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Municipal finance straining under growing rules, regs.

The federal government is intruding more than ever into the world of municipal finance. even though the 105th Congress is history, federal regulatory agencies are implementing and enforcing rules and regulations which can directly affect local authority and liability.

And voters, (tomorrow) and other beneficiaries of municipal bonds, are making decisions which can directly affect outstanding municipal bonds and credit ratings.

Cities Beware

In the last two years, the federal Securities and Exchange Commission (SEC) has brought enforcement actions against 50 municipalities. For cities and city elected leaders, these actions have meant federal investigations, threats, and a cloud over the cities' credit rating.

The actions have imposed significant costs on the cities to defend themselves and, in some cases, involved federal threats of fines in the millions of dollars, in addition to eliminating the tax-exempt status of outstanding municipal bonds. The actions by the independent federal regulatory agency have come as part of its crackdown on fraud and abuse in the municipal-bond market.

The intense federal scrutiny is not a result of pressure by the White House or Congress. Rather it appears to be part of an expanded attack by the agency on cities and municipal finance. The agency believes it has a responsibility to protect shareholders and bondholders, as opposed to taxpayers. The SEC has made "cleaning up" the $1.2 trillion municipal bond market a priority. This campaign is likely to grow.

1996 was the first time the SEC ever sought to bring charges against a single "general purpose" city or town for federal securities fraud. Prior to that time, the federal agency focused its attention on municipal bond dealers and advisors, or, in some instances, on special districts, or agencies that issue tax exempt debt, but cannot impose general purpose taxes or issue tax-exempt municipal general obligation bonds. Since 1996, the agency has widened its net and has even recently indicated its interest in holding cities liable for failure federal securities fraud for failure to disclose YK2 problems.

The SEC crackdown has targeted both small cities, without the resources to defend themselves against full-blown federal investigations and charges, and some of the nation's largest cities.

The widening SEC actions against cities and towns have come simultaneously with expanding investigations and actions by the Internal Revenue Service (IRS) against cities.

According to the IRS, the federal agency currently audits as many as 300 municipal tax-exempt bond transactions taken by cities and towns at any given time.

If the federal agency determines that a city or town has violated federal tax rules or regulations when it sells its bonds or notes to the public, the city's securities could lose their tax-exempt status, the city could find its credit rating in trouble, and the city's bondbolders could suddenly find themselves holding taxable instead of tax-exempt municipal bonds.

Arbitrary or Audits

Not to be outdone, the IRS is expanding its enforcement efforts against cities and towns. The agency plans to send questionnaires next year to 100 to 200 municipalities who issued tax-exempt municipal bonds in 1991 and 1992 as part of its expanding municipal bond audit program.

The federal agency is seeking to examine compliance with arbitrage and spending rules that applied to cities for the first time as a result of the Tax Reform Act of 1986. The IRS expects to send the questionnaires after April 1999 as the first phase of the project.

In the second phase, in 2000, the IRS may audit any of those surveyed cities or towns. The new effort will be starting at the same time the IRS moves to its next stage of following up its first bond audit program -- an examination of small-issue industrial development (idb) bond deals.

Most municipal bond attorneys concur that cities that receive a questionnaire from the IRS will not be subject to SEC disclosure requirements, because the questionnaires are random. Moreover, the IRS plans to publish educational materials on arbitrage requirements, filing 8038 forms, and the qualifications of small-issue bonds to help city officials understand their obligations under the tax code. Stay tuned.

That Burning Sensation

None of the above even counts the wide-ranging investigations by the SEC and the IRS of cities because of so-called yield-burning abuses. These investigations and audits of dozens and dozens of cities began in 1996. Generally they involve excessive markups on tax-exempt municipal bonds sold to cities or towns by investment houses or bankers to complete certain types of municipal bond deals, known as advance refundings.

By marking up the bonds, the underwriters can "burn" down their yields. This enables the underwriters to retain funds that, under IRS arbitrage rules, should have gone to the federal treasury. Often the yield burning rooked the city and its taxpayers.

