1. The Bonds are Sold: Pitfalls of Post- Issuance Compliance
MIDWEST REGIONAL
PUBLIC FINANCE CONFERENCE
April 21, 2017
Joe L. Norton
Bill Burns
Beth Warren

2. A New Focus on Compliance
Lost Federal Revenue
from Tax-Exempt Bonds:
$187.7
Billion
over
5 Years!

3. A New Focus on Compliance

4. A New Focus on Compliance

5. A New Focus on Compliance
Issuing tax-exempt debt provides
economic advantage to Issuers
In exchange, limitations are imposed by the federal government at the time the bonds are sold AND
as long as the bonds are outstanding.
“Post-Issuance Compliance”

6. A New Focus on Compliance
Post-Issuance Compliance Requirements
Where are they found?
Federal Tax Code & Regulations
Tax Certificate for each financing
Continuing Disclosure Undertakings
Written Compliance Procedures
Regulators are asking…
Can you prove you are in compliance?

7. A New Focus on Compliance
How does my Issuer prove compliance?

8. The Compliance Requirements
Account for Expenditures
Account for Investments
Account for Use
Account to Investors

9. The Compliance Requirements
Account to Investors

10. Accounting to Investors
SEC regulates the national securities markets
Municipal bonds, notes, certificates of participation = securities
SEC’s concerns
Investor protection
Market efficiency

11. Underwriters SEC has broad authority to regulate underwriters
SEC uses its authority to regulate underwriters to indirectly impact disclosure obligations of municipal issuers

12. Rule 15c2-12 Applies to underwriters (not issuers)
Mandates a baseline of disclosure for municipal securities –
- official statements
- annual reports
- event notices
There are exemptions for certain offerings and financings

13. Continuing Disclosure Undertakings
Underwriter must obtain an undertaking from an “obligated person”
Contractual obligation of obligated person
Components
Annual Report (Audit + Operating Data)
Event Notices (14 Events)
Notice of failure to file
In new official statements, disclosure about noncompliance during 5-year historical period

14. Rule 15c2-12 – Obligated Person
The rule requires an underwriter to obtain from one or more “obligated persons” a compliant continuing disclosure undertaking “Obligated person” – an entity committed by contract or other arrangement to support payment of all or part of the offered securities

15. SEC and… Municipal Bonds?

16. Heightened Enforcement Recently
Very significant activity
by Muni Enforcement Division
since 2013:
State of Illinois; Allen Park, Michigan; Harrisburg, Pennsylvania; City of South Miami, Florida; West Clark, Indiana Community Schools; Miami-Dade County, Florida, Public Health Trust; Greater Wenatchee (WA) Regional Events Center; State of Kansas; Harvey, Illinois; Allen Park, Michigan; Westlands Water District (CA); Ramapo, New York
Miami, Florida (Jury Trial – Verdict for SEC)
MCDC (71 Issuer Settlements)

17. MCDC — Issuer Settlement Terms
Cease and Desist Order
Within 180 days establish policies and procedures, including training, regarding continuing disclosure obligations
Disclose in future offering documents for 5 years
Certify to SEC that you have done these things
Cooperate with any future SEC investigations
No civil penalties

18. Anti-Fraud Rules Anti-Fraud Rules – Primary Source of Issuer Liability
Official Statement may not contain a material misstatement or omission
It is illegal for an Official Statement to contain a materially inaccurate statement, or for an Official Statement to exclude a material piece of information
Issuers and issuer officials may be liable

19. What “Fraud?” According to SEC, negligence may include:
Failure to follow procedures
Failure to review documents to certain standards
Failure to have the correct personnel review documents (e.g., CFO may not have all operations details)
Coupled with a material misstatement or omission
Focus on omissions!

20. SEC’s Focus

21. Continuing Disclosure Compliance – Step 1
Find the undertakings
**Continuing Disclosure Undertaking, Continuing Disclosure Agreement, Continuing Disclosure Certificate or Bond Resolution**

22. Continuing Disclosure Compliance – Step 2
Review the specific requirements of each undertaking
Filing Deadline (e.g., 180 days after fiscal year end)
Audit requirement specifics
Other financial information and operating data
Should be described by reference to specific tables in the Official Statement
Operating data is information about the obligated person’s own operations
Quantitative; not demographic information; not projections

