Executive Summary
For years, public companies have used shelf registration for their securities — an arrangement allowing a single offering document to be filed permitting the issuance of securities over time and in multiple issues. For public companies, whose securities must be registered in advance of sale with the SEC, shelf registration is the registration of a “new issue” that can be prepared up to two years in advance of the date on which the securities are actually issued and sold. This shelf registration permits an issue of securities to be offered quickly when funds are needed or market conditions are favorable. This alert discusses ways in which municipal-securities issuers and conduit borrowers can implement a process similar to shelf registration (Shelf Registration Program) to provide greater flexibility in the timing of the issuance of municipal securities, which may be of great value during a turbulent market environment. We note that the Shelf Registration Program may be available to borrowers and issuers considering issuing securities other than revenue bonds, including the issuance of commercial paper, bond anticipation notes or other notes, certificates of participation, special facilities revenue bonds, and long-term fixed or variable-rate debt. Accordingly, for ease, we use the term “bond” in this alert to refer collectively to each of these securities.
This alert discusses the benefits of a Shelf Registration Program and describes certain considerations that must be addressed in order for an issuer or conduit borrower to satisfy federal income tax laws, federal and state securities laws, and other state laws applicable to municipal securities. Most of the securities laws regarding the registration of securities for public companies, including shelf registration, do not apply to municipal securities. However, the registration regime is a useful framework in which to develop a Shelf Registration Program that would be similar in effect to that of shelf registration of securities for public companies. There are significant benefits to the development of a Shelf Registration Program:
- A Shelf Registration Program has the advantage of being able to go to market quickly
- A Shelf Registration Program adds value for issuers undertaking significant capital improvement programs over a period of time
- A Shelf Registration Program may be more attractive in cases in which a borrower knows that it is likely to experience negative arbitrage on its project fund
Of course, there are practical and legal considerations to weigh before adopting a Shelf Registration Program, which are identified throughout.
I. The Offering Document
It is important to note that variations of the Shelf Registration Program we describe currently exist. Several issuers have sold “extendible securities,” which involve the issuance of bonds in tranches, with a single issuer/borrower approval, reduced closing papers, and a single credit enhancer providing a letter of credit that increases as each tranche is delivered, up to a pre-determined maximum commitment that is described in the initial offering documents for the securities. Additionally, issuers also have developed draw-down loan programs and commercial paper programs, which use a similar strategy. A Shelf Registration Program takes certain principles from these existing models, but adds greater flexibility. As part of the Shelf Registration Program, a conduit borrower (or issuer) would post an initial offering document with the Municipal Securities Rule-Making Board’s electronic municipal market access system (EMMA), and this offering document would be used as a “base document” for the issuance of one or more series of bonds over an extended (two-year) period of time. As the borrower or issuer issued additional series of bonds within the period, it would prepare and file supplements to that base document with EMMA.
Critical to the process is that a governmental issuer of tax-exempt, municipal securities implement a program pursuant to which tax-exempt bonds can be issued sequentially, over time (which we refer to in this memorandum as the “extended offering period”) for its benefit or for the benefit of a conduit borrower. The bonds are issued when and as convenient to the issuer and the borrower, or in response to market conditions at a particular time that may be more favorable to the borrower than conditions would be at another time. The program operates on the assumption that as many governmental issuer, regulatory, and corporate borrower approvals as possible have been obtained and as many of the “core” documents as possible are negotiated and executed, at or prior to the commencement of the extended offering period.
In a shelf registration of public company securities, a registration statement, containing a “base prospectus,” is filed with the SEC, and that base prospectus describes one or more different types of securities that the issuer may offer from time to time after the effectiveness of that registration statement and during the two-year period thereafter. Each time an actual offering is made (and securities are “taken down from the shelf”), a “prospectus supplement” describing the terms of the securities and the offering is prepared and filed with the SEC. The base prospectus and the prospectus supplement are distributed together and function as a single disclosure document. Because the registration statement is already effective at the time of the offering, and the prospectus supplement does not need to be declared effective, an offering of securities “off the shelf” can be completed very quickly.
Applying (and borrowing) shelf registration principles, the issuer and the borrower might consider an extended offering period of not more than two years from the date the first “offering document” is posted with EMMA. The first offering document can be a preliminary offering document.
