Posted by Len Weiser-Varon on March 21, 2012

SEC Issues Investor Bulletin Regarding Municipal Bonds

BY CHARLES CAREY

On March 19, the SEC’s Office of Investor Education and Advocacy issued an Investor Bulletin http://www.sec.gov/investor/alerts/municipalbonds.htm to help educate individual investors about municipal bonds.

While the Investor Bulletin is fairly basic and addressed primarily to investors generally, the list of some of the risks of investing in municipal bonds included in the Bulletin may be helpful to issuers and underwriters when preparing or reviewing disclosure documents.  The risks highlighted in the Bulletin (and a few additional thoughts) are outlined below:

Call risk. Call risk refers to the potential for an issuer to repay a bond before its maturity date.  (It should be noted that in addition to the “call” provisions which might apply to the obligations being offered for certain types of obligations, investors may also be interested in information as to past call practices of the issuer.)

Credit risk. This is the risk that the bond issuer may experience financial problems that make it difficult or impossible to pay interest and principal in full.  (Credit ratings are of course available for many bonds, and used by many individuals as a proxy for their own credit analysis; however, in light of the recent problems with “rated” mortgage-backed and asset-backed obligations, an increasing number of investors are attempting to look through the credit ratings and make their own determination of credit risk.)

Interest rate risk. A bond’s market price will move up as interest rates move down and it will decline as interest rates rise, so that the market value of the bond may be more or less than its par value. U.S. interest rates have been low for some time. If they move higher, investors who hold a low fixed-rate municipal bond and try to sell it before it matures could lose money because of the lower market value of the bond.

Inflation risk. Inflation is a general upward movement in prices. Inflation reduces purchasing power, which is a risk for investors receiving a fixed rate of interest. It also can lead to higher interest rates and, in turn, lower market value for existing bonds.

Liquidity risk. This refers to the risk that investors won’t find an active market for the municipal bond, potentially preventing them from buying or selling when they want and obtaining a predicable price for the bond. Many investors buy municipal bonds to hold them rather than to trade them, so the market for a particular bond may not be especially liquid and quoted prices for the same bond may differ.

Change in tax law risk. While not included in the Bulletin’s list of risks, discussions in Washington as to the possible repeal or limitation of the exclusion of interest on municipal obligations are raising concerns in the municipal markets.  Changes in the tax treatment of municipal obligation will have an immediate effect on market values of affected obligations.

The Investor Bulletin is clearly intended as fundamental guidance to investors. The list of risks included in the Investor Bulletin is by no means comprehensive and not necessarily a list of risks that should be disclosed in offering documents. However, the list does highlight factors the SEC believes are important to investors and similar disclosures have become fairly routine in corporate and mutual fund risk disclosure sections.

Posted by Len Weiser-Varon on March 21, 2012

IRS Announces Closing Agreement Process for At-Risk Student Loan Bonds

The IRS has announced the procedures, and settlement cost methodology, for issuers seeking to preserve the tax-exemption of those student loan bonds that are at risk of being declared taxable due to the issuer's attempted compliance with arbitrage restrictions using a loan-swapping technique that the IRS has determined is ineffective.  The closing agreement arrangements, which are only available for bonds not already under audit by the IRS, may require substantial payments from issuers that used loan-swapping and wish to avoid uncertainty as to the tax status of affected bond issues.  Addiitonal detail is provided in our Advisory on this subject.   http://www.mintz.com/newsletter/2012/Advisories/1742-0312-NAT-PF/index.htm

Posted by Len Weiser-Varon on March 20, 2012

SEC Focuses On Municipal Underwriter Compliance With Due Diligence Obligations

BY LEN WEISER-VARON

On March 19, the SEC’s Office of Compliance Inspections and Examinations released a National Examination Risk Alert http://www.sec.gov/about/offices/ocie/riskalert-muniduediligence.pdf reporting on its examinations of broker-dealers for compliance with municipal bond underwriter due diligence obligations under the SEC’s prior interpretive releases and under SEC Rule 15c2-12.

