By CHRISTIE MARTIN and MIKE SOLET

On September 28, 2017, the Internal Revenue Service (IRS) withdrew previous proposed regulations and released new proposed regulations (the “Proposed Regulations”) relating to public approval requirements for tax exempt private activity bonds.  The Proposed Regulations (found at https://www.federalregister.gov/documents/2017/09/28/2017-20661/public-approval-of-tax-exempt-private-activity-bonds) are intended to update and streamline implementation of the public approval requirement for tax exempt private activity bonds provided in section 147(f) of the Internal Revenue Code, including scope, information content, methods and timing for the public approval process.   They generally do not change the requirements for issuer approval and host approval set forth in the current temporary regulations originally promulgated in 1983.

Continue Reading IRS Releases New Public Approval Proposed Regulations

By LEONARD WEISER-VARON

The IRS’s recently-published proposed regulations for Section 529A qualified ABLE programs have taken some wind out of the sails of state program administrators and potential program managers who had hoped for regulations that hewed closer to the requirements in effect for qualified tuition programs under Section 529, on which Section 529A was based.  Some state officials and would-be program managers are evaluating whether cost-effective ABLE programs can be launched given what, at first blush, appear to be substantially greater administrative burdens imposed on state programs by the proposed ABLE regulations.

The hesitation provoked by the proposed regulations is understandable when one compares the IRS’s proposed administrative requirements to those applicable to Section 529 programs. Section 529 programs are not required to check whether an account owner is eligible to open an account, are not required to check on an annual basis whether the account owner’s status has changed, and are not required to inquire into or track the use of account withdrawals.  (As originally enacted, Section 529 did make programs responsible for determining whether distributions were qualified or unqualified, a requirement so unworkable that Congress amended Section 529 to eliminate it and make the recipient responsible for documenting the use of the distribution upon inquiry by the IRS.)

In marked contrast, the proposed ABLE regulations would require that ABLE programs do all of the above.

The resulting cost issue for ABLE programs and their potential customers is obvious. Due to statutory restrictions under Section 529A, annual contributions to ABLE accounts cannot exceed an inflation-indexed $14,000; Section 529 accounts have no such limit. Moreover, each state’s 529A program is limited to that state’s residents, unless another state elects to have its residents use the other state’s program instead of establishing its own program.  Section 529 programs, on the other hand, can gather assets from the entire nation.  If one adds to the substantially smaller projected amount of a particular ABLE program’s assets under management the expenses associated with the increased staff and systems programming necessitated by the additional verification and recordkeeping requirements imposed by the proposed regulations, the math is simple: greater expenses divided into fewer assets equals substantially higher program expenses to be recovered from program participants, and therefore reduced investment returns for the future expenses of disabled individuals.

A fair reading of the ABLE Act is that Congress intended the IRS, not the state programs, to be the watchdog that would ensure that ABLE programs are used by the disabled and for qualified disability expenses, and intended the Social Security Administration to determine whether ABLE account distributions are used for housing or unqualified expenses (in which case they are factored into the disabled individual’s eligibility for SSI benefits, whereas ABLE account distributions for non-housing qualified disability expenses are disregarded.)  But in an era where federal agency resources, particularly the IRS’s, are stretched, the proposed regulations have been drafted to effectively shift that responsibility, and the attendant costs, to the state programs.

The question the state programs and their potential contractors are struggling with is what exactly these unexpected and unwelcome responsibilities entail, and how much expense has been shifted from the federal government to the disabled community.  If the well-intentioned and long-sought ABLE Act is to achieve its objective, it will be in the interest of Congress, the IRS and the disability community, not just the state programs, to ensure that the administrative burden is reduced to the minimum necessary to make these programs function as intended.

The proposed regulations are not technically binding before they are finalized, and it is possible that, following the current 90 day comment period, the IRS will issue final regulations that lighten some of the proposed burden on ABLE program administrators.  But whether and when any more program-friendly final regulations will be issued is unknown, and the disability community deserves to have access to ABLE programs sooner than the indefinite future.  Unless and until the IRS, by advance notice or other clarification, provides better answers, individual states that wish to go forward with ABLE programs in advance of final regulations will need to reach a comfort level that they can comply with the IRS’s unexpected views on what a state must do to maintain its ABLE program’s beneficial tax status without making the pass-through costs of operating an ABLE program so expensive as to potentially outweigh the tax benefit.

A consensus on what practices are sufficient to comply with the proposed regulations without saddling ABLE programs with impracticable and expensive procedures will take some time to evolve.  Here is an initial perspective:

1)       Account–opening:

The proposed regulations state that “[a] qualified ABLE program must specify the documentation that an individual must provide, both at the time an ABLE account is established for that individual and thereafter, in order to ensure that the designated beneficiary of the ABLE account is, and continues to be, an eligible individual.”