The following items should be included in the preliminary offering document, in addition to those items typically included such as bondholders’ risks, description of the issuer, tax matters, and the book-entry system:
- For conduit transactions, the type of information concerning the borrower that is typically included within an “Appendix A” to a traditional preliminary official statement. As with the traditional preliminary official statement, this information should be as comprehensive as possible and should include the most recently available operating and financial information for the borrower. The information should be presented in a manner that contemplates future updates through the supplemental offering documents delivered from time to time. Ideally, the preliminary offering document would be prepared and delivered as soon as the borrower’s annual audited financial statements became available. The audited financial statements would be included in the preliminary offering document.
- A description of the various modes in which securities may be offered, including fixed rate. This concept constitutes a deviation from the general practice of limiting the description of the mode to that which is immediately contemplated, but is practically required in order to provide for flexibility of issuance during the extended offering period.
- If credit or liquidity facilities are contemplated for any series of bonds, a description of the type of credit or liquidity facility, and, if a commitment has been provided, a statement that a commitment has been obtained (subject to the confidentiality requirements of the offering credit or liquidity facility provider). The material conditions to the commitment should be described.
- A comprehensive description of the plan of finance, including the process of issuing securities during the extended offering period.
During the extended offering period, the borrower should supplement the preliminary offering document, on a quarterly basis, with each supplement, including (as attachments or by incorporating by reference) subsequent annual and quarterly filings (and “listed event” notices, if any), together with any other necessary updates to the information included in the preliminary offering document to ensure that the preliminary offering document, as supplemented to date, appropriately and adequately describes the material information concerning the borrower, the bonds, and any risks associated with the purchase of the bonds. This approach is not only appropriate from a securities law perspective, but also is consistent with accessing the market more quickly in response to evolving market conditions.
At the time of issuance of any series of bonds offered pursuant to the base preliminary offering document, as then supplemented, the parties would need to ensure that such document satisfied the requirements of SEC Rule 15c2-12, which requires that a preliminary official statement be “deemed final” and exclude only that information typically associated with pricing a bond issue.
When a particular series of the securities are priced and a bond purchase agreement executed, an “official statement” for those securities should be prepared. The official statement could consist of a single document, or a series of documents designated as the official statement (through incorporation by reference, if legally permissible as described above), including the preliminary offering document, a “wrap” that bears the title or designation as the “official statement,” the most recent supplement to the preliminary offering document and, if the bonds are sold after annual audited financial statements for the ensuing fiscal year become available, such financial statements. The official statement also will include a description of compensation to the underwriter and all essential terms of the bonds, including maturities, purchase prices, redemption provisions, Committee on Uniform Security Identification Procedures (CUSIP) numbers, yields (if fixed rate or issued in a mode functionally equivalent to a fixed-rate mode), and the essential terms of related items such as hedges and credit and liquidity facilities.
Bonds issued during the extended offering period need not be limited to new bonds issued to finance new projects or to refinance existing bonds or other debt. Bonds subject to issuance during the period also can include existing bonds that are anticipated to be converted from one mode to another mode during the extended offering period, or bonds that will remain in their existing mode but will be reoffered into a new interest rate period following mandatory tender. If the plan of finance initially contemplates such conversions, then the existing bonds that may be converted should be adequately described. Conversions involve a set of tax issues not discussed here ? generally, a “no reissuance” or “no adverse effect” tax opinion would be rendered in connection with a conversion. Accordingly, the opinions to be delivered upon conversion also should be adequately described.
Before examining the issues a borrower should consider prior to using a shelf registration-type program, a note about propriety of the process for an individual borrower is needed. The process proposed in this memo may not be appropriate for each issuer and conduit borrower. Each borrower must carefully weigh its disclosure practices and procedures before implementing the modified shelf registration process discussed here. This process is not for every issuer or borrower.