The release of the Risk Alert dovetails with remarks made by SEC officials at recent municipal bond conferences to the effect that the SEC is ramping up its enforcement-related reviews of municipal bond underwriters’ due diligence practices.   

Findings in the Risk Alert include:

  • The compliance examinations revealed instances where underwriters neither maintained nor had policies requiring the maintenance of written documentation regarding due diligence efforts.  The Risk Alert notes that some underwriters asserted that it is not industry practice to maintain such written records and that their outside counsel had recommended that such records not be maintained.  The Risk Alert states that such a practice of intentional non-documentation makes it difficult for underwriters to demonstrate that they have complied with their due diligence obligations and their supervisory obligations relating to conduct of due diligence.  The Risk Alert indicates that “[t]his approach might lead to lax due diligence practices at a time when there are growing concerns over the fiscal well-being of some municipalities.”
  • The Risk Alert identified examples of certain practices used by certain underwriters that “evidence some due diligence and supervisory review” and that could assist underwriters in compliance/ enforcement examinations regarding whether and how they are meeting their due diligence obligations: 

*                 detailed written policies and procedures addressing the nature of due diligence requirements under Rule 15c2-12 and the firm’s expectations as to how its personnel can develop the reasonable belief in the truthfulness and completeness of key representations in an offering document required under SEC interpretive guidance;

*                  senior level “commitment committees” that review and approve categories of underwritten deals, including review of due diligence memoranda describing diligence calls and documentary due diligence, and, for categories of transactions that are exempted from committee review based on ratings or recent prior review by the committee of a transaction involving the same issuer, review of such memoranda by the committee chairman or another committee member;

*                  firm-developed diligence checklists, which may include narrative responses relating to past familiarity with the issuer and other factors relevant to the requisite reasonable belief relating to the offering document;

*                  due diligence memoranda prepared by bankers detailing the subjects discussed in due diligence calls, issues noted and how such issues were resolved;

 *                 outlines for diligence calls prepared by counsel;  

 *                 records regarding on-site examination activities such as site visits, discussions with issuer personnel and examinations of issuer records and forecasts; and

 *                  recordkeeping checklists that assist personnel in generating and preserving due diligence documentation.

 

 

                       

Posted by Len Weiser-Varon on February 08, 2012

MSRB Proposes Limits on Underwriter Consents to Indenture Amendments

By LEN WEISER-VARON

The MSRB has put out for comment a proposed interpretive notice http://www.msrb.org/Rules-and-Interpretations/Regulatory-Notices/2012/2012-04.aspx designed to eliminate or reduce instances in which underwriters of new bonds issued under a parity indenture or bond resolution consent to amendments to such instrument on the issuance date of the new bonds during the brief period in which the underwriter owns the bonds prior to their resale to the underwriter’s customers.  According to the MSRB’s request for comment: “While underwriters may technically be bondholders during the period between the time they purchase an issuer’s bonds and the time they distribute the bonds to investors, they are still underwriters while they hold bonds with a view to distribution.  As such, they will not be negatively affected by the amendments to which they consent.  In fact, they may have a monetary incentive to consent to the amendments and, accordingly, a conflict of interest.”

The proposed interpretive release would characterize such underwriter consents to amendments  as a potential violation of MSRB Rule G-17, which requires broker-dealers to “deal fairly with all persons in the conduct of their municipal securities activities.”   The notice does not impose a blanket prohibition on such consents, and declines to establish any standard (such as amendments that are materially adverse to existing bondholders) for what might constitute an unfair consent by an underwriter.  The notice does provide, as an example of an underwriter consent that could be deemed a violation of MSRB Rule G-17, a consent to amendments that would reduce the security for existing bondholders (e.g., eliminating or reducing a debt service reserve requirement, releasing collateral or loosening additional indebtedness tests.) 

The notice provides that such underwriter consents would not constitute a duty of fair dealing violation if (i) the indenture or resolution expressly provide that an underwriter can provide bondholder consent and (ii) the offering documents for the outstanding previously issued bonds disclosed that bondholder consents could be provided by underwriters of other securities issued under the indenture or resolution.  The voting of bonds acquired by a broker-dealer without an intent to distribute also would be exempted, as would underwriter consents to amendments to the terms of variable rate demand obligations at the time of their mandatory tender.   .