For those account owners who are ABLE-eligible because they are eligible for SSI or SSDI disability benefits, the preamble to the proposed regulations suggests that “[f] or example, a qualified ABLE program could require the individual to provide a copy of a benefit verification letter from the Social Security Administration and allow the individual to certify, under penalties of perjury, that the blindness or disability occurred before the date on which the individual attained age 26.”  This suggestion may be workable if the Social Security Administration will provide such benefit verification letters with respect to the then-current tax year in short order upon request by an individual wishing to open an ABLE account.  Otherwise, if an individual can only provide a prior year benefit verification letter to the state program, states will need to decide whether, in connection with an account opening, they can rely upon the account owner’s certification, under penalties of perjury, that such eligibility status has not changed since the year in which the benefit verification letter submitted to the program was issued by the Social Security Administration.

As to those account owners who are ABLE-eligible under Section 529A because they file an eligibility certification and a physician diagnosis with the Secretary of Treasury, the preamble to the proposed regulations states that “[w]hile evidence of an individual’s eligibility based on entitlement to Social Security benefits should be objectively verifiable, the sufficiency of a disability certification that an individual is an eligible individual for purposes of section 529A might not be as easy to establish.”  The proposed regulations state that “a disability certification will be deemed to be filed with the Secretary [of Treasury] once the qualified ABLE program has received the disability certification”, which “deemed” filing, according to the preamble, is designed  “to facilitate an eligible individual’s ability to establish an ABLE account without undue delay.”

Taking the IRS at its word that the shifting of the certification filing from the Treasury, as specified in the statute, to the states, as specified in  the proposed regulations, is designed to “facilitate” account-opening “without delay,” it seems sensible to interpret the regulations as requiring a state to confirm no more than that a certification facially stating what the proposed regulations require has been signed or e-signed by the account owner (or his or her agent, parent or guardian), and is accompanied by a physician’s signed or e-signed letter facially providing the diagnosis on which the account owner’s certification relies.

Based on the proposed regulations, it appears that the certification filed with the ABLE program by or on behalf of the account owner must be signed or e-signed under pains and penalties of perjury and should state something along the following lines:

“(i)(A) I have the following medically determinable physical or mental impairment: _____________________________.  This impairment results in marked and severe functional limitations (as defined below), and—

(1) Can be expected to result in death; or

(2) Has lasted or can be expected to last for a continuous period of not less than 12 months; or

(B) I am blind (within the meaning of section 1614(a)(2) of the Social Security Act);

(ii) Such blindness or disability occurred before the date of my 26th birthday.

For purposes of this certification, “marked and severe functional limitations” means  the standard of disability in the Social Security Act for children claiming Supplemental Security Income for the Aged, Blind, and Disabled (SSI) benefits based on disability (see 20 CFR 416.906). Specifically, this is a level of severity that meets, medically equals, or functionally equals the severity of any listing in appendix 1 of subpart P of 20 CFR part 404, but without regard to age. (See 20 CFR 416.906, 416.924 and 416.926a.) Such phrase also includes any impairment or standard of disability identified in future guidance published in the Internal Revenue Bulletin. Consistent with the regulations of the Social Security Administration, the level of severity is determined by taking into account the effect of the individual’s prescribed treatment. (See 20 CFR 416.930.)  Conditions listed in the “List of Compassionate Allowances Conditions” maintained by the Social Security Administration (at www.socialsecurity.gov/compassionateallowances/conditions.htm) are deemed to meet the requirements of clause (i) of this certification.”

Based on the proposed regulations, it appears that the physician’s diagnosis accompanying the account owner’s certification must be signed or e-signed by the physician and should state:

“I hereby certify that I am a physician meeting the criteria of section 1861(r)(1) of the Social Security Act (42 U.S.C. 1395x(r)).  I further certify that I have examined ____________ and that, based on my examination, I have determined that s/he has the following physical or mental impairment: ________________________.”

The ABLE program administrator would need to determine that the account owner’s certification has been signed or e-signed in the name of the account owner or by someone who has certified that he or she is the account owner’s agent, parent or guardian, and that the diagnosis inserted in the blank of such certification matches the diagnosis in the blank of the physician’s diagnosis, and that the physician’s diagnosis is signed or e-signed.

