Lawyer Criticizes Proposed Arbitrage Bond Restriction Regulations.

Richard F. Kane of Bricker & Eckler, Columbus, Ohio, has criticized the bidding requirement in the proposed regulations on arbitrage bond restrictions under section 148, stating that it won't provide issuers with certainty that they have purchased U.S. government securities at fair market value. Kane urges the Service to adopt, instead, regulations that permit issuers to rely on a certificate of the escrow provider concerning fair market value, without the need for a bidding process.

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November 7, 1996

Internal Revenue Service

Re: Proposed Treasury Regulations Section 1.148-5(d)(6)(iv)-(viii)

Ladies and Gentlemen:

[1] As you are now engaged in the process of considering the comments submitted to you relating to the above referenced proposed treasury regulations (the "Proposed Regulations"), I think it is appropriate that I bring to your attention information relating to a recent attempt to apply the Proposed Regulations.

[2] The State of Ohio, acting through the Treasurer of State ("State"), recently completed an advance refunding of certain bonds issued in 1989 (the "1989 Bonds"). The 1989 Bonds were issued as Tax Exempt Bonds, within the meaning of Treas. Reg. Sec. 1.150-1(b). The refunding bonds were issued as taxable bonds. Bricker & Eckler was Co-Bond Counsel for the refunding bonds.

[3] To assure compliance with the terms of the trust agreement governing the 1989 Bonds and with Section 148 of the Code, and the regulations promulgated thereunder, the State was required to acquire and deliver to an escrow trustee direct obligations of the United States (i) of such principal amounts and maturities and interest payment dates and bearing interest at such rates as to provide moneys sufficient, without reinvestment of thereof, to make timely payment of principal and interest on the 1989 Bonds, and (ii) producing a yield not greater than the yield on the 1989 Bonds.

[4] Given the relatively short defeasance period (the final maturity of the 1989 Bonds is September 1, 2000, and principal installments mature on March 1 and September 1 of each year up to that date), and the yield on the 1989 Bonds (6.917%), the State was reasonably confident that there was little possibility for "yield burning" regardless of the method used to acquire the escrow securities. However, at my suggestion, the State decided to attempt to acquire the escrow securities in a manner that would satisfy all of the provisions of the Proposed Regulations.

[5] I have enclosed a copy of the Notice of Escrow Purchase By Treasurer of State of the State of Ohio (the "Notice"), which Notice was distributed to a number of primary dealers in U.S. government securities approximately one week before the date (October 16th) on which offers were to be submitted. The State did not use a bidding agent to conduct the solicitation, as personnel in the Treasurer's Division of Investments have considerable experience in acquiring U.S. government securities.

[6] Notwithstanding the provision of the Notice that offers be submitted by 2:00 p.m., none of the offers were delivered timely to the State. Between 2:00 p.m. and approximately 3:17 p.m., the State received seven (7) offers sent by fax. Of these, only three (3) conformed to the terms of the Notice. With respect to the other four (4) offers, the offerors either failed to use the offer form attached as Exhibit A to the Notice or failed to properly complete and sign that form.

[7] The State sent a fax copy of the lowest priced (highest yield) offer to its verification agent, who confirmed that the offer satisfied both the defeasance and yield limitation requirements for the escrow. Prior to the 3:00 p.m. deadline for accepting an offer (per the conditions of the Notice), the State advised the low offeror that its offer was to be accepted. At that time, the offeror claimed that it's offer was no longer open and refused to confirm a sale of the escrow securities in accordance with its offer. Without waiving any rights which the State may have against that defaulting offeror, the State repeated the verification process with respect to the next lowest offeror and accepted that offer.

[8] I believe that the State's experience in connection with this escrow acquisition demonstrates that the Proposed Regulations may not be workable. The procedure adopted by the State was designed to afford all bidders an equal opportunity to bid (a requirement of the Proposed Regulations). Because of the requirement to verify the lowest bid for purposes of defeasance and yield limitation, the State appropriately notified prospective bidders that they would have to hold their bids open for at least an hour. Apparently, given the price fluctuations in the government securities market, the time period for holding the bids open was not considered acceptable, and as a result (i) all bids were submitted after the deadline for submission as set forth in the Notice, and (ii) the lowest bidder refused to honor its bid even though it was requested to do so before the end of the "hold open" period.

