WASHINGTON — An industry group has asked regulators to consider municipal bond marketing practices and several muni rules as they develop guidance on the issue price of bonds.
In a letter sent to the Treasury Department last week, the Securities Industry and Financial Markets Association warned there are widespread misconceptions about the marketing of municipal bonds. The group also said department officials should be careful that their guidance not run afoul of Municipal Securities Rulemaking Board rules that govern primary offering practices, fair dealing and bond pricing.
“If you want to change or limit those practices so as to address concerns about 'issue price,’ we ask that you be clear as to what you are seeking to limit and coordinate those changes with the MSRB rules,” SIFMA said in the 10-page letter.
Any guidance should take into account that issue price “has been a vexing issue for practitioners with respect to tax-exempt bonds for years,” SIFMA said.
Michael Decker, managing director and co-head of the muni division at SIFMA, said there are some inconsistencies in the way that bond lawyers have interpreted current issue price rules.
“Rules seem to be applied differently in different transactions,” Decker said in an interview. “We would like to see new-issue price rules to provide enough clarity and consistency for all market participants.”
The Internal Revenue Service has been concerned about “flipping” and other pricing practices, particularly in connection with Build America Bonds, that raise questions about whether the correct issue price was set for the bonds.
Issue price is key to determining the maximum bond yield for tax purposes, which has a bearing on whether an issuer of tax-exempt bonds is meeting arbitrage requirements and whether an issuer of BABs is receiving an appropriately sized federal subsidy payment. BAB issuers receive subsidy payments equal to 35% of their interest costs.
The lower the issue price for bonds bearing a stated interest rate, the higher the yield. If the issue price for the bonds is set too low, the bond yield is likely too high and results in the issuer retaining impermissible arbitrage from taxable investments of the bond proceeds.
The IRS formed a seven-person team that is using the online EMMA system and other data from the MSRB to monitor bond prices and taking other action to uncover suspicious pricing practices.
Part of the uncertainty surrounding the issue price of bonds is that “underwriters and tax counsel, all are largely focused on the process of pricings, whereas the IRS, with its apparent emphasis on data derived from the MSRB’s Real-Time Trade Reporting System, seems to be focused on the results of pricing,” SIFMA said. The group argued that there are many occasions in which the MSRB’s data will show higher prices than the initial offering prices, such as with interest rate changes.
IRS rules require that the issue price for each maturity of tax-exempt bonds is the first price at which a substantial amount of the bonds is sold to the public — not the underwriters — with 10% considered to be a substantial amount.
Decker said the “public” as defined by the Treasury and IRS is narrow, and when rewriting the rules officials should include sales of non-syndicate dealers, hedge funds, and similar categories such as members of the public.
“It is in the best interest of the issuer if the marketing of a bond issue is not limited exclusively to potential investors that the tax rules define as being members of the public,” SIFMA said. “Limits on marketing bonds to as wide a range of investors as possible will impose additional costs to issuers.”