It should be noted that draft tax instructions for Form 5498-QA released by the IRS require a program to report to the IRS annually, for each account and by code number, “the type of disability for which the designated beneficiary is receiving ABLE qualifying benefits.” The code menu on the draft IRS instructions is:

Code 1-  Developmental Disorders: Autistic Spectrum Disorder, Asperger’s Disorder, Developmental Delays and Learning Disabilities

Code 2 – Intellectual Disability: “may be reported as mild, moderate or severe intellectual disability”

Code 3 – Psychiatric Disorders: Schizophrenia, Major depressive disorder, Post-traumatic stress disorder (PTSD), Anorexia nervosa, Attention deficit/hyperactivity disorder (AD/HD), Bipolar disorder

Code 4 – Nervous Disorders: Blindness; Deafness; Cerebral Palsy, Muscular Dystrophy, Spina Bifida, Juvenile-onset Huntington’s disease, Multiple sclerosis, Severe sensoneural hearing loss, Congenital cataracts

Code 5 – Congenital anomalies: Chromosomal abnormalities, including Down Syndrome, Osteogenesis imperfecta, Xeroderma pigmentosum, Spinal muscular atrophy, Fragile X syndrome, Edwards syndrome

Code 6 – Respiratory disorders: Cystic Fibrosis

Code 7 – Other: includes Tetralogy of Fallot, Hypoplastic left heart syndrome, End-stage liver disease, Juvenile-onset rheumatoid arthritis, Sickle cell disease, Hemophilia, and any other disability not listed under Codes 1-6.

The tax instructions state that “the … information will only be used for aggregate reporting purposes as required by law.”

The notion that a state ABLE program established to provide investment accounts should have any role in determining which of the above panoply of medical conditions, if any, an account applicant suffers from sends off all sorts of alarm bells for many of those involved in structuring such programs. This proposed requirement can only be met by the relevant state program, if it can be met at all, by coding into the Form 5498 whatever condition the applicant and the physician have filled in on the forms submitted when the account is established. Even that will require coding additional fields into the ABLE programs’ operating system and may require staff to translate the conditions specified in the application materials into the appropriate code. And in the case of applicants who establish ABLE eligibility via eligibility for SSI or SSDI benefits, the diagnosis may not be apparent from the benefits letter submitted as proof. This is an unwarranted level of complexity and expense for the questionable benefit of then adding up all the painstakingly gathered disability codes into an aggregate report that has nothing to do with the ABLE program’s operations. But unless and until the IRS signals relief from this proposed requirement, ABLE programs that wish to go forward will need to design systems capable of generating such coding, at the expense of ABLE program participants.

2)           Annual recertification:

As noted above, the proposed regulations require that programs specify the documentation that must be provided after an account is opened to establish the account owner’s continued disabled status.  According to the proposed regulations,  “a qualified ABLE program may choose different methods of ensuring a designated beneficiary’s status as an eligible individual and may impose different periodic recertification requirements for different types of impairments.”  The proposed regulations include several impractical suggestions on compliance that presume that the state program has expertise on the likely length of particular disabilities (see the above list) and the likelihood of a cure being found for particular disabilities.  However, the proposed regulations also state: “If the qualified ABLE program imposes an enforceable obligation on the designated beneficiary or other person with signature authority over the ABLE account to promptly report changes in the designated beneficiary’s condition that would result in the designated beneficiary’s failing to satisfy the definition of eligible individual, the program also may provide that a certification is valid until the end of the taxable year in which the change in the designated beneficiary’s condition occurred.”

It seems likely that most states will follow this suggestion and include a requirement of such notice of change in disability status in the participation agreement or similar agreement executed or adopted by an account owner when the account is opened.  There is no reason to think that such a covenant by the account owner is any less “enforceable” than any other contractual agreement by the account owner, but as the proposed regulations are unclear on what the IRS means by “enforceable”, it may be prudent to state that the IRS is a third-party beneficiary of that particular covenant, so that the IRS can enforce it as it sees fit in the event it is breached by the account owner.

3) Tracking distributions:

The most perplexing provision in the proposed regulations states that “[a] qualified ABLE program must establish safeguards to distinguish between distributions used for the payment of qualified disability expenses and other distributions, and to permit the identification of the amounts distributed for housing expenses as that term is defined for purposes of the Supplemental Security Income program of the Social Security Administration.”

The proposed regulations also provide that “[i]f the total amount distributed from an ABLE account to or for the benefit of the designated beneficiary of that ABLE account during his or her taxable year does not exceed the qualified disability expenses of the designated beneficiary for that year, no amount distributed is includible in the gross income of the designated beneficiary for that year.”  Accordingly, for tax purposes, particular distributions are not made for qualified or unqualified purposes, or for housing purposes; instead, distributions may be requested at any point in the year, and then are simply compared in the aggregate to the account owner’s aggregate qualified disability expenses for the applicable tax year.

