Outline for Discussion of New Issue Price Rules

May.24.2017

New tax rules relating to establishing the issue price of publicly offered tax-exempt bonds become effective soon. This outline describes the new issue price rules, provides a high-level strategic analysis to help guide a discussion between an issuer and its advisors, and sets forth (at the end) the regulations themselves.

Basic Principles

Effective Date: The new tax rules for establishing the issue price of bonds apply to all tax-exempt bonds sold on or after June 7, 2017. Some preparation is required in advance of the pricing date to make sure the provisions of a notice of sale or bond purchase agreement (and any related agreement among underwriters) allow for the issuer to implement the new rules in the manner desired.

Issue Price established by CUSIP: The rules apply on a CUSIP-by-CUSIP basis. The sum of the CUSIP issue prices is the issue price of the entire issue of bonds. It is best to focus on CUSIPs rather than maturity dates due to split coupons or other features that materially differentiate the terms of bonds of the same maturity. The issue price for each group of substantially identical bonds is established separately.

Actual Facts and Safe Harbors: The approach of the new rules is to provide a baseline rule that establishes issue price based on actual facts (i.e., the first price at which 10% of a CUSIP is actually sold to the public) and then to provide safe harbor rules that allow the issuer to use the initial offering price as the issue price if certain requirements are satisfied, regardless of whether 10% of each CUSIP is sold at the initial offering price. If satisfying a safe harbor is desired but not achieved, actual facts will control.

Sales to Public: Perhaps the most helpful rule is that all sales by an underwriter to a party that is not an underwriter are treated as sales to the public. Any party that is not connected to the issuer through a contract or series of contracts (e.g., BPA, AAU, retail distribution agreement) is treated as the public. A sale of bonds to a known “flipper” is as good as a sale of bonds to a buy and hold investor.

Actual Facts Rule: Issue price can always be established based on the first price at which 10% of the principal amount of a CUSIP is actually sold to the public. Note that this rule may not be as clear as it seems. The exact time of sales of bonds to different investors may not be easy to establish.

Hold-The-Price Rule: One safe harbor that can apply in all public offerings is the hold-the-price rule. The issue price of a CUSIP is the initial offering price for that CUSIP (as evidenced by the pricing wire), so long as the underwriters have agreed in writing not to sell or offer any bonds of that CUSIP at a price higher than the initial offering price for a period of five business days after the sale date. The five-day requirement ends early if at some point 10% of the principal amount of that CUSIP has actually been sold to the public at any combination of prices that are not higher than the initial offering price.

Competitive Sale Rule: For bonds sold in a typical competitive sale process, the issue price of a CUSIP is the initial offering price for that CUSIP (as evidenced by the pricing wire), so long as the issuer receives at least three bids for the bonds from reasonably competitive bidders. The detailed requirements of this safe harbor, set forth at the end of this outline, should be consulted. Note that if three bids are not received, the winning bidder can be required (for example, in the notice of sale as a condition of making the bid) to satisfy the hold-the-price rule. The two rules are not mutually exclusive.

Strategic Analysis

Certainty Required by Issuer: The most important strategic point is for the issuer to develop a policy regarding the level of certainty it wants as to the issue price of bonds. For some bond issues, being certain of the issue price will not be a legal requirement and will not be likely to materially impact tax compliance. Uncertainty as to issue price will always bring with it certain practical risks, however, such as uncertainty as to bond yield for rebate calculation purposes. Each issuer must decide whether it will require a high level of certainty as to issue price in all cases or only in the cases in which an uncertain issue price results in material tax compliance risk.

Certainty Required by Tax Counsel: It may be useful to prepare a list of transaction types in which certainty as to issue price is important. The most obvious example is an advance refunding in which the refunding escrow can be invested at close to the yield on the bonds, but there are many other circumstances in which issue price certainty is required, such as bonds that require a volume cap allocation or are subject to the 2% costs of issuance limitation. Note that this point is nuanced. For example, an advance refunding escrow with a yield 20 basis points below the bond yield may not be a concern if the issue price is uncertain for only a couple of small CUSIPs but may be a significant concern if the issue price is uncertain for a large term bond.

Pricing Impact: The issuer’s policy with respect to issue price certainty should be informed by the expected pricing impact of imposing the hold-the-price rule. That is principally a question for a financial advisor. While the hold-the-price rule is new and untested, the impact on pricing may be hard to predict. Thus, the issuer’s policy may evolve with the market and may warrant different policies for different executions. To the extent the pricing impact of the hold-the-price rule is small, issuers are should consider always requiring underwriters to hold-the-price.

Standard Forms: Another strategic question is whether the issuer will want to establish standard forms of issue price certificates. There are fairly obvious pros and cons to the use of standard forms. In this context, it seems likely that the form of issue price certificate will be a prominent point in drafting bond purchase agreements and notices of sale. Having standard forms may facilitate that process.