II. Regulatory and Contractual Considerations
Governmental Approvals
TEFRA Hearing and Approval
Prior to the Extended Offering Period, the borrower should work with the issuer(s) to hold the Tax Equity And Fiscal Responsibility Act Of 1982 (TEFRA) hearings and to obtain the required approvals for the projects that are anticipated to be financed during the extended offering period. A “TEFRA approval” for a plan of finance is valid if the first series of bonds is issued within one year of the approval and subsequent series of bonds are issued within three years after the first series. The new proposed public approval regulations are more liberal and may facilitate the efficiency of this approach. With that said, both issuer approval and host jurisdiction approval may be required at the beginning of the extended offering period.
The “Bond Resolution”
Some governmental issuers, by law, regulation, or internal policy, require that “substantially final” documentation be approved by the board of the governmental issuer as a condition of the approval. A substantially final submission rule will most likely necessitate that the governmental issuer approve each series prior to issuance, if substantially final means that the actual terms of the bonds to be offered and sold must be described in those documents, including a bond purchase agreement. Other governmental issuers may be more flexible and approve the issuance of bonds on the basis of “parameters” resolutions, authorizing bonds the terms of which fall within those parameters (such as principal amount, interest rates or methods by which interest rates are determined, redemption provisions, compensation to the underwriter, and maturity). There may be less ability to implement a shelf registration type program in jurisdictions where the governmental issuers have laws, regulations, or policies that require, directly or indirectly, that the board approve each series specifically under substantially final or similar submission requirements.
For those governmental issuers whose laws, regulations, or policies permit the adoption of broader resolutions that would delegate approval of the final terms to an officer, or permit the transaction to proceed as long as it is consistent with the parameters set forth in the resolution, the approval process would be similar to the process described below to be approved by the board of the borrower. If documentation is required to be presented to the board of the governmental issuer for approval, such documents should be as specific as possible, consistent with local and state laws and regulations and governmental issuer policy. A reporting mechanism might be appropriate, by which the borrower updates the board of the governmental issuer periodically as to status during the extended offering period.
Regulatory Approval
If bonds are intended to finance a project that requires regulatory approval under state law such as certificate of need, then the duration of the validity of relevant state regulatory approval of that project will affect when bonds must be issued (or perhaps proceeds applied) during the extended offering period. The shorter the approval duration, the more a Shelf Registration Program’s benefits may be diminished.
Borrower Approvals
Boards of not-for-profit corporations that frequently access the capital markets may be more comfortable with relatively broad authorizing resolutions than not-for-profit corporation boards that do not.
The borrower adopts a resolution authorizing the issuance of bonds in one or more series, for the extended offering period, subject to a maximum aggregate principal limit. The interest rates authorized may be fixed or variable, in no event to exceed a specified rate (which may be applicable to fixed-rate bonds only, or which also may apply to variable-rate bonds, meaning that the maximum authorized rate would be higher than one would expect for a variable-rate series of bonds). The compensation to the underwriter can be determined in the aggregate or on a per-series basis, with ranges based upon the type of bonds offered, sold, and delivered. The authorized maturity can be “generic” (i.e., the maturity of no bond can exceed “x years”).
A committee may be established, consisting of corporate officers, board members, non-officer management staff, or others depending upon the degree to which the board is comfortable with delegation to non-board members to approve the terms of each individual series. The committee also may be a standing committee of the board. The committee should be authorized to meet by telephone on minimum notice (if permitted by state law and corporate bylaws).
The resolution also should authorize the delivery of notes in series (subject to the maximum aggregate principal limit), under a base document such as a master trust indenture, to provide for parity position of the various creditors. Finally, the resolution should authorize derivative instruments, credit and liquidity facilities, and additional security (subject to certification by management of its necessity based upon market conditions) if anticipated (subject to certification as described above). The board should consider requiring management to deliver regular reports to the board during the extended offering period describing activity and progress.
The board also may determine that it is appropriate to include certain limitations on its approval. For example, the resolution may require that if a merger, acquisition, or divestiture occurs, or if certain specified financial conditions or performance standards (such as capitalization ratio, days-cash-on-hand levels, debt service coverage ratio, or cash-to-debt ratio) are not maintained or satisfied, then either the approval must be reviewed and possibly ratified (or modified), or reauthorized if the events or conditions occur. The resolutions also may expressly provide that the authorization is prospectively null if any specified event or condition occurs.