Because the account owner is not required for tax purposes to link a particular withdrawal to a particular expenditure, it is mystifying how the IRS and the Social Security Administration think programs can discharge this tracking and reporting duty.  No guidance whatsoever is provided on this point in the proposed regulations.  Given that some portion of the disabled community is expected to use ABLE accounts as transaction accounts, a requirement that states demand and examine invoices or receipts for each requested distribution, and determine in each case whether the amount is qualified or non-qualified and, if qualified, relates to housing, would substantially delay distributions and impose staffing requirements on programs or their contractors that would dramatically increase the expense ratios of ABLE investments. A distribution verification requirement is exactly what was amended out of Section 529 by Congress, and Congress did not reintroduce it statutorily when it enacted Section 529A.

This distribution tracking requirement, if not eliminated or clarified promptly by the IRS and the Social Security Administration, risks delaying or stopping many potential ABLE programs, particularly if interpreted to require anything more from the state program than a “check the box” section on distribution request forms.  States that are willing to proceed pending further clarification of this troubling element of the proposed regulations will likely provide account owners with distribution forms that ask that each requested distribution be broken down into subtotals relating to housing expenses, other qualified disability expenses, and unqualified expenses, all as determined and certified by the account owner under pains and penalties of perjury.  The state programs will make the required monthly reports to the Social Security Administration on the basis of such certifications.  Even the tracking of these subtotals and the related systems programming requirements will impose requirements on ABLE programs, and resulting expenses for ABLE program investors, that Section 529 programs are not burdened with and that are properly left between the Social Security Administration and those account owners receiving federal disability benefits.

By LEN WEISER-VARON

The IRS today published, right on deadline, its proposed regulations relating to Section 529A state-sponsored “qualified ABLE programs,” under which  tax-advantaged investment accounts may be established to fund future “qualified disability expenses” of eligible disabled individuals.

The regulations are detailed and this posting will not attempt to summarize them in their entirety. Rather, a few provisions of the proposed regulations are highlighted below, along with some initial reactions.

Applicability: The regulations are issued as proposed regulations, and therefore technically are not in effect. Comments are due within 90 days of the publication date in the Federal Register, and a public hearing on the regulations will be held on October 14, 2015. The preamble to the regulations indicates taxpayers and state programs can rely on the proposed regulations until final regulations are adopted. Somewhat perplexingly, the preamble also indicates that the final regulations will be applicable to taxable years beginning after December 31, 2014. To the extent this suggests that the final regulations will be applicable retroactively, it appears inconsistent with the promise made in IRS Notice 2015-18 that “[t]he Treasury Department and the IRS intend to provide transition relief with regard to necessary changes to ensure that the state programs and accounts meet the requirements in the [regulatory] guidance, including providing sufficient time after issuance of the guidance in order for changes to be implemented.” One hopes that the IRS will clarify that such a transition period will be provided after final regulations are adopted, versus retroactive application of such final regulations to any taxpayer or program that has not complied with the proposed regulations; otherwise, programs and taxpayers may be forced to comply with the proposed regulations even though they are not legally effective.

Who May Establish an ABLE Account: Section 529A requires that the tax owner of any ABLE account be the eligible disabled beneficiary. The proposed regulations provide that if the beneficiary cannot establish the account on his or her own, it may be established on the disabled beneficiary’s behalf by an agent under power of attorney or, if there is no such agent, by a parent or legal guardian. This narrows the field of potential relatives who can establish an ABLE account for a disabled individual, and eliminates the ability of a non-parent to establish such an account unless he/she has a power of attorney or is a legal guardian. It also appears to preclude, or at least not acknowledge, the use of custodial accounts, such as an UTMA account, which is surprising.

Eligible individual determination: The proposed regulations are disappointing from the perspective of administrative ease and clarity on the key question of what documentation is required to establish and maintain an ABLE account. As an initial matter, the regulations cast the responsibility for verifying eligibility status on the state programs. The regulations indicate that a “qualified ABLE program must specify the documentation that an individual must provide, both at the time an ABLE account is established for that individual and thereafter, in order to ensure that the designated beneficiary of the ABLE account is, and continues to be, an eligible individual.”

There are two statutory methods for an individual to qualify as eligible for an ABLE account. One is the filing of a disability certification with the Secretary of the Treasury that certifies that the individual has a qualifying disability or is blind and that such disability or blindness occurred before the individual’s 26th birthday; the certification must include a physician-signed diagnosis of the relevant disability or blindness. The proposed regulations provide that “a disability certification will be deemed to be filed with the Secretary once the qualified ABLE program has received the disability certification.” The regulations are silent on what level of diligence the state program must engage in, if any, to establish that papers that purport to be a disability certification comply with the substantive requirements (including type of diagnosis) of the regulatory definition of a disability certification. This provision is likely to be perceived as problematic by state programs and to provoke a high level of pushback during the comment period from state administrators who believe that eligibility status should be between the taxpayer and the federal government, not something that a state has any role in verifying.