The notice is interesting in that it interprets a broker-dealer’s fair dealing duty as applying literally to “all persons”, including prior bondholders with which it has no relationship.  The notice does not address other techniques used by issuers to facilitate indenture amendments, such as disclosure in offering documents that purchasers of newly offered bonds will be “deemed” to have consented to specified amendments.  Such other techniques may not raise the same concerns, as they typically involve new bondholders that will actually have long-term exposure to the amended security provisions.  In any event, to the extent such other techniques do not involve action by the underwriter, the MSRB has no jurisdiction to regulate such techniques.     

The MSRB’s release indicates that the interpretive notice, when finalized, will have prospective application only.  Comments are due to the MSRB by March 6, 2012.     

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Posted by Len Weiser-Varon on December 14, 2011

Regulations Issued for Remote Participation in Meetings Subject to the Massachusetts Open Meeting Law

By JOHN R. REGIER

The Massachusetts Attorney General recently promulgated regulations authorizing remote participation in meetings subject to the Open Meeting Law under certain prescribed circumstances.

The Massachusetts Open Meeting Law has long required public bodies to conduct their business in meetings that are open to the public. They cannot, for example, take action by unanimous written consent, as many private sector boards can. Before 2009, when the legislature enacted substantial revisions to the Open Meeting Law, there was some uncertainty about whether members of public bodies could participate in meetings by telephone. The Attorney General’s office had always said no, but a few district attorneys, who had jurisdiction over meetings of local bodies, had said yes.

When the law was revised in 2009, the answer became clear. Remote participation in meetings was prohibited, effective July 1, 2010, without the permission of the Attorney General’s office. (The power to enforce the Open Meeting Law was also consolidated in the Attorney General’s office.) The Attorney General was given the power to authorize remote participation by members of a public body not present at the meeting location, so long as the absent members and all persons present at the meeting location would be clearly audible to each other and so long as a quorum of the body, including the chair, would be present at the meeting location. By promulgating the new regulations, the Attorney General has decided to allow such remote participation under certain circumstances, although the Attorney General strongly encourages members of public bodies to be physically present at meetings whenever possible.

If a public body wishes to avail itself of this flexibility, it must first take formal action to adopt the practice of remote participation, generally by majority vote of the body. Such a vote will permit remote participation in subsequent meetings of that body and of its committees. In the case of cities and towns, the mayor (or other chief executive officer) in a city and the board of selectmen (or other chief executive officer) in a town are authorized to adopt the practice for all local public bodies in that municipality.

As required by the statute, members of a public body who participate remotely and all persons present at the meeting location must be clearly audible to each other, and a quorum of the body, including the chair or, in the chair’s absence, the person authorized to chair the meeting, must be physically present at the meeting location. Members of the public body who participate remotely are permitted to vote.

There are five permissible reasons for remote participation. The chair (or other person chairing the meeting) must make a determination that one or more of the following factors make the member’s physical attendance unreasonably difficult:

(a)  personal illness;

(b)  personal disability;

(c)  emergency;

(d)  military service; or

(e)  geographic distance.

At the start of the meeting, the chair must announce the name of any member who will be participating remotely and the reason. All votes must be taken by a roll call.

A member participating remotely may participate in an executive session, but must state at the start of the session that no other person is present and/or able to hear the discussion at the remote location, unless the presence of that person is approved by a simple majority vote of the public body.

A public body may use any technology that enables the remote participant and all persons present at the meeting location to be clearly audible to one another, including telephone, Internet, or satellite-enabled audio or video conferencing. If video technology is used, the remote participant must be clearly visible to all persons present in the meeting location.

A municipality or public body may adopt policies that prohibit or further restrict remote participation.

