WASHINGTON -- The East Baton Rouge Mortgage Finance Authority yesterday shelved its planned $69.6 million re-refunding of escrowed-to-maturity housing bonds after municipal bond dealers charged that the deal might violate securities laws.
"We were very concerned that there would be a perception that something was wrong with this deal," said Robert Gaston, chairman of the authority. However, he said that participants in the deal did not think that anything was the matter with it and that the authority "reserves the right" to go forward with the deal in the future, should it decide to do so.
But it is unlikely that the authority would be able to proceed with the deal, market participants said, because new Internal Revenue Service rules on refundings that go into effect for bonds issued after June 17 of this year would prohibit such transactions, in which escrows are shifted among bond issues.
And while federal regulatory officials refused to comment on this specific transaction, their comments about the general disclosure requirements for such transactions made it appear the deal might have violated securities laws if it had gone forward.
The authority recently proposed refunding its remaining outstanding 1979 single-family housing bonds to obtain an interest rate savings. The bonds were then advance-refunded and escrowed to maturity in 1989.
The authority was trying to close the proposed re-refunding before June 17 in advance of the implementation of the new IRS rules, said Richard D. Leibowitz, partner at the law firm of Breazeale, Sachse & Wilson, which is serving as issuers' counsel to the authority.
The authority had issued taxable bonds in 1989 to refund the defeasance of the 1979 single-family housing bonds to their maturities, a series ranging through 2010. The authority had planned to issue low-coupon tax-exempt bonds to refund the taxable issue. The housing bonds, which had been been regarded as noncallable by some traders and had been trading at premiums of 104% or higher, were to be redeemed at 101.50% next month.
The authority had obtain approval for the deal from the Louisiana State Bond Commission after the lawyers involved in it stated on the record that it would meet all tax and securities laws.
But J.C. Bradford & Co., a Tennessee-based broker-dealer, and other firms that had traded the bonds cried foul play. They charged that the East Baton Rouge Mortgage Finance Authority did not properly follow the disclosure requirements prescribed for such transactions by the Securities and Exchange Commission, the Municipal Securities Rulemaking Board, and the Public Securities Association.
The authority, the dealers said, failed to disclose in the official statement for the 1989 taxable refunding issue that it had reserved its right to call the 1979 bonds before their stated maturities.
J.C. Bradford put its concerns in a letter yesterday and urged Morgan Keegan & Company, lead underwriter for the issue, to stop the transaction. The letter warns that if the deal does go forward Morgan Keegan will be held "liable for any damage or loss of injury incurred."
The letter says that calling the escrowed-to-maturity bonds would be "highly improper not only because of the losses which will be forced upon the current bondholders "were never properly advised that the possibility of such a call existed."
"We just do not think the deal should go through -- and if it does it will damage the marketplace," said J. Ronald Scott, partner and national municipal bond manager at J.C. Bradford & Co, in an interview. "The O.S. on the 1989 issue didn't do what it was supposed to do, which is to notify the marketplace," he added. Mr. Scott said that J.C. Bradford is trying to find out how many of its customers are exposed to losses on the bonds held, said that his firm itself has virtually no exposure.
Jane Parker, vice president and manager of municipal trading at Legg Mason Wood Walker Inc.'s New Orleans office, also was concerned about the proposed deal. "I happened to find out about it [the scheduled defeasance] by chance," she said. "We feel that a lot of investors were misled by the omission [in the 1989 offering statement], and that many will be hurt," she added.
Several broker-dealers, including one major New York firm, had reported that they had thought the bonds were noncallable. ADP Inc., a company based in Jersey City that takes information from J.J. Kenny Information Systems and puts it on the screens of about 100 broker-dealers did not show the bonds as callable until last Friday.
Participants of the deal this week had acknowledged that the official statement for the 1989 refunding issue had not disclosed the issuer had reserved its right to call the bonds early, but said that such disclosure was not required because the refunding was taxable and would go to investors outside the municipal market.
"Those bonds were sold in an institutional taxable market. The official statement would provide very little disclosure to municipal retail buyers," said Michael G. McMahon, with MG McMahon & Co., the financial adviser for the planned deal.
Willis Ritter, a lawyer with Ritter & Eichner, special tax counsel for the deal, agreed that such disclosure was not needed in the official statement for the 1989 taxable refunding deal. He and Mr. McMahon said that the authority had disclosed its right to call the bonds early in the notices of defeasance that were issued on Feb. 2, 1989 and Feb. 9, 1989. They said the authority had issued a special statement in April 1989 clarifying that the bonds could be called.
Both Mr. McMahon and Mr. Ritter said the planned deal had met all of the necessary disclosure requirements and that traders were complaining because they had either failed to check the call provisions, perhaps so they could continue to trade the bonds a higher-than merited premium.
But SEC officials, without commenting on the specific transaction, confirmed yesterday that their June 25, 1988 letter to the Municipal Securities Rulemaking Board on such transactions require issuers to disclose their call rights in both the official statement to the refunding, whether or not it is taxable, as well as the defeasance notices. And the Municipal Securities Rulemaking Board issued a similar statement.
"We said in our letter that we thought this was a material piece of information that should be in both documents," the notice of defeasance and the official statement, said Robert Colby, SEC chief counsel. "It needs to be in the official statement to make things clear, so that it's not misleading," he added. The MSRB issued a similar statement of that position yesterday.
George Brakatselos, a vice president with the PSA, said that group's resolution on such deals also made clear that the disclosure of a right to call had to be in the official statement of the first refunding document.
Mr. McMahon and Mr. Ritter had claimed that if the disclosure of a right to call was in the defeasance notice, it did not have to be in the official statement because the SEC, MSRB and PSA had said the documents had to be read together. Mr. Ritter had also noted that the PSA guidelines were not binding.
