1. The Importance of Being Earnest with The SEC and The IRS
In the last several years, the field of municipal finance has become more heavily regulated, and hence increasingly more complex. Arbitrage and Rebate Regulations (1993), Municipal Securities Rulemaking Board Rule G-37 (1994), amendments to Securities and Exchange Commission's ("SEC") Rule 15c2-12 (1995), Municipal Securities Rulemaking Rule G-38 (1996), and Private Activity Bond Regulations (1997) are but a few of the rules and restrictions promulgated by regulators in the 1990's.
In addition to these regulatory initiatives, both the SEC and the IRS continue to aggressively pursue enforcement actions. Arthur Levitt, the chairman of the SEC, has repeatedly expressed his concerns about disclosure in the municipal securities market and, at his direction, there has been a dramatic increase in SEC enforcement action. The IRS at every opportunity announces that it has a large number of tax-exempt bond issues under investigation or audit.
Both the IRS and SEC continue to be very interested in yield burning and excessive mark-up issues. In January 1998, the SEC filed civil fraud charges against Rauscher Pierce Refsnes, Inc. alleging excessive mark-ups on Treasury Securities in connection with an advance refunding. On April 23, 1998, the SEC issued an order regarding the settlement reached in a yield burning action relating to Meridian Securities, Inc. and CoreStates Capital Markets (as successor to Meridian). The Meridian case had several unique features. First, CoreStates, as successor to Meridian, was not accused of wrongdoing itself and made an early effort to clean up alleged past improprieties it had inherited. It is unclear what impact, if any, there would have been on the settlement had CoreStates arrived at the table with unclean hands. Second, the IRS, SEC and Department of Justice worked together and accomplished what some were skeptical could ever happen, a global settlement involving all three agencies. Finally, it is not unreasonable to expect this settlement template to be trotted out in future yield burning cases as it was the culmination of a lot of time and effort in an area that, for better or worse, is deemed to be a priority of the SEC and IRS.
The SEC is proceeding with a few dozen investigations involving inadequate disclosure with respect to tax-exempt bond issues. Issuer officials who once thought that they were shielded from liability when they relied on the expertise of their professionals have found out that the SEC does not necessarily agree with them, and to their dismay, they have increasingly become the targets of investigations. The governmental targets of such investigations are often forced to spend large amounts of money to defend themselves. Indeed, several state and local associations have expressed their outrage over such enforcement actions. The National League of Cities denounced the SEC for following...
"an unprecedented strategy of enforcement and regulatory actions targeted at municipal officials and general purpose - local governments". . . which targets in particular "smaller cities with inadequate resources to defend themselves, imposing the choice of large legal costs or signing a consent agreement which brands them as failed institutions of the public trust."
As a result of its investigation of Orange County, California, the SEC settled a securities fraud action against the County and individual county supervisors with a public cease and desist order. The SEC rejected county officials' claims that they were protected because they had relied on their professional advisors. The SEC made clear in its report that...
" A public official who approves the issuance of securities and related disclosure documents may not . . . recklessly disregard facts that indicate that there is a risk that the disclosure may be misleading. When, for example, a public official has knowledge of facts that bring into question the issuer's ability to repay the securities, it is reckless for the official to approve disclosure to investors without taking steps appropriate under the circumstances to prevent the dissemination of materially false or misleading information regarding those facts. In this matter, such steps could have included becoming familiar with the disclosure documents and questioning the issuer's official, employees or other agents about the disclosure of those facts." (emphasis added)
The SEC followed Orange County with administrative proceedings against Nevada County, City of Ione, and Wasco PFA, California for certain alleged misrepresentations and omissions contained in the offering documents. In these proceedings, professionals and participants allegedly did not pay attention to important details. At least one of the professionals was chosen based on its significantly lower fee proposal and it was this professional whose work product was found by the SEC to be deficient and misleading. Experienced disclosure counsel presumably would have picked up the misstatements and omissions. Any tendency to award key professional roles to the low bidder without taking into account the experience level of the professionals should be tempered by the knowledge of the critical role that experienced counsel providing comprehensive review and advice will play in maintaining a reasonable reliance defense. Retaining experienced disclosure counsel can greatly reduce the risk of a problem arising.
While there is nothing issuers can do to eliminate the possibility of an investigation, there are steps that can be taken to lessen: (1) the likelihood that issuers will become a target of an investigation, and (2) the risk that issuers will be personally charged with wrongdoing. Now, more than ever, it is extremely important for issuers to stay actively involved with all aspects of their bond issues, hire experienced professionals who are well-versed in all of the latest developments in securities and tax laws, and stay fully informed so that they will be able to assert that their reliance on professional advice was reasonable.
2. Assisted Living Financings under Section 142(d)
The good news is that resolution of issues raised under Private Letter Ruling 9740007 are indeed on the IRS' Business Plan and Ed Oswald, an attorney-advisor at the Treasury Department, has publicly stated that he understands the problem this private letter ruling has caused. Many significant issues with widespread effect did not make the Business Plan and thus will not be taken up this year. Attrition and reorganizations have left the IRS understaffed which leads to the bad news. At the NABL Washington, D.C. Seminar, Rebecca Harrigal of the IRS and Ed Oswald declined to comment on when an announcement would be forthcoming and what form it would take. Saul Ewing participated in a dialogue which culminated in the National Association of Bond Lawyers submitting a letter to the IRS and Treasury urging them to permit the financing of assisted living facilities owned by proprietary entities that agree to comply with the low to moderate income residential rental requirements of Section 142(d) of the Code, so long as the facilities do not provide continual or frequent medical, skilled nursing or psychiatric services. This formulation is consistent with the tax credit regulations and would enable both 501(c)(3) and for profit assisted living operators to continue to provide residential rental housing to seniors with a need for some assistance with activities of daily living.
3. Agenda of the IRS
At the NABL Washington, D.C. Seminar, Gerald Sack and Charles Anderson conveyed those areas which they believed had potential for abuses and would likely be the subject of increased IRS scrutiny:
(i) Creation of 501(c)(3) organizations in order to enable for-profit corporations to unduly benefit from tax-exempt financings which are only ostensibly consummated for the benefit of the 501(c)(3) organization. Gerald Sack was appalled when he read that one public corporation had bragged in a report it released that by using a 501(c)(3) borrower the corporation successfully reduced its cost of capital and kept the asset and liability off of its balance sheet. Group exemptions are no longer expected to be issued;(ii) Of course, the IRS is expected to continue its crusade against yield burners; and
(iii) As a result of their random audit program for IDBs, expect follow up on the $10 million small issue limitation which the IRS believes is frequently violated.
This Update was written by Steven Goldfield, Esquire. Mr. Goldfield is an Associate in Saul, Ewing's Philadelphia Office concentrating in Public Finance. If you would like additional information, please contact Mr. Goldfield by telephone at (215) 972-7861; by fax at (215) 972-1843; or by e-mail at sgoldfield@saul.com.
Note: Posted articles are for general information only and should not be considered legal advice.