Regulations proposed by the New York State comptroller's office for the use of certificates of participation could substantially limit the future sale of these securities by state municipalities, market executives said.

The rules, released by the comptroller's office last week, say COPS should be used only for the costs surrounding capital improvements.

Officials in the comptroller's office have said they believe the use of COPS for purposes other than capital improvement violates the 1991 law that gave New York municipalities authority for the first time to enter into installment purchase contracts and to sell COPs.

As a result, the proposals, appearing yesterday in the State Register, should put the brakes on what many market professionals see as the greatest potential use of COPs by municipalities - deficit financing and the refunding of other debt to address budget problems.

Market executives with knowledge of how the rules were developed say the regulations will likely derail a series of these deals being considered by municipalities across the state.

"These regulations lay out pretty well what COPs should be used for," said Kenneth W. Bond, a partner at Sullivan, Donovan, Bond & Bonner, a New York City-based bond counsel. Mr. Bond was part of a Government Finance Officers Association committee that provided the comptroller's office with feedback on the proposed regulations. "There should be no issuing of deficit COPs and no COPs for refundings," he said.

So far in 1992, only two New York State issuers - the city of Syracuse and the state - sold COPs, for a total of $107.1 million, according the Securities Data Co. The municipal market witnessed five COPs issues in New York in 1991, totaling $116.9 million,

Bond attorneys and investment bankers said this trend of lackluster issuance is likely to continue, in large part because the new regulations would not allow COPs to finance several forms of budget relief.

"The new regulations will only increase issuance to the extent that deals are delayed pending" publication the final regulations, said C. Todd Miles, a partner in the law firm of Hawkins, Delafield & Wood. "But I can't say there will be a rush to do COPs deals. "

The comptroller's office was given statutory authority by the state Legislature in 1991 to establish rules for the use of installment purchase contracts, in which a municipality sells and then leases back a facility to investors. The transaction, which the Legislature designed to help municipalities finance improvements on buildings and other facilities owned by the local government, is completed through the issuance of COPs to investors.

The rules will now be available for a 45-day public comment period, although most market observers say any changes in content will be minor.

In recent months, however, the use of installment purchase contracts and the issuance of COPs has emerged as a thorny issue in municipal finance. Many state municipalities facing a sour economy and budget problems have considered COPs transactions to provide budget relief. Many others, including Rensselaer County, N.Y., are at the moment deciding if they should issue COPs to cure their fiscal ills.

Philip W. Wood, the county's chief Ascal officer, said "there are differing opinions if a municipality can or cannot" issue COPs to finance deficits. "But if [the transaction] is precluded by the comptroller, we won't do it."

In April, the Troy, N.Y., Industrial Development Authority sold lease revenue bonds through a sale and leaseback of several county office buildings to help cover a budget gap. Although the authority did not issue COPS, the deal brought sharp criticism from officials in the comptroller's Division of Municipal Affairs because officials said the 1991 law did not specify whether installment purchase contracts can be used for deficit financing.

During recent meetings with Government Finance Officers Association members, the comptroller's office gave in to market executives' demands to make it easier for municipalities to issue COPs through negotiated, rather than competitive, sales.

At the same time, the office resisted all attempts by members of the group to allow municipalities to issue COPs for budget relief. The comptroller's office brushed aside one request that would have given local governments the authority to refinance existing debt, such as general obligation bonds, through the issuance of COPs.

This refinancing provides budget relief because COPs, unlike GOs, have level debt service. State law requires issuers of GOs to pay down most of the debt in the early years of the issue. Level debt service provides budget relief by spreading this cost over a number of years.

Still, at least one market professional, Joel H. Moser, a partner in the law firm of Moser & Moser, believes COPs can be used for budget relief despite the comptroller's regulations. Mr. Moser, who designed the Troy deal, also believes that many municipalities will take advantage of this authority.

Mr.Moser said that just like the state can issue bonds through various authorities, create one-shots for budget relief, and bypass the state constitution's voter approval clause, the Troy authority and other municipalities can engage in an installment purchase contracts and sell COPs to fund a deficit.

He said New York State courts have consistently upheld the state's right to create corporations and issue debt without voter approval. He pointed out that this violates the state constitution. However, the courts have never ruled that the "net effect" of a transaction should prevent, the state or other municipalities from issuing securities as long as "every step taken in the process is valid," Mr. Moser said.

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