Bond Voyage: Navigating the waters of post-issuance compliance. Kristen Savant and Drew Slone Norton Rose Fulbright US LLP June 18, 2015

Size: px

Start display at page:

Download "Bond Voyage: Navigating the waters of post-issuance compliance. Kristen Savant and Drew Slone Norton Rose Fulbright US LLP June 18, 2015"

Shon Harvey
5 years ago
Views:

1 Bond Voyage: Navigating the waters of post-issuance compliance Kristen Savant and Drew Slone Norton Rose Fulbright US LLP June 18, 2015

2 2

3 Why can t I just set it and forget it? Possible IRS or SEC enforcement actions resulting in monetary or other penalties Loss of tax-exemption on the bonds (can be retroactive) Punishment by the market 3

4 Tax Law Compliance

5 Tax Covenants Compliance is a two-part test based on: Reasonable expectations as of issue date Actual compliance throughout term of financing 5

6 Tax Covenants Authorizing Document General Covenants to rebate arbitrage profits, file information report, not cause the interest on the bonds to become taxable; comply with private use restrictions Certificate as to Tax Exemption Covenants and Representations regarding: Sizing the deal to the capital projects Reasonable expectation regarding the timing for the expenditure of bond proceeds Rebate and Private use covenants Information Return for Tax Exempt Governmental Obligations (Form 8038-G) 6

7 Requirements for Tax Exemption Include Compliance with: Private use limitations Arbitrage restrictions Information report filing requirements (Filing of Form 8038-G) 7

8 Private Business Use With limited exceptions, private activity bonds are not tax exempt. A bond is a private activity bond if it meets either the Private Business Tests or the Private Loan Financing Test Private Business Tests include both the Private Business Use Test and the Private Security/Payment Test In general, the Private Business Use Test is met if a nongovernmental person directly or indirectly uses more than 10% of the proceeds of a bond issue in the aggregate 8

9 Who is a Nongovernmental Person? A nongovernmental person is an entity other than a state or local government, or an instrumentality of a state or local government. For example, a non governmental person would include: the federal government A section 501(c) (3) organization Any for-profit concern or non-profit concern that is not a section 501(c) (3) organization. Exception for General Public Use. Use by the general public is generally NOT treated as private business use. 9

10 Private Business Use Sale of the property to a nongovernmental purchaser Lease of the property to a nongovernmental lessee Exceptions apply for short-term arrangements Management Contracts (in which the District authorizes a third party to operate a bond financed facility) Naming right arrangements Preference arrangements Sponsored Research Agreements 10

11 When are the tests applied to analyze the qualification of a bond? Private activity bond status is generally tested as of the issue date Whether the issuer reasonably expects that the issue will meet the private activity tests over the enter term of the issue. However, bonds can later become private activity bonds if, subsequent to the issue date, the issuer takes a deliberate action that causes the issue to meet the private activity tests A deliberate action is generally defined as any action within the issuer s control 11

12 Compliance with Arbitrage Requirements: Yield Restriction Gross proceeds generally may not be invested at a yield that materially exceeds the bond yield. Exceptions to Yield Restriction include: 3-year temporary period for capital financings 90-day temporary period for current refunding escrows Reasonably required reserve or replacement fund Bona fide debt service fund 12

13 Compliance with Arbitrage Requirements: Rebate Arbitrage earnings from investing gross proceeds generally must be rebated to the federal government Exceptions to Rebate: Small issuer exception (less than $5 million in all issuances for the year and meet certain other requirements) Six Month Spending Exception 18-Month Spending Exception Two Year Spending Exception Bona Fide Debt Service Fund Rebate generally must be paid every five years and upon retirement of the bond issue. In certain circumstances, a failure to pay rebate timely will not result in a loss of tax exemption on the bonds if the issuer pays the correct rebate amount with interest (and penalties, if applicable) and demonstrates to the Internal Revenue Service (IRS) that it did not have willful neglect 13