Posted by Len Weiser-Varon on November 23, 2011

Court Dismisses Harrisburg Chapter 9 Petition - Rules Harrisburg Not Authorized to File

BY BILL KANNEL AND ADRIENNE WALKER

The bankruptcy court ruled today that the City of Harrisburg’s Chapter 9 petition filed by the Harrisburg City Council was not specifically authorized under Pennsylvania law.  After extensive briefing from the parties concerning, among other things, the constitutionality of Act 26 – the law passed in June 2011 to prohibit “third class” cities like Harrisburg from filing Chapter 9 -- the court ruled the law was constitutional and prohibited Harrisburg from becoming a Chapter 9 debtor.  The case has been dismissed.

At the hearing, the court quickly narrowed the multitude of issues presented in the briefs of the Commonwealth of Pernnsylvania, Mayor of Harrisburg, Harisburg City Council, a citizens group and various creditors of Harrisburg.  The court focused the parties’ argument on (a) the constitutionality of Act 26, and (b) if Act 26 is found to be unconstitutional, whether the City Council’s vote to and filing of the Chapter 9 petition complied with applicable law.   

  • Act 26 is Constitutional

The court ruled that Act 26 is constitutional.  In support of its ruling, the court held that Act 26 did not violate the Pennsylvania constitution, which requires that bills have a single subject that is reflected in the title of the bill and that the final bill passed be related to the original purpose of the filed bill.  The court reasoned that Pennsylvania case law supports a holding that the overarching legislative purpose of Act 26 was to direct the fiscal purpose of the state and this includes its prohibition of financially distressed municipalities filing under Chapter 9. 

  • City Council Process:  Separation of Duties Between City Council and Mayor

Because the court ruled that Act 26 was constitutional, the court said it had no need to address the second issue involving whether, under local law, the Mayor was required to file the Chapter 9 petition.  Nevertheless, the court addressed this second issue because of the possibility that its constitutionality ruling will be appealed.  The court ruled that under local rules of governance the Mayor is the CEO of Harrisburg and is required to initiate any legal proceedings – including the filing of a Chapter 9 petition.  While the City Council was required to vote to file for Chapter 9, the Mayor was ultimately the only party who could file the Chapter 9 petition.  The City Council’s action in filing the Chapter 9 was not authorized by the Mayor and therefore the court ruled the Chapter 9 petition was invalid on that basis as well. 

 

 
Posted by Len Weiser-Varon on November 15, 2011

Harrisburg City Council responds to Objections to Chapter 9 Eligibility

BY BILL KANNEL 

As expected the Harrisburg City Council has filed a reply to the numerous objections to the Chapter 9 filing of Harrisburg initiated by the City Council.  The City Council’s brief (harrisburg response.pdf) appears to be the only timely filed reply to the objections to the Chapter 9 filing. 

The brief appears to devote significant space to issues outside of the Bankruptcy Court’s request for briefing.  With respect to specific issues the Bankruptcy Court asked to be addressed the City Council makes the following arguments.

  • Specific State Authority to File

The Council argues that Harrisburg was specifically authorized to file a Chapter 9 bankruptcy under Act 47, the Pennsylvania statute dealing with distressed municipalities.  The Council argues that access to bankruptcy is to be liberally construed and that Act 26, which amended the Pennsylvania Fiscal Code to prohibit “cities of the third class” such as Harrisburg from filing under Chapter 9 until July 1, 2012, was “. . . enacted without debate or ascertainable knowledge of those who voted on it....”  The brief also argues that Act 26 violated the impairment of contract clause of the United States Constitution because the prohibition on filing did not exist when Harrisburg became subject to Act 47 and that Act 26 also violates the equal protection clause of the United States Constitution and the Pennsylvania constitution. 

  • City Counsel Authority under Local Law or Ordinance

With respect to the issue of whether the Council itself was authorized under local law or ordinance to file a bankruptcy petition, the Council's brief is not entirely clear but appears to make arguments based on separation of powers between the City Council and the Mayor’s Office and  the city solicitor's status as only an “acting solicitor”.

We did not find the City Council’s brief particularly compelling or effective in rebutting the objections to the Harrisburg's Chapter 9 filing.

