Issue price is key to determining the bond yield for tax purposes, which has a bearing on whether the issuer of tax-exempt bonds is meeting arbitrage requirements or whether an issuer of a taxable build America bond is receiving an appropriately sized federal subsidy payment.
Treas. Reg. § 1.148-1(b) defines “issue price” as “defined in sections 1273 and 1274. Generally, the issue price of bonds that are publicly offered is the first price at which a substantial amount of the bonds is sold to the public. Ten percent is a substantial amount. The public does not include bond houses, brokers, or similar persons or organizations acting in the capacity of underwriters or wholesalers. The issue price does not change if part of the issue is later sold at a different price. The issue price of bonds that are not substantially identical is determined separately. The issue price of bonds for which a bona fide public offering is made is determined as of the sale date based on reasonable expectations regarding the initial public offering price. […] The issue price of bonds may not exceed their fair market value as of the sale date.”
The Government Finance Officer’s Association issued best practice guidelines in October 2010 for pricing on a negotiated sale to avoid problems. The Bond Buyer article referenced below states that the GFOA guidelines list eleven recommendations for confirming issue price, including communicating to the underwriter specific goals to be achieved in the pricing of bonds and expectations regarding the roles of each member of the financing team. The GFOA also urges issuers to take steps during the underwriter selection process and before final pricing to manage the compensation of underwriters.
Practical Definition of Issue Price:
This definition of issue price shown under the previous heading has the elements described below – an underwriter’s or purchaser’s certificate regarding issue price should reflect these elements:
- For publicly offered bonds:
- Actual sale: Issue price is the first price at which at least 10% is sold to the public. But see the reasonable expectations alternative.
- Public: The public doesn’t include bond houses, brokers or similar persons or organizations acting in the capacity of underwriters or wholesalers.
- Separate: Issue price of bonds that are not substantially identical is determined separately.
- Reasonable Expectation: Issue price is determined as of the sale date based on reasonable expectations regarding the initial offering price. This means, the underwriter can either certify that at least 10% was actually sold or that the underwriter “reasonably expected” on the sale date that at least 10% would be sold at the issue price. Reasonable expectation is possible only if the bonds were offered at a bona fide public offering. Note that it may be easiest for the underwriter to certify that “all” bonds were actually offered in such bona fide public offering, but it would probably be okay if the underwriter states that at least 10% of each maturity and interest rate of the bonds was offered in the bona fide public offering. The Code and Regulations do not require that all 100% of each maturity and interest rate be actually publicly offerred as long as you can satisfy the 10% sale expectation. Obviously, if no bonds of a particular maturity and interest rate are offered, there cannot be an expectation to sell at least 10% of such maturity and rate! In other words, at least 10% of each maturity and interest rate must be offered.
- Fair Market Value: There must be certification that the issue price of the bonds does not exceed the fair market value of the bonds. (Note, the reason for OID and OIP is to get a fixed rate bond to a fair market value when the face amount of the bond does not otherwise represent a fair market value.) Fair market value is defined in Treas. Reg. § 1.148-5(d)(6).
- Example Certification: (1) As of __________ __, 20__ (the “Sale Date”), the Underwriter offered all of the Obligations to the general public (excluding bond houses, brokers or similar persons or organizations acting in the capacity of underwriters or wholesalers) in a bona fide public offering at the prices and yields that the Underwriter reasonably expected the principal amount of each maturity of the Obligations would be initially sold, as shown on Attachment 1 hereto. (2) Such offering prices and yields represented fair market prices and yields for the Obligations as of the Sale Date. (3) As of the date hereof [the issue date], at least 10% of each maturity and interest rate of the Obligations has been first sold at such prices and yields to the general public (excluding bond houses, brokers or similar persons or organizations acting in the capacity of underwriters or wholesalers) prior to the sale, allocation or allotment of any of the Obligations to any purchasers at prices and yields other than those set forth on Attachment 1 hereto. [Note: This certification may be a bit broad (a belt and suspenders certification), in that it uses the reasonable expectation certification, but then also has the underwriter make an actual issue date statement regarding the sale of the bonds. However, the statements taken together more broadly support the reasonableness of the issue price, while also providing a more exact issue price that does not rely on reasonable expectations. In other words, the problem of determining reasonableness is mitigated.]