14 Post-Issuance Monitoring Record Maintenance IRS agents conducting examinations of tax-exempt bond transactions will look to the issuer to provide books, records, and other documents in order to determine continued compliance with federal tax requirements Proper records to maintain include, but are not limited to: Basic records relating to the bond transaction Documentation of expenditures of bond proceeds Documentation of the use of property by public and private parties (e.g., copies of management contracts and leases) Documentation of investments of bond proceeds Length of time to maintain records Maintain sufficient records to establish compliance with all applicable federal tax requirements until three years after final maturity of the bonds (some bond counsel recommend 6 years after final maturity). Continued maintenance of records beyond this point is also sometimes necessary, particularly in situations involving refundings, some rules such as private business use requires you to look back over the combined term of both the refunded and refunding bonds. Written Procedures 14

15 IRS Activities Include: Remedial Actions Voluntary Closing Agreement Program (VCAP) Compliance Checks Examinations (or audits) Random Initiatives 15

16 Remedial Actions IRS guidance provides remedial actions to cure excessive private activity. Remedial actions include: Redemption or defeasance of nonqualified bonds Alternative use of disposition proceeds

17 Voluntary Closing Agreement Program (VCAP) The VCAP program provides issuers of tax-exempt bonds with a mechanism for resolving certain tax law violations that otherwise would cause the bonds to lose their tax exemption. Under VCAP, an issuer that discovers a post-issuance violation can approach the IRS and seek to resolve the violation by entering into a negotiated settlement, or closing agreement, with the IRS. A closing agreement typically, but not always, would involve a payment by the issuer to the IRS. An issuer may initiate VCAP discussions with the IRS on an anonymous basis.

18 Voluntary Closing Agreement Program (VCAP) The VCAP is unavailable if: Other remedial action is available under published IRS guidance (absent extraordinary circumstances); The IRS is auditing the bond issue; The tax exemption of the issue is being reviewed by the IRS Appeals Office or a court; or The IRS determines that the violation was due to willful neglect.

19 Examination vs. Compliance Check An examination (also known as an audit) is a review of an organization s books and records and makes a determination as to whether the bonds are tax-exempt or taxable May be random or they may be based on some information that the IRS has received or read about the bonds The IRS also undertakes initiatives (e.g. current refundings and advanced refundings A compliance check is a review to determine whether an organization is adhering to recordkeeping and information reporting requirements Not a determination of tax liability Compliance checks can lead to examinations No penalty for refusing to participate in a compliance check, however the IRS has the option of opening a formal examination 19

20 Securities Law Compliance

21 21

22 Securities Law and Municipal Bonds Purpose is to provide Broker-Dealers access to information to make recommendations of municipal securities in the secondary market. Underwriters must obtain continuing disclosure agreements from Issuers and other obligated persons to provide material event disclosures and annual financial information on a continuing basis. 22

23 Rule 10(b)(5) and anti-fraud provisions Issuers of municipal securities are governed by the anti-fraud provisions of securities laws, which prohibit using fraudulent information (omissions or false statements) in the sale of a security Objective is to create a marketplace where investors in bonds have access to material information (i.e., information that a reasonable investor would consider when purchasing the bonds) 23

24 Rule 15c2-12 Scope The Rule applies to information during the offering and sale of securities, and continuing information after sale and delivery. During the offering, an issuer must provide preliminary official statements and official statements After issuance, the issuer must provide annual financial information and material events. An offering may be exempt if it meets certain criteria (par amount/limited offering/short-term maturity) 24

25 History of Enforcement By Securities and Exchange Commission: Offering Documents Orange County Board Responsibility Enforcement action against Board of Supervisors, County/other County officials. Supervisors were aware of material information concerning Orange County's financial condition which brought into question the County's ability to repay its securities, but approved Official Statements that failed to disclose such information. SEC found that Supervisors did not fulfill their obligations under the antifraud provisions of securities laws. SEC did not seek monetary penalties States of New Jersey, Illinois, Kansas Enforcement actions for securities fraud brought against issuers based on inadequate disclosure regarding underfunding of pensions Allen Park, Michigan Enforcement action against city, former mayor and city administrator for misleading investors in an offering document in connection with a movie studio project. First time a municipal officer held liable for others violations as a control person. Mayor to pay a $10,000 penalty. 25

