WASHINGTON – The National Association of Bond Lawyers is urging the Treasury Department and Internal Revenue Service to create special, more lenient issue price rules for competitive transactions, particularly small deals.
In a three-page letter recently sent to Treasury and IRS officials, NABL asked Treasury to create a special rule or safe harbor, under which, if a muni issuer distributes a notice of sale or a notice inviting bids to underwriters interested in bidding on the bonds and also receives at least three bids, then the issue price will be the price at which the underwriter offers the bonds to the public, on a maturity by maturity basis. For smaller competitive deals, involving $30 million or less of bonds, the issuer would not have to meet the three-bid requirement.
"An underwriter has much less ability, and thus no incentive, to not price the bonds fairly and correctly in a competitive bid situation," said the letter, which was signed by Ken Artin, NABL's president and a lawyer at Bryant, Miller & Olive.
"The IRS should be encouraging competitive deals," Artin said in a brief interview.
"A lot of issuers have to do competitive bids and given the nature of the beast, the safe harbor makes sense." Artin said that NABL proposed that small issuers be exempted from the three-bid requirement after finding that some seek competitive bids for issues as small as $500,000 of bonds. "They're just not going to attract the number of bids that the larger issuers are, so we didn't want to penalize them," he said.
NABL's letter comes after John Cross, Treasury's associate tax legislative counsel told local finance officials meeting here in December that the department is open to considering providing some relief from issue price rules for competitive sales.
The Government Finance Officers Association warned the IRS last September that if it doesn't provide a safe harbor from issue price rules for competitive deals, issuers' borrowing costs will increase. The group said that "underwriters … will build more of a risk premium into prices they are willing to bid, or may not longer participate in competitive sales because they will have few orders prior to bid."
Other muni market groups, including dealers, have raised similar concerns.
Issue price is important because it is used to help determine the yield on bonds and whether an issuer is complying with arbitrage rebate or yield restriction requirements, as well as whether federal subsidy payments for direct-pay bonds such as Build America Bonds are appropriate.
Under existing rules, the issue price of each maturity of bonds that are publicly offered is generally the first price at which a substantial amount, defined as 10%, are reasonably expected to be sold to the public.
But tax regulators became concerned that some dealers were "flipping" bonds -- selling then to another dealer or institutional investor who then sold them again almost simultaneously, with the prices continually rising before the bonds were eventually sold to retail investors. They felt the stated issue prices for the bonds were not representative of the prices at which the bonds were actually sold.
Treasury and the IRS tried tighten the rules in 2013 by proposing new ones that replaced the "reasonable expectations" standard with actual sales and increased the definition of "substantial amount" to 25% instead of 10%. Those rules drew many complaints so Treasury and IRS scrapped them.
Under new issue price rules the tax regulators proposed in June, for both negotiated and competitive sales of bonds, the issue price of a maturity would generally be the first price at which 10% of the bonds are actually sold to the public.
If 10% of a maturity hasn't been sold by the sale date, issuers could employ an "alternative method" for determining issue price. Under that method, the issue price would be the initial offering price of the bonds sold to the public, as long as the lead or sole underwriter certified to the issuer that no underwriter filled an order from the public after the sale date and before the issue date at a higher price than the initial offering price. An exception could be made if the market moved after the sale date, but the underwriter must document any market movements justifying a higher price.
NABL and other muni market groups say these rules wouldn't work for competitive deals, which are unique to the muni market and typically don't involve abusive pricing.
In a competitive sale, underwriters bid for the bonds based on their assessment of the market at that time, with little or no premarketing because they may not be awarded the underwriting. By submitting a bid, the underwriter generally agrees to publicly offer the bonds. Typically the firm selected to underwrite the bonds is the one who could generate the lowest yield for the issuer. The winning bidder would have very little time to receive and fill orders to establish the issue price under the proposed issue price rules because the notice of sale would typically require it to deliver the reoffering price information with a half hour or perhaps up to two hours after the award, according to NABL.