Posted by Len Weiser-Varon on November 09, 2011

Recent Developments Regarding Issuer Responsibility for Reviewing Initial Offering Prices of Bonds

BY JEREMY SPECTOR

Following the advent of Build America Bonds (BABs) in 2009 and securities law rulemaking that has resulted in the posting of virtually instantaneous trading data on the EMMA website (msrb.emma.org) hosted by the Municipal Securities Rulemaking Board (MSRB), the IRS has repeatedly expressed concerns about how initial offering prices (a/k/a “issue prices”) on municipal bonds are determined on the primary market and whether certifications of such prices for tax purposes are correct.

Why the concern? Why has this concern been exacerbated in recent years? Why hasn’t the IRS addressed its concern by publishing new regulations?

The “issue price” determines the yield, for tax purposes, on the bonds. The lower the issue price for bonds bearing a stated interest rate, the higher the yield. IRS regulations specify that the issue price for tax-exempt bonds is, for each maturity, the first price at which ten percent of bonds is sold to parties other than underwriters. For a bona fide public offering of all of the bonds, issue price can be established based on reasonable expectations on the sale date. Typically, issuers rely upon issue price certifications provided at closing by the underwriters.

An erroneous issue price can cause the US Treasury to lose tax revenues. In the case of tax-exempt bonds, an erroneously low issue price may create an erroneously high bond yield and result in the issuer retaining impermissible arbitrage on taxable investments made with tax-exempt bond proceeds. In the case of BABs, a requirement of the federal subsidy is that the issue price cannot be higher by more than a de minimis amount than the par amount of the bonds. Accordingly, a determination by the IRS that the “issue price” was erroneously calculated could cause loss of tax-exempt status in the case of tax-exempt bonds and loss of subsidy in the case of BABs.

The IRS’s concerns with issue price first surfaced in the context of 32 BAB audits. Two factors account for the concern. First, a correct issue price is particularly critical in the context of BABs, because of Code Section 54AA(d)(2)(C)’s limitation on the amount of premium. Second, the relatively recent availability of live trade data on EMMA has made it increasingly feasible to spot what may appear to be discrepancies between issue price certifications delivered by underwriters upon issuance of bonds and the prices at which bonds are traded shortly after, and sometimes shortly before, such certifications are delivered.

In some of the BAB audits, the IRS observed suspicious trading activity which it still appears to be investigating. The suspicious activity included situations where (1) a portion of a maturity is sold at the initial offering price and another portion is sold at higher prices; (2) a portion of a maturity remains unsold by the underwriter with the rest sold at prices above the initial offering price; and (3) dealers purchase all or a portion of a maturity and quickly resell at higher prices in what appears to be the primary market. A common theme seems to be a trend of increasing prices when the public buys on the secondary market, sometimes on the same day the bond purchase agreement is signed by the underwriter.

In response to its concerns the IRS has launched two compliance check initiatives to educate issuers and learn more about how issuers “due diligence” the issue price on their bonds. In addition, the IRS has reached an agreement with the MSRB, announced on October 24 (see the MSRB press release), to allow the IRS access to the MSRB’s internal regulatory website, with its up-to-date trade data, and to other information available to enforcement agencies (such as FINRA) that the MSRB works with to regulate the municipal market. The IRS’s agreement with the MSRB regarding such access includes an acknowledgment that the MSRB’s regulatory website is designed to help administer the securities laws and not the tax laws and that its market data may be incomplete for federal tax purposes. For example, the data reported to the MSRB does not always distinguish between sales to dealers and sales to the “public.”

So far, the IRS seems to have learned that most issuers rely on the issue price certificate provided by the underwriters to establish issue price without further due diligence. The IRS’s compliance check initiatives contain questions relating to procedures an issuer uses to review available trading data to confirm compliance with federal tax requirements. These questions appear to encourage issuers to look behind the issue price certificate and to use publicly available municipal market data, such as data available on EMMA, to spot problems. In light of this increased scrutiny by the IRS of trade data, issuers, out of an abundance of caution, are well advised to review trading data on EMMA and to raise any questions with their underwriters and bond counsel whenever such data shows a quick uptrend on and immediately after the sale date and before the bond closing. Downtrends in issue price would tend to indicate that an issuer received excellent pricing on the sale date, a scenario the IRS is unlikely to question.