Tax Issues1
Although in general, each new series of bonds issued during the extended offering period is a new and separate “issue” for federal income tax purposes, it might be possible to structure a single series of bonds issued during that period that would be treated as a part of a single larger issue for tax purposes. In particular, the definition of issue contained in the federal tax regulations provides that “bonds issued pursuant to a draw-down loan are treated as part of a single issue.” The issue date of the issue is the first date on which the aggregate draws under the loan exceed the lesser of $50,000 or five-percent of the issue price. Little authority under this provision exists, but it is possible that a program could be structured to be the functional equivalent of a draw-down loan. Also, bonds issued on different dates are generally treated as the same issue for federal tax purposes if a purchase contract for all of the bonds is entered into at the same time. If such cases, it might be unnecessary to deliver complete new tax opinions to investors for each series (although it would still probably be prudent to have bond counsel render at least a “no adverse effect” opinion approving each new draw.)
Issuing bonds pursuant to a single plan of finance as separate issues rather than as a single issue could increase tax administration costs of the issuer or conduit borrower. For example, each separate bond issue will require separate rebate computations and private-use monitoring. In the case of qualified 501(c)(3) bonds, the borrower will generally be required to complete a Form 990 Schedule K for each separate bond issue.
On the other hand, in some cases issuing bonds as separate issues for tax purposes may be beneficial. For example, the American Recovery and Reinvestment Act of 2009 contains certain provisions intended to make “new money” bonds issued in 2009 and 2010 more marketable by providing preferential tax treatment that benefit certain types of purchasers (particularly banks). In the case of a plan of finance including bonds issued before and after 2010, it could be important to ensure that bonds issued on different dates are not treated as part of the same issue for tax purposes.
Before concluding this section, it is appropriate to touch on the change of law risk — the effective dates to new tax laws and tax regulations take a number of forms. On the one hand, certain tax law effective dates have been based on the date bonds are issued (in such an event, change of law risk would exist for bonds issued under a Shelf Registration Program). Other transitional rules have been more liberal; for example, some are based on the date that there is a binding contract for construction. For those reasons, although we do not care to speculate too much about change of law risk, we note that it could exist.
III. Implementation Considerations
1. Extended Offering Period Underwriting Agreement or Arrangements With a Financial Advisor
The parties to the transaction should consider binding themselves to the program at its onset pursuant to a contract referred as the “extended offering period underwriting, purchase and placement agreement.” Under this agreement, the investment banker agrees to underwrite various series of bonds during the extended offering period pursuant to a separate bond purchase agreement for each series (or for various series to be issued simultaneously), with customary conditions, indemnities, representations and warranties, and document delivery requirements to be included in each bond purchase agreement. The agreement may provide that the obligation of the investment banker to underwrite (or place) bonds during the extended offering period is subject to certain conditions, including, by way of example, the following:
- The investment banker is identified on the cover of the preliminary offering document as the underwriter.
- Each series is offered pursuant to an official statement (or other offering document) for that series.
- The investment banker is compensated for specified services and out-of-pocket expenses during the extended offering period, regardless of actual issuance and in addition to compensation for underwriting.
- The borrower agrees to update the preliminary offering document during the extended offering period.
- To the extent the transaction is not otherwise exempt from the provisions of SEC Rule 15c2-12, the borrower agrees to supplement a master continuing disclosure agreement or statement at the time the supplement referred to in the preceding clause is approved.
- The borrower agrees to cause its independent accountant to provide its consent to the use of the audit opinion in the preliminary offering document and each official statement.
- The borrower agrees to cause its independent accountant to provide an agreed-upon procedures letter (with the forms identified and attached to the agreement) as a condition to the execution of each bond purchase agreement.
- The governmental issuer and the borrower agree not to rescind, amend, or supplement their respective approving resolutions without notice to the investment banker. Any such rescission, amendment, or supplement would constitute cause for termination of the agreement by the investment banker.
One tax consideration concerning the single bond purchase contract arrangement is whether this type of agreement would be treated as establishing the date on which all of the bonds under the program are “sold”; if so, this type of agreement would result in the bonds being treated as a single issue. The analysis could depend on how the arrangement is drafted. If subsequent bond purchase contracts in substance establish the legal and financial obligation, the bonds would probably not be as sold under the overall agreement. For variable-rate bonds in particular, however, there could be a difficult question regarding whether bonds are sold under the original overall contract or under the subsequent bond purchase contract.
