WASHINGTON — In the absence of clearer federal tax rules on issue price, a handful of bond lawyers have taken it upon themselves to assist issuers in reviewing and understanding the Municipal Securities Rulemaking Board's EMMA pricing data for new muni bonds, sources said.
Depending on the circumstances, the issuers and their lawyers may wind up having discussions with the underwriter to learn more about its marketing process. However, it's relatively uncommon for that process to continue beyond the closing or involve every deal and every situation, according to sources.
"I have been doing this with issuers and it works very well," said one lawyer who did not want to be identified. "The underwriters don't mind and they are more than willing to come in after the closing and explain to issuers what EMMA shows. Having issuers participate in that way is really beneficial to the process."
The lawyer began assisting issuers in understanding bond pricing since the beginning of the year when the Internal Revenue Service announced its initiative to use EMMA data to determine if muni bonds were initially offered at prices that raise questions about tax-law compliance.
Issue price is key to determining the bond yield for tax purposes. The determination of the bond yield has a bearing on whether an issuer of tax-exempt bonds is meeting arbitrage requirements or whether an issuer of Build America Bonds is receiving the correct level of subsidy payments from the federal government.
Under IRS rules, the issue price for each maturity of bonds is the first price at which a substantial amount of them are sold to the public, with 10% considered to be a substantial amount. However, the rule only applies if all of the bonds of a specific maturity are offered to the public at that price. The public "does not include bond houses, brokers, or similar persons or organizations acting in the capacity of underwriters or wholesalers," the rules say.
The IRS has been encouraging issuers to police their own bond pricing by using EMMA trade data and other information to determine whether the underwriter's certification of issue price is accurate.
Issuers are motivated to get the best price for their own economic purposes, while the IRS is interested in the accurate issue price for tax purposes, said Steve Chamberlin, manager of compliance and program management for the IRS' tax-exempt bond office.
"If an issuer takes steps to proactively engage in a conversation with the underwriter to understand exactly how the primary offering unfolded, they will then better understand the pricing outcome and can not only evaluate whether they got the best price, but also whether they correctly determined the issue price for tax purposes," Chamberlin said. "We've heard from practitioners that when issuers communicate that expectation up front with the underwriter, the increased transparency has helped them better evaluate the pricing of their bonds generally and their tax compliance specifically."
Some lawyers think if there is increased transparency between underwriters, dealers and issuers, underwriters will be more careful in offering bonds to the public and documenting their pricing process.
"It's a good idea for issuers to take note of the interest that the Service has expressed in the issue price," said Hobson Presley Jr., founder of Presley Burton & Collier LLC. "The Service has told issuers that it is surveying the EMMA pricing data. One thing issuers can do is also let underwriters know that they too will survey the EMMA pricing data and ask their underwriters to come in after closing and explain to them what the EMMA pricing data shows. That's one proactive step they can take to show their concern for the issue and try to maintain the integrity of their pricing."
"There's always a need for issuers to better understand the pricing process," said Eric Johansen, former treasurer for Portland, Ore., and chairman of the Government Finance Officers Association's debt committee.
He suggested issuers review the GFOA best practices for pricing bonds in a negotiated sale. "That occasional issuer who comes into the market every few years is unlikely to be familiar with the most up-to-date pricing practices and therefore should retain a financial adviser to assist in the bond pricing process," he said.
Another lawyer said he has seen a slight increase in the number of clients who are willing to pay a financial adviser to look at trading data since the IRS' concern with issue price.
Unless the issuer has a financial adviser, the lawyer said he reviews the EMMA data alone. In some circumstances he will discuss the bond pricing process with more sophisticated issuers who express an interest in issue price. However, not all bond lawyers go out of their way to review the EMMA trading data, he said.
Rather than simply sending the underwriter the issue price certificate for their signature, he contacts them directly and asks them to confirm that they did in fact sell 10% of each maturity of the bonds to the public at the initial offering prices.
"It's very easy to just sign a certificate without looking at it," he said. "I think most underwriters are much more sensitive to issue price and those forms than they have ever been before. It's getting a lot more scrutiny. You will see comments from their in-house legal staff more. Some of them are trying to impose their own form of an issue price certificate, rather than the form of bond counsel."
The lawyer said he only reaches out to the underwriter to discuss bond pricing if "it's a bond deal important to the tax-exemption" and if there is something alarming in the trading data. One such deal is an advance refunding where the escrow yield is close to the bond yield.
National Association of Bond Lawyers president Kristin Franceschi dismissed the idea that there has been a "groundswell of bond lawyers helping issuers go through pricing data."
"Tax lawyers are reviewing EMMA data to the extent that they feel it necessary for their tax opinions," Franceschi said. "Honestly, I would not expect that we would start to do that because we are lawyers not financial advisers."
However, she anticipates more lawyers will become more aggressive in suggesting issuers get representation to review pricing data. She said lawyers give their clients "borderline business advice" all the time and issue price isn't different from anything else. Franceschi and other bond lawyers have emphasized that issue price is not an issuer's problem and it's difficult to extrapolate any reliable information by simply viewing trade data on EMMA.
Michela Daliana, a partner with Hawkins Delafield & Wood LLP, is doubtful that subsequent inquiry into the pricing process from an issuer would produce a better result. She said if market participants want to engage in nefarious practices, they will find a way. "Once a deal is priced, what can an issuer, whether they are large or small, really do to correct that?" Daliana said. "They can inform themselves, educate themselves, but they really can't change it."