Post Issuance Bond Compliance
Illinois Association of School Business Officials
Kyle Harding
Anjali Vij
May 16, 2012
3196205
Presentation Outline
• Federal Tax Issues
– Overview of IRS Enforcement
– Investment of Bond Proceeds -- Arbitrage Rebate
– Use of Bond Proceeds -- Private Use
• Securities Law Issues
– Continuing Disclosure/Rule 15c2-12
• Post Issuance Compliance Tools
– Record-Keeping Policy
– Compliance Checklist
2
Federal Tax Issues
•
Various consequences of non-compliance with tax rules:
– Interest treated as taxable
– Loss of BAB/RZEDB subsidy, if applicable
– Additional arbitrage rebate may be owed (non-paid or underpaid
rebate amounts, plus interest)
– Penalties
3
Tax Issues – Overview of IRS Enforcement
• Increased enforcement by the IRS
• As of February 2011, the IRS was examining 23 Build America Bond
issues
• The IRS provided a “Government Bond Financing Compliance Check
Questionnaire” to approximately 200 governmental issuers that
issued bonds in 2005 to track recordkeeping and post-compliance
policies
4
Tax Issues – Overview of IRS Enforcement
(continued)
•
Focus on Advance Refundings: in May, 2011, the IRS sent 269 questionnaires to
governmental entities that issued advance refunding bonds between July 1, 2009
and June 30, 2010
– Questionnaire covers:
• Debt management policies and procedures for determining when to
advance refund a bond issue
• Qualification requirements applicable to advance refundings
• Arbitrage requirements applicable to advance refundings
• Procedures related to the determination of issue price
• Record retention procedures
• Procedures related to the timely identification and correction of tax
violations
•
IRS will conduct more than 100 audits of advance refunding bonds (Robert Henn,
manager of the IRS’ tax-exempt bond office, at the SIFMA and MSRB’s municipal
regulation seminar on 9/26/11)
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Investment of Bond Proceeds –
Arbitrage Rebate Rules
•
Arbitrage: Spread between (i) the interest due on tax-exempt bonds and
(ii) the earnings on the investment of such tax-exempt bond proceeds in
higher yielding securities.
•
Rebate: Issuer must pay (or rebate) arbitrage profits to federal
government.
•
Anything above bond yield gets paid to the US Treasury, unless you meet
one or more exceptions:
– Small issuer exception
– Spend-down exceptions
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Arbitrage Rebate Exceptions
•
•
6-Month Exception - no rebate payment required if all proceeds of the
issue are spent within 6 months of the issue date.
18-Month Spend-down Exception
Period
Spend-down
Requirement
6 months
15%
12 months
60%
18 months
100%
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Arbitrage Rebate Exceptions (continued)
•
•
Two-Year Construction Spend-down Exception
– At least 75% of the proceeds must be spent on construction expenditures
Period
Spend-down
Requirement
6 months
10%
12 months
45%
18 months
75%
24 months
100%
Certain refunding issues
– Small Issuer Exception applied to the refunded obligations.
– Average maturity of the refunding obligations is not later than the average
maturity date of the refunded obligations.
– No refunding obligation has a maturity date later than 30 years of the issue
date of the original obligation.
