The effective date of the new issue price regulations (Regulations) is less than a week away, and because of the need to discuss and plan for application of the new rules with issuers, underwriters and financial advisors for bonds that will be subject to the new rules, we are already gaining experience with documentation relating to the Regulations. NABL and SIFMA have done an excellent job of providing model documents – sale documents in the case of SIFMA and issue price certifications in the case of NABL – that will significantly smooth the transition from a reasonable expectations standard for establishing issue price to a general rule based on actual sales. Use of these model documents, with some variations, should ease the burden, which could otherwise be overwhelming, of negotiating these documents for each type of bond sale with each underwriter. Like all model documents, however, there will undoubtedly be fine tuning as we gain more and more experience working with the Regulations and negotiating documents for specific transactions. This post notes two negotiating issues that have been raised in current transactions.
In the NABL model hold-the-offering-price certificates, the lead underwriter in an underwriting group is asked to certify that each underwriter has agreed in the sale documents not to offer or sell the bonds at a price higher than the initial offering price during the “holding period,” which is a requirement of the Regulations. Additionally, the model certificate includes a statement that no Underwriter has offered or sold any maturity of the hold-the-offering-price maturities at a price that is higher than the respective initial offering price for that maturity of the issue during the holding period. Some underwriters have expressed concern over providing this certification as lead underwriter because it relates to actions of other members of the underwriting group and selling group as to which the certifying underwriter may not have direct knowledge. In response to this concern, a couple of qualifiers have been suggested, including (1) adding a knowledge qualifier to the statement ( e.g. “To the Underwriter’s knowledge, pursuant to such agreement, no Underwriter has offered or sold . . . .”) and (2) basing the statement on representations made by members of the underwriting group and selling group.
In considering these alternatives, it is important to note that the Regulations only require that “Each underwriter agrees in writing that it will neither offer nor sell the bonds to any person at a price that is higher than the initial offering price to the public during the [holding period].” The basis for requiring the above certification from the lead underwriter is apparently the following statement in the preamble to the Regulations: “Accordingly, a failure to meet a specific eligibility requirement of a rule for determining issue price, such as an underwriter’s breach of its hold-the-offering-price agreement under the special rule for use of initial offering price, will result in a failure to establish issue price under that rule and a redetermination of issue price under a different rule.” Unfortunately Treasury has created confusion by including this statement in the preamble while including a different rule in the Regulation itself, which requires only an agreement to hold the offering price. Of course, in the case of an inconsistency, the Regulation should certainly prevail over the preamble. But the IRS might argue that the preamble should be taken into account in interpreting the Regulation (even though on its face the Regulation appears quite clear). In any event, the inclusion of this certification is prudent in light of the preamble statement but, particularly in light of the source of the concern – the preamble rather than the Regulation — the concern raised by underwriters as to the basis of this certification should be met with reasonable accommodation that does not impose a significant burden on underwriters.
Qualifying Competitive Sale but Issue Price Based on Actual Sales
Each of the SIFMA Notice of Sale models for competitive sales states that the issuer intends to apply the competitive sale/initial offering price rule to establish issue price. Those models include alternatives in the event that one or more of the requirements of a competitive sale (e.g., obtaining three bids) are not met. The model applicable where the issuer chooses not to apply hold-the-offering-price to a non-qualifying competitive sale requires the winning bidder to report to the issuer the prices at which the bonds of each maturity are sold until the 10% threshold is met (or all of the bonds of the respective maturity are sold). Implicit in the fact that this reporting requirement only applies to a non-qualifying competitive sale is that the issuer has committed to use the competitive sale/initial offering price rule if the competitive sale qualifies under the Regulations.
It is very likely that this is the rule an issuer would want to apply in these circumstances. However, it must be noted that the issuer is not required to choose the method of establishing issue price until the issue date. Thus, even if the requirements for a competitive sale are met, if it should happen that less than 10% of one or more maturities is sold on the sale date, and if interest rates rise immediately after the sale date, the general rule for establishing issue price based on sales of the first 10% might result in a lower price and higher arbitrage yield than would result under the competitive sale/initial offering price method of setting issue price. The issuer would be permitted to choose the general method of establishing issue price, rather than the competitive sale/initial offering price method. For this reason, an issuer might choose to revise the terms of the notice of sale to require that the underwriter report actual sales until the 10% threshold is reached regardless of whether the competitive sale requirements are met. Of course, this should be discussed with the issuer and the financial advisor to consider whether imposing this additional burden on the winning bidder might either discourage underwriters from bidding or cause underwriters to bid at a lower price.