As an alternative to structuring a relationship with an investment banker for the duration of an extended offering period, the issuer and borrower may consider an arrangement with a financial advisory firm for the duration of the extended offering period, on many of the same terms described above (eliminating those that are obviously geared toward the underwriting process). Each series of revenue bonds offered and sold during the extended offering period can be purchased on a negotiated basis with the same investment banker or bankers, or perhaps sold through competitive bidding that is supervised and managed by the financial advisor. Investment banks will need to consider whether this arrangement triggers any additional net-capital requirements.
2. Core Bond Documents
The parties should be legally authorized to execute and deliver the core bond documents (bond trust indenture and supplements, escrow agreements, loan agreements and supplements, supplements to a master trust indenture) pursuant to the advance approvals of the governmental issuer and borrower. Bond indentures should be multi-modal to offer flexibility in reacting to current market conditions. Series can issued as additional bonds under a single bond indenture pursuant to supplemental bond indentures, so the conditions to issuance of additional bonds should be expressly stated.
Ideally, a bond indenture and loan agreement will be executed at the commencement of the extended offering period, pursuant to which securities of various series and modes may be issued during the extended offering period. Pursuant to the loan agreement, the borrower will agree to borrow the proceeds of each series of bonds as issued and sold.
If the borrower has created a credit group under a master trust indenture, each series can be secured separately by separate master notes issued pursuant to sequential supplemental master trust indentures. Each series will require its own bond purchase agreement, with customary terms as described generally above.
The borrower should enter into a continuing disclosure agreement at the commencement of the extended offering period, obligating itself to delivery identified information through the EMMA system. This advance undertaking also will allow for more consistent disclosure in the primary offering and eliminate the necessity of addressing continuing disclosure when each series is issued.
Each series will require its own tax agreement or certificate (or other appropriate designation of the document that typically includes representations and covenants associated with tax-exempt securities). Although consideration can be given to the use of a “master tax agreement” developed and executed at the commencement of the extended offering period, that master agreement could be of limited utility in some cases due to the fact- and number-intensive character of each series of bonds.
3. Due Diligence
At the beginning of the program, a “base due diligence review” should be planned and implemented, along with procedures to update that review periodically during the extended offering period. If as part of this Shelf Registration Program, the issuer or borrower creates and maintains an electronic records system that is accessible to finance team members who are responsible for the due diligence review, the team should be able to efficiently complete the periodic due diligence updates. Any review of any contracts relating to the use or proposed use of the financed facilities should be completed during that base due diligence review. Due diligence updates should occur prior to the date each subsequent offering document will be distributed to investors. Each due diligence update will entail, at a minimum:
- Interviews with senior management
- Reviews of corporate minutes of meetings conducted since the immediately preceding due diligence review
- Amendments to organizational documents
- Amendments to existing material contracts
- New material contracts, internal financial statements and information such as budgets, and other material facts that the parties can identify
4. Role of the Accountants
The process for independent accountant review, consent, and delivery of agreed-upon procedures letters to the underwriter should be efficient, while also recognize the inevitability of the accounting firm’s internal review processes.
Consents should be broad enough to include consent to using the audit opinion in not only the preliminary offering document, but in each supplement to it, or each offering document that is a component of the plan of finance to be entered into during the extended offering period. To provide clarity and certainty, the consent letters should be drafted to include that broader consent. Obviously, if the extended offering period extends beyond one fiscal year, or into a period of a succeeding fiscal year during which an audit opinion for a new set of financial statements will be issued, then consent extending beyond the end of the current fiscal year could not be supported.
Consideration should be given to the use of a procedures letter that is more flexible than that traditionally used. For example, a procedures letter can be requested in which the external auditors perform the “first part” of a traditional procedures letter (review of minutes and internal financial records and interviews and advice concerning operating performance and financial condition), with the borrower’s CFO certifying the “tie” between financial data in Appendix A to internal financial statements and schedules.
Additionally, consideration should be given to producing and filing comprehensive unaudited quarterly financial statements, including footnotes appropriate to the quarterly nature of the financial information, consistent with pertinent and current accounting industry rules and standards. A comprehensive set of quarterly footnotes will provide quantitatively more information to investors that some may consider as reliable, if not more reliable, than management discussion and analysis (MD&A) language that they typically review in quarterly and annual reports.