23. Sample Undertaking Language
Section 2. Provision of Annual Reports.
(a) The Issuer shall not later than 180 days following the end of the Issuer’s fiscal year commencing with the year ending June 30, 2016, file with the MSRB, through EMMA, the following financial information and operating data (the “Annual Report”):
(1) The audited financial statements of the Issuer for the prior fiscal year, prepared on a modified-cash basis. If audited financial statements are not available by the time the Annual Report is required to be filed, the Annual Report shall contain unaudited financial statements in a format similar to the financial statements contained in the final Official Statement relating to the Bonds, and the audited financial statements shall be filed in the same manner as the Annual Report promptly after they become available.
(2) Updates as of the end of the fiscal year of the financial information and operating data contained in the final Official Statement related to the Bonds, as described in Exhibit A, in substantially the same format contained in the Official Statement
Filing Deadline
Audit requirement, including accounting basis
Operating Data Required – included in an exhibit

24. Continuing Disclosure Compliance – Step 3
Prepare annual report(s)
Obstacles
Information not yet available
Audit delays
Information provided by third
party sources (County Assessor)

25. Continuing Disclosure Compliance – Step 4
File the annual report; document compliance by keeping records

26. Event Notices The Frequent Three*
Bond calls (if material) and tender offers
Defeasances
Rating changes
*In a timely manner, notice of a failure to file Annual Report

27. Event Notices The Other Eleven
Payment delinquencies
Non-payment related defaults (if material)
Unscheduled draws on reserves reflecting financial difficulties
Unscheduled draws on credit enhancements reflecting financial difficulties
Substitution or failure of credit or liquidity providers
Material events affecting tax status (including adverse tax opinions and IRS determinations of taxability)
Modifications of bondholder rights (if material)
Release, substitution or sale of security (if material)
Bankruptcy or similar events
Merger, consolidation, acquisition or sale of substantially all of the assets of an obligated person (if material)
Appointment of successor or additional trustee (if material)

28. Fool me once…
SEC views an issuer’s prior compliance with undertakings during prior 5 years as “material”
Disclose to investors in Official Statements
Include a plain-language summary of material failures to comply in the past five years
Be wary of “remedial” language unless you are sure it is correct! (“…the Issuer is now in full compliance with its undertakings”)

29. The Compliance Requirements
Account for Expenditures

30. Accounting for Expenditures
Identify the Project
Identify Total Project Costs
Identify Bond Proceeds and Earnings
Complete a Final Written Allocation

31. Accounting for Expenditures
Spending Bond Proceeds vs Accounting for Project Expenditures

32. Accounting for Expenditures
How do we ensure Bond proceeds only go to eligible Project costs? “Final Written Allocation”

33. Accounting for Expenditures
Final Written Allocation
Needed for New Money Financings
Prepared After the Project is Complete
Uses Issuer’s Accounting Records
Includes Expenditures for Bond Proceeds & Other Money
Tells the IRS How ALL the Money was Used

34. Accounting for Expenditures
Should we just keep bond money
in a separate bank account?
Separate account = simple tracking?
Total Project costs need to be tracked
Incorporate into regular accounting system
Decide before bonds are issued

35. Accounting for Expenditures
Identify the Project & Your Budget

36. Accounting for Expenditures
Track TOTAL costs for the entire Project regardless of “financing source”

37. Accounting for Expenditures
Once Project is complete…
Update the Project budget to account for Actual Results

38. Accounting for Expenditures
What does a Final Written Allocation look like?
Anything missing?

39. Accounting for Expenditures
Accounting Records!
Date
Payee
Amount
Invoice number

40. The Compliance Requirements
Account for Investments

41. Accounting for Investments
Identify money that must be tracked
Account for proceeds and earnings
Comply with rebate and yield restriction rules
Follow special investment pricing rules

42. Accounting for Investments
General Investment Limits (Arbitrage)
Bond Yield vs. Investment Yield
Example
Bond Yield = 3%
Bond proceeds invested at 4%
1% of excess earnings must be paid
or rebated to the Federal Government

43. Accounting for Investments
Financing “proceeds” MUST be tracked:
Construction/Project Fund
Costs of Issuance Fund
Escrow Fund
Debt Service Reserve Fund

44. Accounting for Investments
Other money MAY need to be tracked:
Debt Service Reserve Fund
Debt Service Fund
Revenue Fund
Operating Fund
Depreciation and Insurance Fund
How do you know what funds to track?