Record Retention: Finally, the issuer might want to consider whether to establish a consistent procedure of obtaining pricing information from underwriters. The issue price rules generally contemplate that the pricing wire and copies of any AAU will be provided to and retained by the issuer. The question is whether the issuer should require some other actual sale information to be provided and retained.

Other Costs: In some cases, conservative assumptions can be made as to the issue price of any CUSIP that is uncertain. For example, a high issue price can be assumed that results in an artificially low arbitrage yield on the bonds. If the issuer is comfortable with that approach (and with the resulting potential increase in rebate liability, for example), the other risks and costs relating to an uncertain issue price can be minimized.

1.148-1(f) Definition of issue price

(1)In general. Except as otherwise provided in this paragraph (f) , “issue price” is defined  in sections 1273 and 1274 and the regulations under those sections.

(2)Bonds issued for money -

(i)General rule. Except as otherwise provided in this paragraph (f)(2), the issue price of bonds issued for money is the first price at which a substantial amount of the bonds is sold to the public . If a bond is issued for money in a private placement to a single buyer that is not an underwriter or a related party (as defined in § 1.150-1(b) ) to an underwriter, the issue price of the bond is the price paid by that buyer. Issue price is not reduced by any issuance costs (as defined in § 1.150-1(b) ).

(ii)Special rule for use of initial offering price to the public. The issuer may treat the initial offering price to the public as of the sale date as the issue price of the bonds if the requirements of paragraphs (f)(2)(ii)(A) and (B) of this section are met.

(A) The underwriters offered the bonds to the public for purchase at a specified initial offering price on or before the sale date , and the lead underwriter in the underwriting syndicate or selling group (or, if applicable, the sole underwriter) provides, on or before the issue date , a certification to that effect to the issuer , together with reasonable supporting documentation for that certification , such as a copy of the pricing wire or equivalent communication.

(B) Each underwriter agrees in writing that it will neither offer nor sell the bonds to any person at a price that is higher than the initial offering price to the public during the period starting on the sale date and ending on the earlier of the following:

(1) The close of the fifth (5th) business day after the sale date ; or

(2) The date on which the underwriters have sold a substantial amount of the bonds to the public at a price that is no higher than the initial offering price to the public .

(iii)Special rule for competitive sales. For bonds issued for money in a competitive sale, an issuer may treat the reasonably expected initial offering price to the public as of the sale date as the issue price of the bonds if the issuer obtains from the winning bidder a certification of the bonds' reasonably expected initial offering price to the public as of the sale date upon which the price in the winning bid is based.

(iv)Choice of rule for determining issue price. If more than one rule for determining the issue price of the bonds is available under this paragraph (f)(2), at any time on or before the issue date , the issuer may select the rule it will use to determine the issue price of the bonds. On or before the issue date of the bonds, the issuer must identify the rule selected in its books and records maintained for the bonds.

(3)Definitions. For purposes of this paragraph (f) , the following definitions apply:

(i)Competitive sale means a sale of bonds by an issuer to an underwriter that is the winning bidder in a bidding process in which the issuer offers the bonds for sale to underwriters at specified written terms , if that process meets the following requirements:

(A) The issuer disseminates the notice of sale to potential underwriters in a manner that is reasonably designed to reach potential underwriters (for example , through electronic communication that is widely circulated to potential underwriters by a recognized publisher of municipal bond offering documents or by posting on an Internet-based Web site or other electronic medium that is regularly used for such purpose and is widely available to potential underwriters);

(B) All bidders have an equal opportunity to bid (within the meaning of § 1.148-5(d)(6)(iii)(A) (6));

(C) The issuer receives bids from at least three underwriters of municipal bonds who have established industry reputations for underwriting new issuances of municipal bonds; and

(D) The issuer awards the sale to the bidder who submits a firm offer to purchase the bonds at the highest price (or lowest interest cost).

(ii)Public means any person (as defined in section 7701(a)(1)) other than an underwriter or a related party (as defined in § 1.150-1(b) ) to an underwriter.

(iii)Underwriter means:

(A) Any person (as defined in section 7701(a)(1)) that agrees pursuant to a written contract with the issuer (or with the lead underwriter to form an underwriting syndicate) to participate in the initial sale of the bonds to the public ; and

(B) Any person that agrees pursuant to a written contract directly or indirectly with a person described in paragraph (f)(3)(iii)(A) of this section to participate in the initial sale of the bonds to the public (for example , a retail distribution agreement between a national lead underwriter and a regional firm under which the regional firm participates in the initial sale of the bonds to the public).

(4)Other special rules. For purposes of this paragraph(f) , the following special rules apply:

(i)Separate determinations. The issue price of bonds in an issue that do not have the same credit and payment terms is determined separately. The issuer need not apply the same rule to determine issue price for all of the bonds in the issue .

(ii)Substantial amount. Ten percent is a substantial amount .

(iii)Bonds issued for property. If a bond is issued for property , the adjusted applicable Federal rate , as determined under section 1288 and § 1.1288-1 , is used in lieu of the applicable Federal rate to determine the bond 's issue price under section 1274.