The Internal Revenue Service (the “IRS”) published proposed regulations defining “issue price” for tax-exempt, tax credit and direct pay obligations (collectively, “Tax Advantaged Obligations”) (the “Proposed Regulations”) on June 24, 2015 in the Federal Register (80 FR 36301). The Proposed Regulations completely replace the widely criticized proposed regulations defining issue price which had been issued on September 16, 2013. Comments concerning the Proposed Regulations are due to the IRS by September 22, 2015 and the IRS will hold a public hearing regarding the Proposed Regulations on October 28, 2015. The Proposed Regulations, along with accompanying changes, will apply to all Tax Advantaged Obligations sold on or after ninety days after they are published in the Federal Register (the “Effective Date”); however, issuers are permitted to use the Proposed Regulations to determine issue price for Tax Advantaged Obligations sold now through the Effective Date.
The Proposed Regulations would replace the long-standing definition of issue price (based upon the underwriter’s “reasonable expectations” on the sale date that at least ten percent of the Tax Advantaged Obligations would be sold to the public at the initial public offering price) with a definition based upon the first price at which ten percent of the Tax Advantaged Obligations are actually sold to the public by the sale date (the “actual sales” method). Alternatively, in situations where the underwriter has been unable to sell at least ten percent of the bonds by the sale date, issue price may be based upon the initial offering price of the Tax Advantaged Obligations on their sale date, regardless of the amount for which they are eventually sold, provided that both the underwriter and the issuer satisfy certain conditions (formally known as the “alternative method based on initial offering price”, but referred to in this discussion as the “prove-it” method).
In particular, the Proposed Regulations impose several obligations on the underwriter to document the issue price of Tax Advantaged Obligations. In order to rely on the initial offering price of the Tax Advantaged Obligations in determining their issue price (i.e., the prove-it method) the underwriter must (1) fill all orders received for the Tax Advantaged Obligations before or on the sale date at the initial offering price and not at a price higher than the initial offering price and (2) certify (a) the initial offering price of the Tax Advantaged Obligations, (b) that it filled all orders received for the Tax Advantaged Obligations before or on the sale date at the initial offering price, (c) that it did not fill an order placed after the sale date, but before the issue date, at a price higher than the initial offering price unless such higher price was the result of a market change after the sale date, (d) that it will provide the issuer with supporting documentation for the matters described in (a) and (b) and that it will provide information for Tax Advantaged Obligations sold at a price higher than the initial offering price as described in (c) or certify that such sale did not occur. Examples of acceptable supporting documentation required by (d) include a copy of the pricing wire, and in instances where obligations were sold after the sale date, but before the issue date, at a price higher than the initial offering price, pricing information (including amounts, prices and sale dates) and information indicating a market change, such as municipal bond indices. Because there may be unexpected instances where ten percent of an issue of Tax Advantaged Obligations is not sold by its sale date, underwriters should have pricing and document production procedures in place to ensure they are able satisfy these requirements by closing.
The Proposed Regulations also impose an affirmative duty of due diligence on issuers in the event the issue price of its Tax Advantaged Obligations is based upon their initial offering price. Issuers must not know or have reason to know, after exercising due diligence, that any of the certifications of the underwriter are false. This requirement may necessitate due diligence calls between issuers and underwriters before closing. Underwriters should work with issuers, bond counsel and underwriter’s counsel to develop suitable due diligence inquiries to assist issuers in fulfilling their obligations and should consider developing procedures to facilitate due diligence calls. Underwriters should be prepared to provide the supporting documentation to issuers, bond counsel, financial advisors, and perhaps even third-party pricing experts.
The Proposed Regulations also require that the issuer maintain documentation to support the issue price of the Tax Advantaged Obligations. In instances where the issue price is based upon the first price at which ten percent of the Tax Advantaged Obligations actually are sold to the public by the sale date (i.e., the actual sales method), the underwriter will need to certify to the actual sale price and provide documentation supporting the existence of at least 10% actual sales at that price. In instances where the issue price is based upon the initial offering price of the Tax Advantaged Obligations (i.e., the prove-it method), underwriters will need to provide the necessary certifications, proof that all bids through the sale date at the initial offering price were accepted, as well as information proving that the higher actual sale price was the result of a market change after the sale date. Underwriters should develop document production procedures which will allow them to assist issuers in satisfying their record-keeping requirements.
While the Proposed Regulations create several additional obligations for underwriters and issuers they also clarify areas that have created uncertainty in the past. The Proposed Regulations clarify the definitions of “public” (anyone other than an underwriter or related party) and “underwriter” (essentially, a member of the selling group, or someone who on or before the sale date directly or indirectly enters into a contract or arrangement with a member of the selling group to sell the obligations). This should clarify which parties do and do not have obligations as underwriters and which parties’ purchases of Tax Advantaged Obligations count towards the ten percent actual sales threshold for purposes of the Proposed Regulations.