- For privately placed bonds: Technically, the same definition applies as for publicly offered bonds. But note the following practical differences:
- Purchase Price: The issue price is simply the price at which the initial purchaser purchases the bonds. There is no bona fide public offering, so the expectation standard doesn’t apply, and there is no need to discuss the sale of a substantial amount since the entire bond issue is sold to the purchaser.
- Fair Market Value: There must still be a certification that the issue price of the bonds does not exceed the fair market value. Purchasers may have a difficult time making this statement, since practically they haven’t necessarily surveyed the market. Instead, the sale took place based on an RFP process or arm’s-length negotiation (see Treas. Reg. § 1.148-5(d)(6) regarding arm’s-length negotiation to establish fair market value). The certification therefore should either explain that the issuer solicited proposals or at least that the price for the bonds was negotiated at arms’-length. This should satisfy the fair market value certification that bond counsel requires.
- Example Certification: The Initial Purchaser purchased, on a direct placement basis, the Obligations on __________ __, 20__ (the “Sale Date”), pursuant to a Private Placement Agreement, dated the date hereof, among _______________ (the “County”), the Trustee and the Initial Purchaser, at the price of $_______________, being the aggregate principal amount of the Obligations. Such purchase price was derived through a solicitation by the County of proposals for the purchase of the Obligations.
EMMA shows certain special condition indicators on its recent trades screen. The indicators show whether any special conditions apply to the trade. Most trades do not have special condition indicators. The categories of indicators are as follows:
- (A) Assumed settlement date: The actual trade settlement date was unknown at the time of the trade. The settlement date is usually after the trade date.
- (B) Broker’s Broker trade: Indicates an inter-dealer trade done by a broker’s broker.
- (L) List offering price/takedown trade: Indicates a trade executed on the first day of trading of a new issue, either by an underwriter or another broker-dealer or bank involved in the initial distribution of the securities at the published list offering price for the security, or by an underwriter to another broker-dealer or bank involved in the initial distribution of the securities at a discount (or “takedown”) from the published list offering price for the security.
- (P) Weighted average price trade: Indicates that a trade was reported using a weighted average price based on multiple transactions done at different prices earlier in the day to accumulate the total amount of bonds needed to make the transaction.
- When Issued trade: Indicates that a trade in a new issue security was executed on or before the final issuance or settlement of the issue of securities by the issuer.
In the News:
“Treasury to Issue Regulations on Issue Price,” The Bond Buyer, March 9, 2012. “Lawyers should not have to look at prices on the MSRB’s online EMMA system to determine if munis were initially offered at prices that raise questions about tax-law compliance.”
“IRS Details How Issuers Can Check Bonds’ Issue Price,” The Bond Buyer, June 14, 2012. (Available here) “When IRS agents look at EMMA data, they look for instances where the bonds were not fully placed, there are upward pricing trends, or simultaneous trades showing less than 100% at the initial public offering and premium trades occurred subsequently. They also look for apparent dealer prioritization over the public and the dealers involved in the trades. […] The TEB’s focus in terms of scrutiny of issue price is primarily with negotiated sales and not competitive sales, according to Dodd. ‘It is our understanding that any of the pricing anomalies that we think we might observe will likely be in respect to negotiated deals,’ she said.”
“IRS Released Proposed Arbitrage Regulations,” Kutak Rock LLP, September 20, 2013. (Available here)
“U.S. Treasury Releases More Workable Proposed Regulations under ‘Issue Price’ for Municipal Bonds,” Greenberg Traurig, LLP, June 30, 2015. (Available here)
Comment Regarding Competitive Sales Exception to the General Rule, National Association of Bond Lawyers, February 22, 2016. (Available here)
- If there are multiple maturities, how will the issue price need to be determined:
- The issue price will need to be determined on a per-maturity basis. A substantial amount of bonds for each maturity must have been sold to know the issue price. A substantial amount is 10%.
- What happens if the underwriter has not been able to sell a “substantial amount” of any particular maturity:
- If a bona fide public offering was made, the issue price is determined as of the sale date based on “reasonable expectations regarding the initial public offering price.” Furthermore, the issue price does not change if part of the issue is later sold at a different price. This means, the issue price can be established either by proving up that a substantial amount of each maturity/interest rate has actually been sold, or at least stating what the reasonable expectations of such sale were by the underwriter on the sale date. See Treas. Reg. 1.148-1(b).
- If the bonds are being privately placed, the issue price is the price at which they are purchased. There is no concept or need of sale of a “substantial amount.”
See TD 9599 for final regulations regarding issue price for publicly traded property.