45. Accounting for Investments
**Tax Certificate or Tax Agreement**

46. Accounting for Investments
How does my Issuer comply? **Arbitrage Computation**

47. Accounting for Investments
Is Arbitrage Compliance required for every bond issue?
YES!
Exception to rebate may be available
All Issuers must account for investments
Yield reduction calculation

48. Accounting for Investments
Any chance we can keep all the earnings?
Slide 8 – Any chance we can keep the excess earnings?
Unfortunately, this hasn’t been a concern in today’s market – no one has earned above the bond yield for some time now. However, when the market starts to turn around…everyone’s focus will change. Question will be if we earn above the bond yield is there any chance we can keep the money?
Yes, there are exceptions that apply that would allow an issuer to keep the money provided they spend the money fast enough. A 6-month, 18-month or 2-year spending exception may apply provided certain mandatory benchmarks are met. Another reason to have your arbitrage computation done on annual basis vs end of 5-year period.

49. Accounting for Investments
What “investment pricing”
rules apply?
Need to establish FMV purchase price
Must follow bidding procedures
Any “safe” investments?
Slide 10 - Special investment pricing rules apply
IRS wants to ensure that investments purchased with proceeds are purchased and sold at fair market value
Historically abuse in this area
Special investment pricing rules may apply and need to followed – Guaranteed Investment Contracts require bidding procedure

50. The Compliance Requirements
Account for Use

51. Accounting for Use Use an Annual Compliance Checklist
Identify the rules and restrictions that apply to bond financed Projects
Identify your role in tracking use of financed Projects

52. ANNUAL COMPLIANCE CHECKLIST
Accounting for Use
What has your Issuer agreed to and
how do you prove compliance?
ANNUAL COMPLIANCE CHECKLIST

53. What Projects are affected? Final Written Allocation
Accounting for Use
What Projects are affected?
Only Projects paid for (in whole or part) with tax-exempt bond proceeds are subject to restrictions
Final Written Allocation

54. Accounting for Use
Permitted “Good Use” of financed Projects includes use by:
The County
The State
Other local governmental entity
General public
*501(c)(3) entity - 501(c)(3) Bonds only*

55. Accounting for Use
Nonqualified Use (“Bad Use”) may result from any arrangement with:
Taxable entity
Person engaged in trade or business
501(c)(3) entity
Federal Government
What is a “bad use” arrangement…

56. Accounting for Use Arrangements that may result in “Bad Use” include:
Sale
Leases
Management/Operating Agreements
Output Contracts
Research Contracts
Granting other special legal rights to Financed Projects (e.g. naming rights)
*Unrelated Trade or Business Use - 501(c)(3)*

57. The sale of a financed Project results in Nonqualified Use
What is “Bad Use”?
The sale of a financed Project results in Nonqualified Use

58. Accounting for Use How long do we have to track this stuff?
IRS restricts the use of financed Projects during the entire term of the bond issue (including refunding bond issues)
Are you saying we have to track FOREVER….

59. What is “Bad Use”?
Example: Bond issue finances computers for District administration building
Two years later District decides to replace computers and sells at a substantial discount
Ten years later the District disposes of the computers
Exception: Do not need to continue tracking if project has no remaining useful life

60. What is “Bad Use”?
A lease of all or a portion of a financed Project may result in Nonqualified Use

61. What is “Bad Use”?
Example: District leases space within District building to local businesses for meetings
Short Term Exceptions:
Leases under 50 days
Leases under 100 days pursuant to rate scale

62. What is “Bad Use”?
Arrangements for a third party to operate or manage financed Projects may result in Nonqualified Use

63. What is “Bad Use”?
Example: District enters into a contract with an entity to operate its bond financed cafeteria
Lots of technical exceptions
No sharing of “net profits”
Contract term 5 years or less
Discuss with bond counsel in advance

64. What is “Bad Use”?
Use by a 501(c)(3) organization of a bond financed Project in an unrelated trade or business results in Nonqualified Use (regardless of profit)

65. How much “Bad Use” is permitted?
Not more than 10% of the proceeds of a bond issue may be used in a “Bad Use”
Limit is 5% for 501(c)(3) organizations
May be reduced to 3% if finance max
amount of COI
“Qualified Equity” can float!

66. Accounting for Use Can we fix it? Modify contract Remedial action
Voluntary Closing Agreement Program (VCAP)

67. Your Role Help track the use of financed Projects
Annual Compliance Checklist
Ask questions early and often!
You’re not expected to be an expert
Identify issues early…
More options available
Avoid jeopardizing tax advantaged status of bonds

68. Conclusion