Nevertheless, under the proposed IRS rules and regulations, it is the cities and towns, not bond dealers, who are targeted by the SEC and IRS subjected to investigations and audits -- even though both agencies have acknowledged that the municipality is often just as much a victim as the federal government. Under the current IRS practice even where the IRS has determined that the city or town is also a victim -- the IRS demands that the city enter into a financial settlement agreement with the IRS, or face having their bonds declared taxable.

According to the Treasury, the city is then free to sue the investment banker in order to make up for the cost of the settlement with the IRS.

More than a year ago, Vice President Al Gore committed to past NLC President Mark Schwartz that the federal government would cease targeting innocent cities and towns. The commitment remains to be honored.

GASPing About Y2K

The Governmental Accounting Standards Board (GASB) last week released a staff technical bulletin mandating cities and towns to provide disclosures with regard to the state of their year 2000 compliance, as well as the resources they have committed to the problem. The bulletin, Disclosures about Year 2000 Issues, is effective for municipal financial statements for auditors' reports dated after October 31, 1998.

The document calls on cities and towns to disclose:

* any significant amount of resources committed to making computer systems and equipment critical to municipal operations year 2000 compliant,

* a general description of how the city or tow-n is affected by the year 2000 issue, and

* information about the city's current stage of readiness.

Easier Riding

Congress did act on a municipal finance or tax issue this year, albeit in the surface transportation legislation, not on a tax bill. The new law, the Transportation Equity Act, Public Law 105-178 or TEA-21, includes provisions to allow cities and other employers to offer transit and vanpool benefits in place of payable compensation for taxable years beginning after December 31, 1998.

That means employees can elect to have before-tax money deducted from their paychecks to pay for transit passes, tokens, or vanpool reimbursement. The new lawact also raises the limit on nontaxable transit passes and vanpool benefits from $55 to $100 per month for taxable years beginning after Dec. 31, 2001.

This provision matches the tax treatment already in the law for employee prepaid parking benefits.

Many cities, including Washington, Los Angeles, and New York, already have transit subsidy programs that allow employers to provide their workers with a tax-free transit subsidy, typically a transit voucher program or a transit pass sales program.

Before TEA-21, employers who offered the transit benefits, which covered buses, subways, trains, and other public transportation, received a deduction on the costs incurred providing the benefit.

The deduction was related to the cost of the benefit, not the amount that the employees excluded from their income to pay for those commuting costs.

Will Your City Be Raided?

As if cities didn't have enough to worry about from bond referenda and federal pre-emption, now the NFL is on the offense. A California superior court judge has ruled that a lawsuit by the Oakland Raiders seeking to break the team's lease with the City of Oakland and Alameda County can proceed to trial.

The suit, if successful, could have a major fiscal impact on the city, county, and their bondholders. It could add to the turmoil surrounding efforts by professional sports franchises to take advantage of cities and city taxpayers.

And when it rains, it pours. Right on the heels of the lawsuit by the NFL Raiders, another tenant of the bond-financed facility, the Golden State Warriors, warned they face a significant loss of revenue due to the National Basketball Association strike. And, to make sure not to let someone else steal a base, the Oakland Athletics are nearing an option to terminate their lease and leave the facility, the city, and the city's taxpayers behind.

The Raiders' are suing to break their 16-year contract to play at the coliseum. The team claims it wants to renegotiate the contract.

The Raiders claim the city and county fraudulently promised sellout crowds if the team would move from Los Angeles to Oakland in 1995. The Coliseum Authority, a joint-powers agency, sold $200 million of municipal tax-exempt bonds to fix up the coliseum as part o the negotiations with the Raiders to try and get them to return to Oakland.

But already the many empty seats at Raider games have left the city holding the ball, diverting resources from the general funds to finance the city's debt service on the coliseum bonds.
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Title Annotation:federal intervention problems
Author:Shafroth, Frank
Publication:Nation's Cities Weekly
Date:Nov 2, 1998
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