An alternative statutory basis for ABLE account eligibility is eligibility for Social Security Act benefits based on blindness or disability that occurred before the individual’s 26th birthday. The proposed regulations are silent on a state’s role in verifying this type of eligibility. The preamble to the proposed regulations states that “for example, a qualified ABLE program could require the individual to provide a copy of a benefit verification letter from the Social Security Administration and allow the individual to certify, under penalties of perjury, that the blindness or disability occurred before the individual’s 26th birthday.” While this non-regulatory example appears potentially less onerous in terms of state verification responsibility than the unclear role of a state program under the proposed regulations upon its receipt of a disability certification, it still raises some potentially thorny questions, such as, for example, whether a program is required to make a competency determination before relying upon a declaration signed by a disabled individual.

The proposed regulations’ treatment of eligibility determinations for years following the year in which an account is established is even vaguer. The regulations provide that “a qualified ABLE program may choose different methods of ensuring a designated beneficiary’s status as an eligible individual and may impose different periodic recertification requirements for different types of impairments.” The proposed regulations suggest that, with respect to the frequency of annual recertifications, ABLE programs “may take into consideration whether an impairment is incurable and, if so, the likelihood that a cure may be found in the future,” a suggestion that casts state officials entrusted with administering a financing program in the combined role of physicians and Nostradamus. The proposed regulations further suggest that a state program may establish a sliding scale of frequency of recertification based on the type of impairment. Less fantastically, the regulations suggest that “[i]f the qualified ABLE program imposes an enforceable obligation on the designated beneficiary or other person with signature authority over the ABLE account to promptly report changes in the designated beneficiary’s condition that would result in the designated beneficiary’s failing to satisfy the definition of eligible individual, the program also may provide that a certification is valid until the end of the taxable year in which the change in the designated beneficiary’s condition occurred.” This type of presumption that an individual continues to be eligible unless the program receives notice to the contrary is on the right track, but what constitutes an “enforceable obligation” by a disabled individual or his or her agent, parent or guardian to report a change in condition is anybody’s guess.

Residency requirement: Consistent with Section 529A, the proposed regulations require that, at the time an ABLE account is established, the designated beneficiary must be a resident of the state offering the program or a resident of a state without a program that has contracted with such other state for purposes of making its residents eligible to participate in such program. The proposed regulations state that for purposes of such residency requirement residency is determined under the law of the designated beneficiary’s state of residence. There is no guidance on whether any proof of residency is required or whether a state may rely on a certification made by or on behalf of the beneficiary as his or her state of residency. The proposed regulations confirm that a change in the beneficiary’s state of residency after an ABLE account is established does not affect the beneficiary’s right to continue to use the applicable ABLE account.

Cumulative contributions limit: The proposed regulations affirm that for purposes of the statutory cumulative contributions limit, which equals the cumulative limit imposed by the applicable state under its Section 529 qualified tuition program, it is permissible for the program to refuse additional contributions that would cause the limit to be exceeded (versus tracking the lifetime contributions to the account, irrespective of investment gains or losses.) This methodology is used by many Section 529 programs but had not been officially blessed by the IRS in that context.

Qualified disability expenses: The proposed regulations provide a hoped-for generous definition of “qualified disability expenses” which states that such term “includes basic living expenses and [is] not limited to items for which there is a medical necessity or which solely benefit a disabled individual.”

State role regarding qualified disability expenses: Quite unexpectedly, the proposed regulations state that “[a] qualified ABLE program must establish safeguards to distinguish between distributions used for the payment of qualified disability expenses and other distributions, and to permit the identification of amounts distributed for housing expenses as that term is defined for purposes of the Supplemental Security Income program.” This purported duty of state programs to monitor the use of distributions from ABLE accounts has no basis in the Section 529A statutory language, is inconsistent with the manner in which similar language in Section 529 has been construed by the IRS, and is at odds with other provisions of the proposed regulations that provide for qualified distribution expenses to be determined by the taxpayer on an annual basis, not by tracing of particular distributions to particular expenses. This provision is highly problematic from a practical as well as a legal perspective and will likely provoke a high level of pushback during the comment period.