26 History of Enforcement By Securities and Exchange Commission Offering Documents City of Miami, Florida suit in U.S. District Court for the Southern District of Florida SEC brought suit against City and former Budget Director for making materially false and misleading statements and omissions about certain interfund transfers designed to cover up a growing fund deficit and get more favorable ratings for bond offerings did not disclose to bondholders that the transferred funds included legally restricted dollars when funds were transferred back, ratings were downgraded complaint seeks injunctive relief and financial penalties against Miami and former Budget Director Miami was already subject to a prior cease and desist order 26

27 Miami cont d. The fact that a city official would enable these false and misleading disclosures to investors merely a few years after Miami had been reprimanded by the SEC for similar misconduct makes this repeat behavior all the more appalling and unacceptable. We will hold accountable not only municipalities, but also individual municipal officials for fraudulent disclosures to investors. George S. Canellos, Co-Director of the Division of Enforcement The budget director has raised the defense of qualified immunity, but lower courts have rejected the defense Case has been appealed to the Supreme Court to determine whether an official can use the defense of qualified immunity in a suit for monetary penalties under a federal statute other than

28 History of Enforcement By Securities and Exchange Commission City of South Miami, Florida misstatements/ omissions are not limited to Preliminary/final Official Statements City penalized for material misstatements or omissions in documents relied on by bond counsel, not just those directly provided to investors Statements dealt with use of proceeds of the bonds which statements were necessary for bond counsel to deliver its opinion City of San Diego Enforcement action stemming from misleading statements in offering documents and other disclosure filings relating to future pension and retiree health benefits "Municipal officials have a personal obligation to ensure that investors are provided with complete and accurate information about the issuer's financial condition." Four former City officials agreed to settle charges and pay penalties (four officials MUST PAY $25,000 each) for falsely certifying that disclosure in offering documents, CAFRs and in continuing disclosure filings was adequate. 28

29 Securities and Exchange Enforcement West Clark Community Schools SEC brought enforcement action under anti-fraud provisions based on the offering document statement regarding past compliance 2005 WC entered into a continuing disclosure obligation 2007 Offering document stated that WC had not failed to comply with disclosure obligation in previous five years School failed to submit any of its contractually required disclosures SEC s cease and desist order requires West Clark to: Retain counsel to ensure that all disclosure submissions are current and accurate Adopt written disclosure policies Designate individual responsible for ensuring compliance Implement annual training for personnel involved in bond offerings and disclosure process Provide annual certification to Superintendent of completion of training Establish policies and procedures to ensure documents and notices posted to EMMA 29

30 Enforcement By Securities and Exchange Commission Municipalities Continuing Disclosure Cooperation Initiative On March 10, 2014, the SEC announced themunicipalities Continuing Disclosure Cooperation (MCDC) Initiative to provide issuers and underwriters the opportunity to self-report instances of material misstatements in bond offering documents regarding the issuer s prior compliance with its continuing disclosure obligations. Offered lighter settlement terms for issuers who voluntarily selfreported such instances (cease and deist proceeding, establishment of procedures, update past filings, provide compliance certification) SEC has not indicated how many self-reported. In GFOA survey, 65% of respondents indicated that they self-reported. 79% of responding issuers had to hire outside consultants to help them at costs ranging from $2,500 to over $12,000. Issuers spent between$18,000 or as little as $2,000 to do the disclosure reviews and between 25 and 250 hours responding to the initiative. 30

31 Enforcement By Securities and Exchange Commission Municipalities Continuing Disclosure Cooperation Initiative The SEC has only publicized one settlement under the MCDC, a July 2014 action against Kings Canyon Joint Unified School District. The SEC found that in three bond offerings between 2006 and 2007, Kings Canyon contractually agreed to disclose annual financial information and notices of certain events pertaining to those bonds. When it conducted a $6.8 million bond offering in November 2010, Kings Canyon was required to describe any instances where it had failed to materially comply with its prior disclosure obligations. In the 2010 offering document, Kings Canyon inaccurately affirmed that there was no instance in the previous five years in which it failed to comply in all material respects with any previous continuing disclosure obligation. Because Kings Canyon failed to submit some of the contractually required disclosures relating to the 2006 and 2007 offerings, the November 2010 bond offering document contained an untrue statement of a material fact. 31

