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IRS panel recommends greater oversight of conduit bonds

The IRS has provided insufficient rules and guidance for conduit bonds, an increasingly popular way for companies and nonprofits to access tax-free financing, an IRS advisory committee says.

June 16, 2011|By Nathaniel Popper, Los Angeles Times

Reporting from New York — A controversial and often risky corner of the municipal bond market should be subject to more oversight, according to a new report by an advisory committee appointed by the Internal Revenue Service.

The report released Wednesday said the IRS has provided insufficient rules and guidance for issuing so-called conduit bonds, an increasingly popular way for private entities to access low-cost, tax-free municipal bond financing.

State and local governments are paid fees to issue these bonds on behalf of companies or nonprofits for projects to boost economic development. The public agencies are responsible for deciding which projects are eligible, including whether they have a clear public benefit and are not unduly risky. But the agencies frequently don't understand the rules and are given little instruction by the IRS, resulting in widely varying standards in the market, according to the report.

Conduit bond projects have included a casino resort and an exclusive airport for private jets. United Airlines, General Motors Co. and other large corporations have availed themselves of this low-cost financing as well.

"There is always a notion that these conduit issuers would play some meaningful oversight function, but that function has never been completely defined," said Michael Bailey, a Chicago tax lawyer and chairman of the IRS committee that wrote the report.

The conduit bond market has grown four times as fast as the broader municipal bond market in the last five years, according to the New York data firm Thomson Reuters. While they represent about 20% of the municipal bond market, conduit bonds are responsible for more than two-thirds of all municipal bond defaults in recent years, according to Income Securities Advisors, a Florida research firm.

The IRS report comes at a time when other authorities have also stepped up their scrutiny of conduit bonds.

The Securities and Exchange Commission is looking at increasing the amount of information that conduit bond borrowers have to provide to investors.

In California, an assemblyman has called for an audit of two of the state's largest conduit bond issuers.

Toby Rittner, the head of an umbrella organization for conduit bond issuers, said he welcomes clear direction from the IRS.

"A thorough review of conduit issuers and more direct supervision by the IRS are an important and welcomed step in continuing to ensure that tax-exempt bonds are administered with total transparency, accountability and due diligence," said Rittner, the president of the Council of Development Finance Agencies.

The report said that local public agencies have had wide leeway in determining their own policies, including the fees they charge the companies and nonprofits seeking conduit financing.

Some public agencies have charged only enough to cover the costs. In other cases, the report said, the agencies have charged fees "intended to maximize income to the issuer (at the expense of the conduit borrower)."

Recently, some public agencies have begun issuing bonds for projects in other cities and even other states, which, the report said, "raises a number of policy issues for Congress, the [IRS], and the community of conduit issuers."

The members of the advisory committee — all outside experts appointed by the IRS — provided a draft guide explaining the basic rules to issuers.

nathaniel.popper@latimes.com

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