Medicaid lien: The proposed regulations state that an ABLE program “must provide that a portion or all of the balance remaining in an ABLE account of a deceased designated beneficiary must be distributed to a State that files a claim against the designated beneficiary or the ABLE account itself with respect to benefits provided to the designated beneficiary under the State’s Medicaid plan … after … the date on which the ABLE account, or any ABLE account from which amounts were rolled over or transferred to the ABLE account of the same designated beneficiary, was opened….” The proposed regulations provide no guidance on whether the program must keep an ABLE account open for a particular period of time following a designated beneficiary’s death, or whether the beneficiary’s estate can direct closure of the account at any time and distribution to the estate of all amounts remaining in the account.

Reporting: The proposed regulations include detailed reporting requirements for ABLE programs, including references to new forms to be used by state programs in reporting data regarding the establishment of ABLE accounts (Form 5498-QA) and in reporting distribution data (Form 1099-QA). The preamble to the proposed regulations also references a Congressional report “that States should work with the Commissioner of Social Security to identify data elements for the monthly reports [required to be submitted to the Commissioner of Social Security], including the type of qualified disability expenses.” As noted above, the suggestion that States will have a duty to report types of qualified disability expenses is both legally and practically problematic.

 

 

By LEN WEISER-VARON

Municipal securities regulators this week provided previews of upcoming regulatory action that suggest that one issue of concern to Section 529 college savings programs will fade away while another one may appear on the horizon.  

In Valentine’s Day testimony for the Senate Banking Committee, SEC Chairman Elisse Walter provided what may be the nail in the coffin regarding the SEC’s suggestion in proposed regulations issued in 2010 that appointed board members of municipal issuers, including state issuers of Section 529 program municipal fund securities, might be obligated to register as municipal advisors.  After receiving a proliferation of comment letters from state issuers and their associations, the SEC has gradually retreated from that controversial position. Chairman Walter’s testimony confirms that the final regulations will contain a registration exception for appointed as well as elected board members of public sector issuers.  http://www.publicfinancematters.com/2013/02/sec-comforts-appointed-board-members-of-municipal-issuers-on-valentines-day/

On another front, recent surveys by FRC (a division of Strategic Insight) regarding sales of Section 529 program investments received attention in the Section 529 community this week, including from an MSRB representative whose pronouncements were less warmly received than Commissioner Walter’s.  The surveys indicate that approximately 60% of brokers and financial advisors discourage their customers from purchasing Section 529 securities through the applicable broker/advisor and encourage such customers to purchase no-load shares directly from a Section 529 program offering such shares.  This conduct is motivated by a variety of considerations, including that no-load shares in one Section 529 program may outperform, due to their lower expenses, advisor-sold shares in a different (or the same) Section 529 program, as well as the potential availability of state tax advantages if the no-load shares are offered by a Section 529 program sponsored by the state in which the purchaser resides. 

The prioritization by a healthy majority of brokers of the customer’s financial interest over the broker’s short-term interest in a sales commission is heartwarming news.  But such brokers may well think that no good deed goes unpunished.  At a College Savings Foundation conference earlier this week, a MSRB representative stated that this trend may motivate the MSRB to issue guidance to the effect that such broker conduct might involve a “recommendation” by the applicable broker that would implicate MSRB Rule G-19’s suitability determination requirements and supervisory procedures. 

Alarm bells have started to ring, both from brokers regulated by the MSRB and to some extent from state sponsors of Section 529 programs that fear that regulation of such non-sales by brokers may motivate some brokers to steer clear of Section 529 programs entirely.

However, what constitutes a “recommendation” is a highly fact-based determination, and what constitutes a recommendation of a particular security is a particularly complicated question in the context of Section 529 programs, which offer multiple investment choices involving a variety of asset classes.  If the MSRB does eventually issue guidance on this point, experience suggests it will be nuanced and responsive to industry input, and that it will remain feasible for a broker to advise a customer against purchasing a Section 529 security through that broker given the availability of no-load direct-sold 529 program shares without triggering suitability review, provided the emphasis is placed on the generic benefit of lower expenses versus the particular virtues of a particular Section 529 program investment.      

 

 

By LEN WEISER-VARON

On February 14, 2013, SEC Chairman Elisse Walter at long last indicated, in testimony for the Senate Banking Committee, that the SEC’s final regulations regarding “municipal advisors” will “address ,,, the need for an exception” to the definition of “municipal advisor” for appointed board members of municipal securities issuers.  This acknowledgment came more than two years after the firestorm ignited by the SEC’s suggestion in proposed regulations issued December 20, 2010 http://www.mintz.com/newsletter/2011/Advisories/0841-0111-NAT-PF/web.htm that appointed board members of issuers of municipal securities were or might be required to register as “municipal advisors,”  That suggestion provoked a substantial share of the over 1,000 comment letters received by the SEC on the proposed regulations.

