Mark Zehner

WASHINGTON — The National Association of Bond Lawyers may consider creating guidance on how attorneys can reasonably rely on tax certificates, following the false certifications market professionals provided for deals involving investment contracts that came to light in criminal bid-rigging cases.

Howard Zucker of Hawkins Delafield & Wood LLP advanced the idea for the project at a NABL teleconference during which members and regulators discussed the ethical lessons bond lawyers can draw from the bid-rigging investigations dating to before 2006 and resulted in subsequent prosecutions of brokers and providers at several firms.

Under “safe harbor” regulations for guaranteed investment contracts, issuers can be sure that the prices of the GICs will be treated as fair market value only if strict bidding rules are followed. The bidding process must be a “bona fide” competitive one featuring at least three bidders, none of which can be given unfair advantage or “last looks” at the bids of other providers.

But the bidding was found to be rigged, rather than competitive, in the criminal cases the U.S. Department of Justice’s antitrust division brought against 20 conspirators, 19 of which have already been convicted. Another case will go to trial next year in North Carolina, targeting conspirators who worked for Bank of America, said DOJ prosecutor Rebecca Meiklejohn.

Mark Zehner, deputy chief of the Securities and Exchange Commission’s pensions and muni enforcement unit, led a parallel civil investigation during the DOJ’s criminal probe.

He said the bid certificates the conspirators provided to bond counsel served as the basis for inaccurate tax opinions and faulty non-arbitrage certificates executed by issuers. Those certificates typically include representations of the issuer regarding the use of bond proceeds,  the time table for spending bond proceeds, and the yield on the bonds. The certificates show that issuers are not earning illegal arbitrage  from investment yields that are higher than the bond yields.  If the Internal Revenue Service discovers a problem with those certifications, it can conclude the bonds’ interest should be taxable rather than tax-exempt.

Zehner said that while Federal Reserve Board’s qualitative easing for the past several years has depressed interest rates and made it unlikely issuers can earn arbitrage, at some point, the policy will change and rates will go up again.

“QE2 has artificially lowered interest rates, so that issuers can’t really earn arbitrage. But at some point in the future, interest rates will go up. As QE tapers, that will likely cause people to play arbitrage games. I’d really like to avoid yield burning III,” Zehner said.

The criminal case against the GIC brokers and providers used as evidence bid certificates on which providers had handwritten conditions on their bids, such as “subject to market” or even simply “subject.” In one case, a GIC provider even scratched out language on the bid certificate stating that bidders followed all applicable rules, writing in the margin “I’ll attest if high bid.” Zehner told teleconference listeners that these are clear red flags bond counsel doing proper due diligence should be able to spot.

“Any bond lawyer worth their salt looking at that would have, should have, been asking questions,” he said.

The issue of how much or how little bond lawyers can rely on documents provided them is not clear cut, participants agreed. Zehner said that while it is clearly unreasonable to expect attorneys to launch long, detailed investigations into every closing certificate, they cannot simply rely on certificates and that previous case law shows that “boilerplate” vague tax certifications might not be enough to pass muster if challenged.

Other warning signs include certificates that provide no facts or have no supporting documentation. The supporting documentation might also be cause for concern, he said, if for example all the bids came from the same fax number or if some of the bids were sent after bidding was to have been closed.

“At what point does bond counsel’s conduct cross that reasonable investigation threshold?” Zehner asked. “I can’t answer that for you.” He added, “There is no such thing as a one size fits all.”

Perry Israel, a panelist and bond lawyer who has his own firm in Sacramento, Calif., said a possible NABL model certificate is “a useful thought,” but expressed doubt as to whether it would provide much protection. Walter St. Onge III of Edwards Wildman Palmer LLP, who was also a panelist, agreed. “Having a model is fine, but it won’t replace looking at the bids,” he said. The lawyers suggested it would be more useful to have guidance about reliance on certificates.

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