been a very damaging thing for the market, for dealers, for issuers, and for everyone involved," he said. "The question is how do you get the parties to settle."
Newton said he does not expect to see bond counsel involved in any settlements or federal enforcement cases because they did what they could to make sure the escrow provider certified to the issuer that securities were purchased for the escrow at fair market value in an arm's-length transaction.
"I believe that in the yield-burning area, the bond lawyers generally tried to do whatever they could to get the appropriate certifications. They did the best they could have done," he said.
Unless the bond counsel conspired with the underwriter to mark up the escrow securities - and there is no evidence of that - they should not be targeted in federal enforcement actions, according to Newton.
Bond lawyers are not responsible for verifying the accuracy of the escrow providers' certifications to issuers, he said.
"It is absolutely impossible to do that," Newton declared. "Lawyers are not equipped or trained to do the pricing of securities."
However, Newton said he fears that lawyers could become drawn into any civil litigation that arises from alleged yield-burning abuses. The concern is that if the Internal Revenue Service tries to tax the underlying refunding bonds, the issuer or investors will sue to recover the money and target the bond counsel as well as the escrow provider and other transaction participants perceived to have deep pockets.
New Certification Procedures Needed
Newton said new certification procedures are needed and that NABL is willing to work with the IRS or the Securities and Exchange Commission to develop them.
"Certainty is needed," he said. "There needs to be an understanding - a safe harbor or whatever - under which the bond lawyer can ask for and receive a certification that can be relied upon and is clear that the responsibility for escrow pricing lies with the escrow provider of financial adviser."
The IRS has proposed a rule under which there would be a so-called rebuttable presumption that yield burning did not occur if an issuer chose an escrow provider from at least three bids in a competitive bidding process. In other words, the IRS will initially presume there was no yield burning, but has the right to change its mind.
But Newton and other NABL members want some kind of safe harbor or process that ensures that if a competitive bidding process or other set of procedures is followed, there will be an automatic and unchanging assumption that yield burning did not occur.
"I think this needs to be resolved for the benefit of the lawyers, issuers, and investors," Newton said.
He also said the SEC's and IRS' major push on municipal enforcement "has been an educational experience for the whole industry." While NABL members may have concerns about certain agency stances, he said, in general, they are pleased that there is more enforcement action taken to halt abuses.
One of the major challenges facing bond lawyers will be "to try to continue to improve our professionalism and reputation despite all of the controversy over pay-to-play," according to Newton.
He said "it will be interesting to see" what kind of rule the American Bar Association's ethics committee comes up with on pay-to-play. The panel was charged by the delegates early last month with writing a rule that makes clear lawyers are prohibited from engaging in pay-to-play practices.
Merit-Based Selection Is Key
Newton said he and other NABL members believe the best safeguard against pay-to-play practices is to ensure that lawyers are selected for municipal transactions on the basis of merit.
Asked about the recent call by a New York City bar group member for bond lawyers to report their political contributions to the Municipal Securities Rulemaking Board, Newton replied: "That's an issue that's way beyond public finance. It ought to be dealt with in the context of campaign finance in general. We can't have a special rule for bond counsel."
King & Spalding, Newton conceded, is one of many NABL-member firms that has refused to adopt the association's "State of Professional Principles With Respect to Political Contributions," which endorses meaningful disclosure of political contributions and gives bond counsel the option of reporting their contributions to the MSRB.
On disclosure, Newton said he thinks most issuers are complying with the SEC's primary- and secondary-market disclosure rules. He said he supports the market's moving toward electronic disclosure, but cautioned that the industry and federal regulators should be careful not to impose undue burdens and costs on small issuers. "What's good for the Port Authority of New York and New Jersey may not make sense for the town of Hahira, Georgia," he said.
Regulatory issues aside, Newton said he wants NABL's educational activities to be a priority area of attention for the organization during the coming year. "I do believe that focusing on our educational mission is the core of what this organization is all about," he said. "We have had a number of important projects that involve professional responsibility issues."
NABL has revised its model opinion for bond counsel and its model engagement letter. For the first time, it is in the process of drafting a model opinion for underwriters' counsel.