At this time, there is confusion about how much and what type of diligence an issuer must do on issue price, as well as on the facts about which sales are meaningful for purposes of issue price determinations. The bond community is still waiting for the IRS to solve these issue price conundrums by writing more manageable regulations which will help issuers more easily identify the line between the primary and secondary market and any requirements for testing issue price certifications.

 

Posted by Len Weiser-Varon on November 03, 2011

Court Rules City of Harrisburg Can Pay Pre-Petition Amounts to Ordinary Course Vendors

BY BILL KANNEL

The bankruptcy court in the City of Harrisburg's Chapter 9 proceeding held a hearing on Tuesday, November 1 on the Mayor’s motion for an order clarifying that the City had the ability to pay its debts in the ordinary course.  The court found that given the limitation on its jurisdiction under Chapter 9 of the Bankruptcy Code and given that Bankruptcy Code Section 363 (which deals with generally with the use, sale or lease of property) is not incorporated into Chapter 9, the City does have the authority to pay its vendors in the ordinary course, including vendors with amounts owed pre-petition (i.e., before the bankruptcy). 

The City Council’s attorney orally moved to delay the briefing and hearing schedule on the issue of whether the City was eligible to file its Chapter 9 petition.  The court declined to extend the November 23 hearing date, indicating that the issues were limited to whether Harrisburg had specific authority under state law to file the bankruptcy petition and whether the City Council had the power to file the Chapter 9 petition on behalf of the City.  The judge noted that these were the central issues raised by the objecting governmental parties (the Mayor’s office, the Commonwealth and Dauphin County) and that the objections filed by the private parties (the unions, the bond trustee and the insurers) were largely duplicative.  The parties did agree, however, to extend the briefing schedules.  As a result, replies to the objection to the filing are due November 14, replies by the objecting parties are due November 19, and the hearing will go forward as scheduled on November 23.

 

Posted by Len Weiser-Varon on October 30, 2011

Objections Filed in Harrisburg Chapter 9 Bankruptcy

BY BILL KANNEL

As expected a number of objections to the Chapter 9 bankruptcy petition filed by the Harrisburg city council were filed on Friday October 28, the deadline set by the Bankruptcy Court for such objections. As expected both the Commonwealth of Pennsylvania and the Harrisburg Mayor’s Office filed objections.

The Commonwealth’s objection focused on the argument that Harrisburg is not “specifically authorized” by the Commonwealth to file a Chapter 9 petition given the June 30, 2011 amendment to the Pennsylvania fiscal code prohibiting cities of the third class like Harrisburg from filing until July 1, 2012.  The objection further argues that the Bankruptcy Court should defer to the Commonwealth’s control over its financially distressed municipalities under Act 47.

The Mayor’s objection - styled as the “Objection of the City of Harrisburg through its Mayor to the Chapter 9 Petition Filed by City Council” - takes a slightly different approach instead focusing on the Optional Third Class City Charter Law.  The Mayor’s objection argues that the resolution authorizing the filing had no force of law as it had not been submitted to the mayor for approval or veto, was not approved by the City Solicitor and was not a proper exercise of the City’s executive power which is vested with the Mayor. 

Objections to the Chapter 9 bankruptcy petition were also filed by Ambac Assurance Corporation, Assured Guaranty Municipal Corp., National Public Finance Guarantee Corporation, Syncora Guarantee Inc., TD Bank National Association, Manufacturer’s Trader and Trust Company, the American Federation of State, County and Municipal Employees District Council 90, the Fraternal Order of Police Capital City Lodge No.12, Dauphin County and Covanta Harrisburg, Inc. (the operator of the incinerator). These objections incorporate or join the Commonwealth’s, the Mayor’s or both sets of objections.

The City Councils’ replies to these objections are due on November 7th and a hearing on dismissal of the petition has been scheduled for November 23rd.

In another development, the Mayor’s office filed a motion on Thursday, October 27, seeking clarification from the court that the City of Harrisburg had authority to pay pre-petition (i.e. from before the bankruptcy) amounts owed to vendors.  That motion has been set for hearing on Tuesday, November 1, at 10:30 a.m. eastern.