WASHINGTON -- The SEC is investigating numerous issues associated with the tax-exempt bond market, including political contributions, consultant fees, conflicts of interest and disclosures about tax matters, an SEC official told bond lawyers meeting here yesterday.
The Securities and Exchange Commission also expects to begin examining sales practices in the tax-exempt bond market, Gary Sundick, associate director of the SEC's division of enforcement, said during a panel discussion at the National Association of Bond Lawyers meeting.
An Internal Revenue Service official, speaking on the same panel, said that the IRS is considering publicly disclosing when bonds lose their tax-exempt status because of tax law violations.
For issuers that opt to settle tax disputes with the IRS to keep their bonds tax-exempt, the IRS is considering involving the state attorneys general in the settlement talks, Marcus Owens, director of the IRS' exempt organizations technical division told the lawyers.
Sundick's remarks about the SEC's enforcement efforts in the bond area appear to be the first such public statements by an SEC enforcement division official.
The SEC, he said, is in investigating a number of cases to see if political contributions or consultants fees were made to obtain bond business.
"We have a number of inquiries underway both on an informal basis and a more formal basis," he said.
In an informal inquiry, the IRS asks market participants to voluntarily provide records and documents. In a formal investigation -- which SEC commissioners must authorize -- the SEC has the power to issue subpoenas for records and documents, he said.
"The basic premise behind these inquiries [involving political contributions and consultant fees] is that the integrity of the municipal securities markets is largely dependent on the efforts of the underwriters is structuring transactions and preparing disclosure documents," Sundick said.
Underwriter selection should "be based on expertise and competence and not on political contributions or other factors," he said.
Another issue stemming from these cases, he said, is whether there were conflicts of interest between the various parties to the bond transaction.
The SEC is also looking at the books and records of the broker-dealers to see what role they played in such transactions and how payments were recorded on their books, he said.
But Sundick said the SEC's current interest in tax-exempt bonds "is by no means limited to the political contributions area."
The SEC is also looking at more general disclosure issues in bond deals, such as whether participants properly disclosed information in bond documents about the use of proceeds, the viability of the project being financed, and the validity of the tax-exempt status of the bonds.
The SEC has some history in dealing with tax issues in the past, Sundick said. The commission, for example, scrutinized whether participants in limited partnerships accurately reported their tax status.
The SEC plans to begin examining industry sales practices, Sundick said, because, as individual investors have been investing billions of dollars in municipal bonds either directly or through mutual funds, "some questions exists as to what these relatively unsophisticated investors know about what they're buying."
The SEC is concerned whether investors are being convinced to switch from one bond to another, what they are being told about why one bond is better than another, and whether they are being informed about mark-ups he said.
"Given the billions of dollars that are going into this field, it warrants a closer look," he said.
Meanwhile, Marcus Owens of the IRS told the lawyers that the agency is exploring the possible use of new innovative enforcement techniques such as disclosing that bonds have lost their tax-exempt status and including state attorneys general in settlement negotiations.
Howard Zucker, a lawyer with Hawkins, Delafield & Wood in New York City, who was also on the panel, said he was worried about the IRS' bringing state attorneys general, who are politically appointed, into bond enforcement cases.
But Owens said: "We would only be doing this in the context of a closing agreement negotiation where an issuer's concern is to raise the IRS' comfort level" that tax laws would be complied with in the future.
Michael Bailey, another IRS official, said the IRS is trying to find innovative solutions to forge partnerships with state and local officials and that state attorneys general might be helpful in some cases, such as those involving private activity bond limits for states.
The IRS plans to issue two sets of procedural guidelines for the enforcement program in the coming months, Owens said.
The first set of guidelines, which could be released within a month, would govern the relationships and coordination between various officials in the IRS' national and field offices.
The second set of guidelines would detail the mechanics of the enforcement program and would cover such things as how the IRS would locate bondholders or when IRS agents should seek court summonses, he said.
Owens said the IRS currently has about 30 audits underway involving 501(c)(3) bond financings. The IRS also is pursuing about 25 audits of bond issues that were triggered by complaints or press reports. An additional 30 to 35 ongoing audits involve claims for refunds of arbitrage payments, he said.
Owens said the IRS must audit refund claims when evidence for the refund has not been provided or the amount of refund being sought is large. The IRS, he said, plans to develop standardized letters for such situations, he said.
The IRS is still working to develop a random audit program, Owens said.