5. Legal Opinions
New opinions or “date downs” will be required for each issuance during the extended offering period. The challenge to the financing team will be to streamline the opinion issuance process. Consideration should be given to the use of an “evergreen” corporate (borrower counsel) opinion, with the delivery of confirming opinions on corporate and regulatory matters when each series of bonds is issued during the extended offering period. Corporate counsel will be required to identify the scope of its review to support the 10b-5 opinion. A new bond counsel opinion (unqualified) would be required for each issuance.
6. Credit and Liquidity Facilities
If the borrower anticipates that all or some of the bonds will be supported by credit or liquidity facilities, the duration of the commitment of the credit or liquidity facility provider should be negotiated and consistent with use during the extended offering period. The credit enhancer will, undoubtedly, impose conditions upon the issuance of each credit or liquidity facility such as maintenance of a base financial condition and financial performance standards, existence of no defaults or potential defaults and document delivery requirements, as well as an increased fee or a special extension fee.2
7. Derivative Products
If derivative products are anticipated for use for some or all of the series during the extended offering period, the ISDA Master Agreement, Schedule, and Credit Support Annex should be negotiated and executed at or prior to the commencement of the extended offering period, including the form of transaction confirmations. If the counterparty is willing, and assuming acceptable market conditions, the counterparty ought to commit, for an appropriate fee (or a premium on the fixed rate payable), on forward delivery. The parties also will need to address any regulatory changes to the existing derivatives regime that may be implemented by federal authorities during the extended offering period.
If the borrower anticipates that proceeds of some or all of the series are to be invested in trustee-held funds for a construction project, consideration should be given to a forward-delivery agreement, again for a fee based upon the duration of the forward-delivery period and principal amount of securities to be delivered.
8. Professional Fees
Transactional professionals may be averse to payment of fees at the conclusion of the extended offering period or payment sporadically at closings during the extended offering period and may require periodic payments during the extended offering period.
9. Closings
Each series will require a separate closing, with typical closing documents executed and delivered. However, it may be possible to abbreviate certain of the documents, as described above, including detailed certifications in favor of date-down certifications. Recent experience has shown that closings often can be handled electronically and by phone, rather than by physical presence, all of which should reduce professional fees.
10. “Stub Period” Financial Information; “Blackout” Period
As a general proposition, financial information is considered current under federal securities laws provided the securities are purchased within 135 days of the last day of the financial reporting period (quarterly stub period or annual). All other information must be current and comply with 10b-5 standards.
Consideration should be given to precluding issuance during the blackout period, which would commence on the 135th day following the end of the third fiscal quarter and the date on which the annual audited financial statements become available. This blackout period could range from a minimum of 30 to 45 days to 60 to 75 days. Use of unaudited fourth quarter “stubs” may be appropriate if investors are adequately informed of the year-end reconciliation, adjustment, and review process and the inherent risks, including, perhaps, a description of the borrower’s historical experience of the difference between unaudited and audited year-end financial statements. Some independent accounting firms will not consent to use of their audit opinions for prior fiscal periods if the offering document includes unaudited 12-month financial information.
1 In general, the IRS might be favorably disposed to a program such as the extended offering period program, because such a program could delay issuance of tax-exempt debt until the proceeds are actually needed (thus eliminating concerns about early issuance or over-issuance).
2 Credit market conditions may preclude a credit or liquidity facility provider from extending a commitment beyond a relatively short duration.
Legal News Alert is part of our ongoing commitment to providing up-to-the-minute information about pressing concerns or industry issues affecting our clients and colleagues.
If you have any questions about this alert or would like to discuss the topic further, please contact your Foley attorney or the following individuals:
Robert J. Zimmerman
Chicago, Illinois
312.832.4521
[email protected]
Janet E. Zeigler
Chicago, Illinois
312.832.4523
[email protected]
Heidi H. Jeffery
Chicago, Illinois
312.832.4518
[email protected]
Dana M. Lach
Madison, Wisconsin
Milwaukee, Wisconsin
608.258.4781
[email protected]