The SEC’s final regulations have not yet been issued and the phrasing of the exception remains to be seen.  However, Chairman Walter’s testimony is consistent with the conclusion long since reached by most municipal market participants that the SEC’s interpretation of the Dodd-Frank legislation as requiring or potentially requiring registration as municipal advisors by non-elected board members who provide input relating to issuance of municipal securities in the course of their board duties was an overreach that would not be implemented.  For board members appointed to municipal bond issuers or to issuers of state-sponsored Section 529 program municipal fund securities, Chairman Walter’s pronouncement is as close to a valentine as the SEC dispenses.

 

By LEN WEISER-VARON

MSRB Rule G-17 has been interpreted by the MSRB as requiring a broker or dealer (“broker”) to  disclose to its customer, at or prior to the time of trade of a municipal security, all material information about the transaction known by the broker, as well as material information about the security that is reasonably accessible to the market.  On February 11, 2013, the MSRB issued a notice of its proposal to consolidate some, but not all, of its multiple interpretive notices relating to the Rule G-17 “time of trade disclosure obligation” in a new Rule G-47. http://msrb.org/Rules-and-Interpretations/Regulatory-Notices/2013/2013-04.aspx

The proposed rule is not intended to alter the substance of a broker’s time of trade disclosure obligation, merely to make it easier to locate that substance in rule form rather than by reviewing a collection of G-17 interpretive notices previously issued by the MSRB, some of which deal with unrelated topics, as G-17 is a fair dealing rule of wide scope.  Facilitating the finding and reviewing of applicable legal requirements is a sensible goal, and it seems unlikely that there will be significant opposition to MSRB’s objective in proposing the “new” rule.

As is generally the case with any attempt to consolidate or summarize, comments on the proposed rule, which are due by March 12, 2013, are likely to focus on what is left out of the rule and on requests for clarification of items that have been unclear under the G-17 interpretations and remain unclear under the proposed rule.

A few preliminary observations on potential improvements to the proposed rule:

  • The Rule G-47 disclosure obligation would apply to purchases and sales between a broker and its customer, whether unsolicited or recommended, and whether in a primary offering or secondary market transaction.  However, prior interpretations deem the time of trade disclosure obligation automatically satisfied if the customer is a “sophisticated municipal market professional” or “SMMP”.  This important exception deserves to be called up from the minor leagues of interpretation to the major leagues of the new rule.
  • Rule G-47 provides a non-exhaustive list of potentially material information that must be disclosed by a broker at or prior to sale or purchase, but, beyond noting that such information may be provided “orally or in writing”, appears deliberately vague about permissible mechanisms for delivering material information.  Rule G-47 indicates that the public availability of material information through EMMA or other established industry sources does not relieve brokers of their obligation to make the required time of trade disclosures to a customer, and that a broker may not satisfy its disclosure obligation by directing a customer to an established industry source.  Though unstated in the proposed rule, presumably a broker can satisfy its obligation to disclose material features of the security by providing a copy of the official statement for the security, which is the primary source of such information, versus by attempting to synthesize, reword or isolate “material” information from immaterial information.  In circumstances where an official statement would include all available material information (which may be the case if there has been no material change to the basic features of the security or credit profile since the date of the official statement), it is unclear whether the Rule is intended to spare the customer the trouble of going to EMMA to review such material disclosure by forcing a broker to provide such disclosure directly to the customer, or whether the Rule’s wording is merely intended to differentiate a generalized statement by the broker that “you can find all material information on EMMA” from a broker-provided link or links to specific EMMA disclosure for the applicable security that the broker has determined contains all required material information.  The MSRB might consider clarifying in the rule whether the provision that “a broker may not satisfy its disclosure obligation by directing a customer to an established industry source” is intended to require the broker to determine whether an established industry source such as EMMA in fact contains all material information at the time of trade (and, if not, to require the broker to supplement EMMA by providing missing material information available from other public sources), or whether it is a complete ban on use of any time of trade disclosure mechanism that does not create a record of whether the customer actually accessed the publicly available information to which the customer was referred by the broker.
  • Proposed Rule G-47 lists 15 specific items that may be material in certain scenarios for purposes of the time of trade disclosure obligation.  This non-exhaustive list focuses primarily on technical features of the security, with the only listed “material” item relating to the underlying credit being item c, “[t]he credit rating or lack thereof, credit rating changes, credit risk of the municipal security, and any underlying credit rating or lack thereof.”  Although the specified items are consolidated from prior notices intended to emphasize the MSRB’s view that such items are or may be material, and are not intended to constitute a compendium of the most frequently material items, when assembled as a list in the proposed rule they highlight the incompleteness of the list.  It seems odd, for example, to list “the investment of bond proceeds” as a potentially material item, while omitting, for example, items such as whether the security is a general obligation, revenue or conduit bond, whether the interest is an AMT preference item and whether a conduit bond is secured by a mortgage and/or gross receipts lien.  The MSRB will need to consider whether half a list is better than none.

