The National Association of Bond Lawyers yesterday released a long-awaited advisory on the federal securities law issues that arise when stripping tax credits from underlying taxable municipal bonds.
The seven-page analysis was written in a question-and-answer format after consultation between NABL members and Securities and Exchange Commission staff. It concludes that while the stripped credits are “most likely” securities, they are probably municipal securities, which means they are exempt from having to register with the SEC under the Securities Act of 1933 or from having to meet corporate-style continuing disclosure requirements under the Securities Exchange Act of 1934.
The advisory applies generally to taxable tax-credit bonds issued by states and localities. It precedes separate tax guidance being drafted by the Treasury Department that is expected to be released by the end of June. NABL warned the Treasury guidance may impact its securities law analysis on stripping, which it defined as the separation of ownership between a tax-credit bond and a tax credit.
NABL members said yesterday that the advisory was the most efficient way of informing the market because any no-action request to the SEC would be limited to the specific facts presented to them.
A crucial portion of the NABL analysis centers around the discussion of whether stripped tax credits are considered “securities” under the 1933 act or the 1934 act.
“Most likely,” NABL says.
Although tax credits generally are not securities, the manner in which the stripped credits are created, offered and sold may result in the stripped credits being considered securities, NABL said.
A standard model for stripped tax-credit financings that has been done to date includes some or all of the following features: municipal securities offered and sold with a principal component and a tax credit component; the ability of the owner of the municipal security to request that the tax component be stripped from the principal component; and after stripping occurs, separate principle certificates and tax credit certificates are separately registered by the paying agent.
Typically a Cusip number for the tax credit component of a new tax-credit bond issue would be assigned at the time of sale of the integrated municipal security. The tax-credit Cusip would consist of the issuer’s core six-digit number, with a three character suffix that differs from the last three characters of the Cusip for the underlying bond. Also, under certain conditions, the underlying municipal bond may bear interest in lieu of providing the owner credits against federal income tax liability, NABL said.
Another question at the heart of the advisory: If stripped tax credits are determined to be securities, would they be exempt from SEC registration? Yes, NABL says, to the extent that the bond documents govern “remedies” available to the owners of both the bonds and the stripped credits.
Such remedies, NABL said, usually include: a split of voting rights between the holder of the stripped credits and the associated municipal bond; pro rata redemption of the muni bond and the stripped credits from excess bond proceeds; the tax credit converting to an interest-paying coupon upon violation of certain covenants of the issuer; and rights of holders of the stripped credits to sue the muni ssuer for covenant violations that negatively affect the value of the stripped credits.
While stripped credits may be found to be securities exempt from SEC registration, NABL cautions that the manner in which they are packaged or marketed in the secondary market could jeopardize the exemption, noting a case in which the former Merrill Lynch & Co., now Bank of America Merrill Lynch, packaged bank certificates of deposit as securities.
However, even if stripped credits are determined to be non-exempt securities, they can still be offered without registration by taking advantage of certain other exemptions under the 1933 Act, such as by selling them in a private placement.
The advisory also includes separate cautionary notes, chief among them that the analysis it is providing is meant only to apply to tax-credit bonds sold by state and local governments, and not, for instance, new clean renewable energy bonds issued by cooperative electric companies.
The advisory was authored by Robert Fippinger of Orrick, Harrington & Sutcliffe LLP, Teri Guarnaccia of Ballard Spahr LLP, Stanley Keller of Edwards Angell Palmer & Dodge LLP, and John McNally of Hawkins Delafield & Wood LLP. Additional comments were provided by Kenneth Artin of Bryant Miller Olive, William Hirata of Parker Poe Adams & Bernstein LLP, Jeffrey Nave of Foster Pepper PLLC, and Walter St. Onge 3d of Edwards Angell Palmer & Dodge.