Investment Company Institute Seeks Clarification of 'State or Local Bond Opinions'

The Investment Company Institute (the "Institute")¹ strongly supports the effort reflected in the recently-issued final and proposed regulations² to require additional disclosure for "covered opinions." We particularly support the treatment provided for state and local bond opinions. The regulation's exception from the definition of "covered opinions" for "State or local bond opinions" will facilitate the continued issuance of short, unqualified tax opinions for municipal bonds; these opinions are critical to permitting over one thousand muni bond funds to make efficient investment decisions with respect to these bonds.

As discussed in our earlier comment letters,³ an extensive discussion of tax considerations in an unqualified opinion on a bond's tax-exempt status would have disrupted significantly the municipal bond markets without providing meaningful offsetting benefits. Additional issue analysis in bond counsel's memoranda provided to the issuer achieves the regulations' objectives without undue market disruption.

We remain concerned, however, that disruption will occur in some aspects of the municipal bond markets without a few additional regulatory changes. Thus, we recommend that the regulations be clarified or revised to provide expressly that "no adverse effect" opinions, tender option bond program opinions, and opinions on qualified 501(c)(3) bonds are "State or local bond opinions." These transactions are either equivalent to an initial bond issuance or present comparable muni-bond market disruption considerations. We also recommend that "State or local bond opinion" be defined to expressly treat electronic communications as "written advice."

"No adverse effect" opinions are beneficial for the muni bond market. These opinions typically are issued, for example, in connection with qualified tender bonds that change remarketing modes (which occurs frequently) and credit enhancement providers (which occurs less frequently). These opinions are issued by bond counsel to provide bondholders with comfort that no disqualifying changes have been made that will affect the tax-exempt status of the bonds. These opinions thus provide muni bond funds with the requisite comfort that their shareholders will receive tax-exempt income.

Notice 88-130⁵, which applies to qualified tender option bonds, does not treat a change in remarketing periods as a change that would cause the bond to be treated as a reissuance. The Proposed Regulations would subject a "no adverse effect" opinion, issued in connection with a qualified tender bond that has experienced a change in remarketing periods, to standards that are different and more disruptive than those applied to the original bond opinion. Such a result would be ironic and inconsistent with both Circular 230 and Notice 88-130. Moreover, because the types of modifications addressed by "no adverse effect" opinions are routine, subjecting these opinions to the disclosure rules for "covered opinions" will be just as disruptive to the muni bond market as applying these rules to a "State or local bond opinion."

Rev. Proc. 2003-84 recognizes the important role that TOBs play in the municipal markets. Specifically, the Rev. Proc. revised otherwise applicable partnership rules because they were "incompatible with the needs of money market funds and of medium- and long-term bond funds that invest in obligations that produce interest that is exempt from tax."⁷

It would be inconsistent with the intent of the guidance of Rev. Proc. 2003-84 to impose different and more disruptive disclosure requirements on TOBs than on other tax-exempt municipal products. TOBs are as much a part of the municipal bond market as VRDNs and other tax exempt municipal bonds the opinions on which are "State or local bond opinions." Similar to VRDNs, clear standards for analyzing TOBs have evolved over time to ensure stability in a market that is extremely sensitive to deviations and uncertainty. Changing the disclosure standards applicable to TOBs will not only adversely affect TOBs, but also will disrupt the entire municipal bond market.

Consequently, the Institute urges clarification that these TOB opinions, including subsequent "no adverse effect" opinions, are "State or local bond opinions." The transactions covered by Rev. Proc. 2003-84 are so non-controversial and have been so thoroughly (and recently) examined by the IRS that they should not facilitate the types of transactions (e.g., income stripping of municipal bonds) that concern Government officials. Moreover, the contemporaneous documentation that would be required of TOB counsel on these "State or local bond opinions" should assist in preventing inappropriate offerings.

This requested clarification is important. Mutual funds regularly receive state and local bond opinions through electronic communication; typically, these opinions are attached to an electronic copy of the offering memorandum. Absent this clarification, tax opinions on municipal bonds might need to be delivered in paper form to satisfy the definition of "State and local bond opinion."

² TD 9165, December 17, 2004 and Prop. Reg. 159824-04, December 17, 2004.

³See Investment Company Institute letters dated March 4, 2004 and March 16, 2004.

⁴Treas. Reg. § 10.35(b)(9) defines "State or local bond opinion" in relevant part as:

⁶ 2003-48 I.R.B. 1159.

⁷ 2003-48 I.R.B. 1159, sec. 2 at 1161.

⁸ Treas. Reg. § 10.35(b)(2) provides in relevant part that "a covered opinion is written advice (including electronic communications) by a practitioner concerning one or more Federal tax issues." Treas. Reg. § 10.37(a) provides that practitioners "must not give written advice (including electronic communications) concerning one or more Federal tax issues if the practitioner bases the written advice on unreasonable factual or legal assumptions."