BY LEN WEISER-VARON

Various comment letters have been filed, and more are being prepared, on the can of worms opened up by the SEC’s December 20, 2010 interpretation that the term “municipal advisor” includes unelected board members of municipal entities who provide “advice” to the entity they serve regarding the issuance of municipal securities, swap transactions and/or investments.

The SEC has not officially addressed the most pressing question: is its interpretation a “proposed” interpretation, so that unelected board members need not be concerned about its application to them before the SEC reviews and reacts to the comments?

The answer, apparently, is that the interpretation is currently effective, but that most board members should not be concerned about needing to register as municipal advisors.  What sort of activity might require registration?  Unfortunately, that remains unclear.

Based on discussions with an SEC official with knowledge of the matter, it appears that to this point the SEC has not been persuaded to back off its distinction between elected and unelected board members.  According to the SEC official, the SEC is concerned about the scenario of a Governor-appointed board member who may dictate, or attempt to dictate, financial decisions to one or more boards.  Apparently, the SEC has particular examples in mind.

The SEC is aware that its interpretation has raised concerns with the large number of unelected board members on state authorities and agencies.  Unfortunately, the SEC official with whom I spoke indicated that the SEC could not offer any comfort that its interpretation is not effective at this time.  However, the SEC official indicated that “we never intended for our interpretation to cover voting on a board resolution or ordinary course board discussions.”  The SEC apparently is actively considering issuing an interim clarification that such “ordinary course” board participation does not constitute “advice” that would cause an unelected board official to be a “municipal advisor”, but is having some difficulty illustrating where ordinary course discussion stops and “advice” starts.

It is understandable why the SEC is struggling with a line-drawing exercise around the meaning of “advice.”  In other contexts, such as the Investment Advisers Act of 1940, there is no definition of “advice” – the need to register arises when a party holds itself out as being in the business of providing investment advice and provides such advice to another party for compensation.  However, the SEC, by suggesting that unelected board members may be “municipal advisors”, has already indicated that a person can be a “municipal advisor” even if the only “advice” the person renders is to the entity or entities  on whose board(s) the person sits, and the SEC has expressly rejected compensation as a factor in whether a person is a “municipal advisor.”

If, as appears to be the case, the SEC wishes to be able to exercise regulatory jurisdiction over certain appointed board members acting in the course of their duties as board members in extraordinary or particularly aggressive ways, it is indeed a difficult line to draw.  And the difficulty in drawing the line, of course, is not just the SEC’s, but that of unelected board members who, apparently, are currently required to figure out whether or not they have crossed that as yet undefined line.

As noted in our advisory on this subject, this same dilemma is being faced by board members and employees of conduit borrowers from municipal issuers (a/k/a “obligated persons”), who may likewise be deemed “municipal advisors” if they provide “advice” to their entity regarding municipal bond issuance, swaps or investment of bond proceeds.

As they say, stay tuned.

 

BY LEN WEISER-VARON

Per today’s Bond Buyer, an “attorney who asked not to be named” dismissed as “hysteria”  concerns about whether unelected board members of municipal entities that issue bonds or invest public funds are currently, or will be, required to register with the SEC and MSRB as municipal advisors.

As an arguable contributor to such “hysteria” (see Andrew Ackerman’s Jan. 6 Bond Buyer article), I don’t disagree that the odds favor some sort of modification or dilution of the SEC’s stated position on this point.  But of course the reason it is unlikely that unelected board members will be subject to a blanket registration requirement is that the SEC will be hearing from numerous municipal entities and trade associations that the SEC’s position on this is unwarranted and problematic.  So the “hysteria” is a necessary element of ultimately getting to the right place on these requirements.

What’s more, a dispassionate don’t-worry-about-it reaction would be easier to adopt if this did not involve an SEC interpretation of existing law.  Unelected board members who “advise” their municipal entities (as well as board members and financial officers of conduit borrowers who advise their “obligated person” entities) may be out of compliance with the registration requirements unless the SEC changes its interpretation.  That’s easier for unidentified attorneys to shrug off than for the affected board members and CFOs.

The SEC would do everyone a favor by clearly stating that it does not expect such board members to register unless and until the proposed rules that accompanied its interpretation are finalized.