32 Enforcement By Securities and Exchange Commission Municipalities Continuing Disclosure Cooperation Initiative Kings Canyon Settlement Issuer must: (1) to establish written policies for its continuing disclosure obligations; (2) to comply with existing continuing disclosure undertakings (including updating any past delinquent filings) within 180 days; (3) to cooperate with any subsequent investigation regarding the false statement(s), including the roles of individuals and/or other parties involved; (4) to disclose the terms of this settlement in clear and conspicuous language in any future bond offering materials for the next 5 years; and (5) to certify to the commission staff that it has complied with these undertakings. 32

33 Continuing Disclosure Agreement Issuer must contractually agree to provide: Financial Statements (audited/unaudited) Operating Data Notice of material events (defeasance, redemptions, ratings events, bankruptcies, etc.) Must file data with the MSRB s Electronic Municipal Market Access System Timing: 6 months typical; movement toward bifurcating operating data to 6 months and audited financial statements Material events within 10 business days for offerings in 2010 or later 33

34 Recommendations Designate Specific Responsible Officer Identify Disclosure Requirements Review EMMA Procedures (offers online training) Work With Current Auditor to Include Supplemental Information If necessary, hire outside consultant (Financial Advisor firms sometimes handle this service) 34

35 Ensuring Compliance (Continued) 35

36 Ensuring Compliance (Continued) Revenue Bond General Obligation Bond 36

37 Ensuring Compliance Most Common Mistakes Filing late Not Providing All Required Information Information From Wrong Time Period Filing under wrong CUSIPs/Identifiers 37

38 38 SEC Director of Enforcement: From my perspective in the Enforcement Division, the lessons to be learned from these San Diego cases regarding securities offerings can be summarized as follows: (1) adopt written disclosure policies and procedures; (2) provide appropriate training to city officials and employees; (3) focus on the big picture issues facing the city; (4) disclose the bad with the good; and (5) (perhaps of most immediate importance to this group), hire auditors with the skills and resources necessary to adequately audit the municipality's financials in connection with its securities offerings.

39 Who We Are Kristen Savant Partner Counsel to underwriters and issuers of municipal bonds Drew Slone Counsel Counsel to underwriters and issuers of municipal bonds 39

41 Disclaimer Norton Rose Fulbright US LLP, Norton Rose Fulbright LLP, Norton Rose Fulbright Australia, Norton Rose Fulbright Canada LLP and Norton Rose Fulbright South Africa Inc are separate legal entities and all of them are members of Norton Rose Fulbright Verein, a Swiss verein. Norton Rose Fulbright Verein helps coordinate the activities of the members but does not itself provide legal services to clients. References to Norton Rose Fulbright, the law firm and legal practice are to one or more of the Norton Rose Fulbright members or to one of their respective affiliates (together Norton Rose Fulbright entity/entities ). No individual who is a member, partner, shareholder, director, employee or consultant of, in or to any Norton Rose Fulbright entity (whether or not such individual is described as a partner ) accepts or assumes responsibility, or has any liability, to any person in respect of this communication. Any reference to a partner or director is to a member, employee or consultant with equivalent standing and qualifications of the relevant Norton Rose Fulbright entity. The purpose of this communication is to provide general information of a legal nature. It does not contain a full analysis of the law nor does it constitute an opinion of any Norton Rose Fulbright entity on the points of law discussed. You must take specific legal advice on any particular matter which concerns you. If you require any advice or further information, please speak to your usual contact at Norton Rose Fulbright. 41

Review of Disclosure Obligations What Municipal Issuers Should Know About Securities Law. October 19, 2015 Study Session Item 1

Review of Disclosure Obligations What Municipal Issuers Should Know About Securities Law October 19, 2015 Study Session Item 1 Overview Introduction Overview of Municipal Bonds & Key Players Securities