Cites Watershed Event
"I'd like for us to get that out this year," he said.
Newton says these projects have been a "watershed event in the public finance industry" and are "perhaps the most important thing that NABL has done over the last two to three years."
The most significant change in the opinions and engagement letters is that they now call on lawyers to identify their clients and the scope of their responsibilities in municipal offerings.
For years, most bond lawyers took the position that their client was the municipal securities transaction itself. But this was out of sync with state ethics rules, which typically call for lawyers to analyze whether they would have any conflicts representing a particular client.
If a lawyer did not have a specific client, he or she could not really do a conflicts analysis. "They'd either take the position that there couldn't be a conflict because they didn't represent anybody, or they just ignored the analysis altogether," Newton said.
This has led to problems. Malpractice insurers have told NABL members that they have found that when a bond counsel does not identify a client and is not clear about what his or her responsibilities are, they are more likely to be targeted in any lawsuit filed over a transaction.
NABL's revisions to these documents are aimed at ensuring that lawyers identify clients and analyze conflicts in municipal offerings.
"I don't think it necessarily changes the way we operate," Newton said. "But it does change the way we analyze conflicts substantially, and frankly I think it brings us more into compliance with the ethical rules because they don't provide any exceptions for bond counsel."
Asked about conflicts regarding issuer selection of underwriters' counsel, Newton said disclosure is not the answer.
The MSRB has twice considered requiring dealers to disclose when issuers inappropriately influence the selection of underwriters' counsel. The board has been concerned that an issuer may select an unskilled underwriters' counsel for political reasons who will not adequately represent the underwriter in determining whether the issuer's disclosures are sufficient under the federal securities fraud laws.
Disclosure Not the Answer
But Newton said he does not think disclosure would be an effective way to address the problem. "Would an investor pay any attention to that in an offering document?" he asked. "Probably not.
Newton said issuers often have legitimate reasons for being involved in the selection process and that if the issuer chooses an underwriters' counsel who cannot do the job, the other lawyers in the transaction can either pick up the slack or pull out of the transaction.
The incoming NABL president said he is very excited about the organization's Web site, adding that "it has the potential to be one of the most valuable things we will have for members."
He said he expects that NABL will continue to produce important publications such as "Federal Taxation of Municipal Bonds" and "SEC Enforcement Actions."
At the same time, he continued, he wants to explore new ventures, such as organizing seminars with the Government Finance Officers Association or other municipal market groups. Both NABL and the GFOA might benefit from a joint seminar that addresses basic securities and tax laws and the selection and responsibilities of lawyers in bond transactions, he said.
Newton has been at King & Spalding for 18 years. He joined the firm in June 1980 after receiving an undergraduate degree in economics, magna cum laude, from Princeton University, and a law degree, magna cum laude, from the University of Georgia Law School in Athens. He was executive editor of the Georgia Law Review during his third year in law school, and received a Woodruff Scholarship.
He has practiced in the public finance arena since joining the firm, doing mostly conduit transactions for nonprofit organizations such as hospitals, educational institutions, and charities. He has also done a number of pollution control or solid-waste financings for utility and industrial companies. While he is most often bond counsel, he serves as underwriters' counsel in a quarter to a third of the transactions in which he is involved. He became partner at the firm in 1987.
King & Spalding is the top-ranked bond counsel and underwriter's counsel in Georgia, according to Securities Data Co. The firm has been bond counsel in 46 issues totaling almost $1.9 billion so far this year, compared with 64 issues amounting to almost $1.3 billion last year in the state. It is third-ranked underwriters' counsel in the state for the year so far, with 18 issues totaling $379 million, compared to its top rank last year with 31 issues that totaled more than $1.3 billion.
Nationally, the firm is ranked in 22d place as bond counsel so far this year, with 56 transactions totaling over $2 billion. Last year it placed 39th, with 72 transactions amounting to more than $1.4 billion.
It is ranked 55th nationally in underwriters' counsel work so far this year, with 30 transactions totaling more than $508 million. This compares with a 24th-place ranking last year, with 40 transactions that amounted to more than $1.5 billion.
"It's still early," Newton said.