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Arbitrage Rebate
•
Arbitrage post-issuance compliance tips:
– Obtain computation of bond yield and establish procedure to track
investment returns
– Monitor compliance with temporary period expectations for
expenditure of bond proceeds
– Monitor compliance with 6-month, 18-month or 2-year spending
exceptions to rebate, if relevant
– Arrange for timely computation of rebate liability and, if rebate is
payable, for timely filing of Form 8038-T and rebate payment
– May engage outside arbitrage rebate consultants to do
computations
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Use of Bond Proceeds Private Activity Bonds
•
•
•
General Rule for Tax Exempt Financing:
– Interest on any State or local government bond is not included in
the gross income of the holder thereof for Federal income tax
purposes
Exception to General Rule:
– Tax exemption does not apply to any “private activity bond”, with
limited exceptions
Private Activity Bond
– Any bond that meets (i) the “private business use test” AND (ii) the
“private payment or security test”
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Use of Bond Proceeds Private Activity Bonds
•
•
“Private business use” occurs when more than 5% of bond proceeds
finance a public facility that is used by nongovernmental trade or
business
– Examples of private use:
• Sale, transfer or lease of property to private user
• Management of property by private user under a management
contract
“Private payment or security” occurs when more than 5% of bond
proceeds are secured by an interest or derived from payments related to
a “private business use” in bond-financed property
– Example of private payment:
• Payments of lease rentals to the issuer by a private operator
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Use of Bond Proceeds
Private Activity Bonds
(continued)
•
Private Activity post-issuance compliance tips:
– Allocate bond proceeds and funds from other sources to ensure
that bond proceeds are used for qualifying costs
– Map out what outstanding bond issue financed which facilities and
in what amounts; Monitor private use of bond-financed facilities to
ensure compliance with applicable percentage limitations
– Identify in advance any new sale, lease or license, management
contract, or other arrangement involving private use
– Promptly consult with bond counsel as to any possible private use––
remedial actions may need to be taken
12
Securities Law Landscape
•
•
•
Formerly, municipal securities largely unregulated
Dodd-Frank expands SEC’s municipal securities authority
– Enforcement budget to increase 100% over next 5 years
– 30 muni securities attorneys, spread across virtually all SEC regions
– “Whistleblower bounty program”
Enforcement Actions
– As of August 2011, 72 entities and individuals charged with
municipal securities violations
• $743 million paid by financial institutions to settle SEC actions
– Enforcement action against New Jersey
• Relates specifically to disclosure of pension obligations
• Action appears based on negligence, not fraud
13
Securities Law Issues—Goals of the SEC
•
•
•
•
•
Enhance timeliness of Information
– Ensure that investors get the information they need prior to the sale
Regulate the Form and Substance of Disclosures
– Conform documents and periodic reports to a form that investors
are accustomed to seeing for other securities
– Standardize the information that must be disclosed
Mandate use of Governmental GAAP Standards
– Provide an independent funding mechanism for GASB
Corporate Style Registration? SEC Review of Disclosure Documents?
The Bond Buyer article from 9/27/11: SEC Commissioner Elisse Walter
wants to see the SEC undertake a “longer-term deeper dive study” of
the muni market
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Continuing Disclosure Undertaking
•
Rule 15c2-12
– Requires an underwriter to enter into an agreement with issuers to
provide certain financial information and event disclosures to the
market
•
Filings must be made electronically at the EMMA (Electronic Municipal
Market Access) portal [www.emma.msrb.org]
•
Word-searchable PDF format
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Continuing Disclosure Undertaking (continued)
•
•
•
Over $10,000,000 (“Full”)
– Annual financial information
– Audited financial statements
– Reportable events
Over $1,000,000 but less than $10,000,000 (“Limited”)
– Audited financial statements
– Reportable events
Less than $1,000,000
– No continuing disclosure
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Continuing Disclosure Undertaking
Reportable Events (continued)
To be filed within 10 business days after the occurrence of the event
•Principal and interest payment delinquencies
•Non-payment related defaults, if material
•Unscheduled draws on debt service reserves reflecting financial difficulties
•Unscheduled draws on credit enhancements reflecting financial difficulties
•Substitution of credit or liquidity providers, or their failure to perform
•Adverse tax opinions, the issuance by the Internal Revenue Service of proposed
or final determinations of taxability, Notices of Proposed Issue (IRS Form 5701TEB) or other material notices or determinations with respect to the tax status of
the security, or other material events affecting the tax status of the security
•Modifications to the rights of security holders, if material
•Bond calls, if material, and tender offers
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Continuing Disclosure Undertaking
Reportable Events (continued)
•
•
•
Defeasances
Release, substitution or sale of property securing repayment of the
securities, if material
Rating changes
•
Bankruptcy, insolvency, receivership or similar event of the Issuer
•
The consummation of a merger, consolidation, or acquisition involving the
Issuer or the sale of all or substantially all of the assets of the Issuer, other
than in the ordinary course of business, the entry into a definitive agreement
to undertake such an action or the termination of a definitive agreement
relating to any such actions, other than pursuant to its terms, if material
•
Appointment of a successor or additional trustee or the change of name of a
trustee, if material
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Voluntary Disclosures to the MSRB
•
EMMA system allows for voluntary disclosures
– Financial/Operating Disclosures
– Event-based Disclosures
•
The MSRB encourages issuers to make these disclosures
– Recent example: MSRB statement on April 3, 2012 regarding
voluntary disclosure of bank loans by state and local governments
• MSRB believes this information is important for market
transparency and to promote a fair and efficient market
19
Voluntary Disclosures to the MSRB (continued)
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Voluntary Disclosures to the MSRB (continued)
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Continuing Disclosure Undertaking (continued)
•
Current consequences for failure to comply
– Bondholder may sue for specific performance
– Disclose failure in future disclosure documents
•
MSRB August 2011 letter to SEC
– Recommendation to amend the Rule to impose consequences for
non-compliance
– More “robust” disclosures
– Enforceable remedial steps
22
Policies and Procedures
•
•
SEC faulted San Diego and New Jersey for lacking necessary disclosure
policies and procedures
– Disclosure should not be a routine procedure of inserting new
numbers
Therefore, issuers should adopt and follow policies and procedures
related to disclosure
– May involve formalization of existing procedures
23
Proposed Legislation:
Municipal Securities Transparency Act of 2011
•
•
•
Rep. Mike Quigley has drafted legislation that would authorize the SEC
to:
– require issuers to disclose primary and secondary market bond
documents directly or indirectly through dealers/others;
– direct the content and timing of those documents;
– require issuers to supply annual financial information in a more
timely fashion and require periodic financial disclosure
Allows the SEC to temporarily suspend trading of any municipal bond if
in public interest
Does not require issuers to file disclosure documents directly with SEC
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Compliance Tools:
Post Issuance Compliance Policy
•
•
•
Establish written procedures that can be understood and implemented
over time even as officials responsible for compliance change
Key features:
1) Record Retention:
– Basic records relating to the bond transaction (transcript)
• Indenture, resolution, ordinance
• Bond counsel opinion
• Tax Compliance Certificate and Agreement
• Final Official Statement
• Bond purchase agreement
• Investment contracts, GICs, interest rate swaps, related bids
• Continuing Disclosure Undertaking or Agreement
25
Post Issuance Compliance Policy (continued)
– Records to demonstrate tax compliance
• investment of bond proceeds
– purchase and sale of securities, SLGS subscriptions, yield
calculations for each class of investments, rebate calculations
– Account statements from bank, escrow agent or trustee
• expenditure of proceeds
– Description of expenditure (capital, operating expense)
– Amount
– Identity of payee
– Invoice or billing statement
– Payment date
• use of bond-financed property by public and private sources
– Leases and management contracts
• sources of payment or security for the bonds
26
Post Issuance Compliance Policy (continued)
– Generally, material records should be kept as long as the bonds
remain outstanding, plus 3 years after the final redemption date
• For a refunding issue, material records relating to the original
new money bonds and material records related to the
refunding issue should be maintained until 3 years after the
final redemption of both bond issues
• General record keeping policy may need to be revised to reflect
the bond record retention policy
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Post Issuance Compliance Policy (continued)
•
2) Designation of Compliance Officer
• Assign responsibility for monitoring and filings
• Include training of the responsible official or employee with
regard to tax and disclosure requirements
• Internal reporting of compliance efforts
• Maintain sufficient information to help successors transition
•
3) Due diligence at regular intervals
• Principal and interest payment dates are good benchmarks
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Post Issuance Compliance Policy (continued)
•
4) Procedures reasonably expected to timely identify and timely correct
noncompliance
• Integrate monitoring of tax law compliance with existing
accounting systems (for example, use special coding on a ledger
to review sales, leases or contracts involving bond financed
property)
• Use of compliance checklist throughout the lifetime of the
financing
• Voluntary Closing Agreement Program
– having written post issuance compliance procedures
allows for more favorable settlement treatment from the
IRS
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Chapman and Cutler LLP
111 West Monroe Street
Chicago, IL 60603
Kyle Harding
(312) 845-3278
harding@chapman.com
Anjali Vij
(312) 845-3472
anjvij@chapman.com
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