[9] Please note that since the advance refunding discussed above was accomplished with proceeds of a taxable bond issue, it was NOT necessary to simultaneously price and size the refunding issue while pricing and sizing the escrow. If this advance refunding had involved the issuance of Tax Exempt Bonds the proceeds of which were to be applied to acquire the escrow, the State (and the underwriter of the refunding bonds) would very likely have needed more time to evaluate the bids. It appears that the participants in the U.S. government securities markets are not currently prepared to grant the necessary time.

[10] In addition, the fact that four of the seven bidders refused to complete and sign the offer form may be an indication that prospective bidders are not currently prepared to make the representations contained in the last paragraph of the offer form; yet receipt of these representations by an issuer from the bidders is essential if the issuer is to comply with paragraphs (C) and (D) of Proposed Regulation Sec. 1.148-5(d)(6)(v).

[11] Based upon the foregoing experience, I respectfully suggest to the Commissioner that, while the objectives of the Proposed Regulations may be reasonable, it appears unlikely that they can be implemented in a manner that will provide issuers the certainty that they have purchased U.S. government securities at fair market value. I urge the Commissioner to adopt a regulation permitting issuers to rely on a certificate of the escrow provider as to fair market value, without the need for a bidding process. If evidence demonstrates that the certification is false, the Commissioner has adequate authority under Section 6700 of the Code to penalize the party making the certification.

Respectfully submitted,

Richard F. Kane

Copy: R. Headen, Esq., Chief General Counsel

NOTICE OF ESCROW PURCHASE

[12] WRITTEN OFFERS will be received by the Treasurer of State of the State of Ohio (the "Treasurer") at the office of the Treasurer on the 9th Floor of the Rhodes Office Tower, 30 East Broad Street, Columbus, Ohio 43215, until 2:00 p.m. Columbus, Ohio time, Wednesday, October 16th, for the sale to the Treasurer, on behalf the of State [sic] of Ohio (the "State"), of direct obligations of the United States of America (the "Escrow Securities"), which will be applied by the Treasurer, together with uninvested cash, to defease all outstanding State of Ohio Liquor Profits Refunding Bonds, Series 1989 (the "1989 Bonds").

[13] The Escrow Securities must be delivered on October 30, 1996 to National City Bank of Columbus, as Escrow Trustee (the "Trustee"). The Escrow Securities, together with uninvested cash which shall be delivered by the Treasurer to the Trustee on October 30, 1996, must be in such amounts and maturities as will provide, without further reinvestment of the proceeds thereof, the following amounts on the following dates:

     Date                         Amount

     March 1, 1997            $9,123,652.50

Types of Offers

[14] Offers must remain open for acceptance by the Treasurer until 3:00 p.m., Columbus, Ohio time, on Wednesday, October 16th. The Treasurer expects to enter into a bond purchase contract for the sale of State of Ohio Taxable Development Assistance Bonds, Series 1996 (the "1996 Bonds") on Wednesday, October 16, 1996. The Treasurer expects that the 1996 Bonds will be delivered on October 30, 1996, and a portion of the proceeds of the sale of the 1996 Bonds will be applied to the payment of the purchase price of the Escrow Securities on that date. THE TREASURER'S OBLIGATION TO PURCHASE THE ESCROW SECURITIES SHALL BE SUBJECT TO THE CONDITION THAT THE TREASURER SHALL HAVE RECEIVED THE PROCEEDS OF THE SALE OF THE 1996 BONDS ON OCTOBER 30, 1996.

Method of Award

[15] The Treasurer intends to accept the offer which provides the State with the highest yield, taking into account the purchase price of the Escrow Securities and the amount of uninvested cash delivered to the Trustee. Yield shall be determined in accordance with U.S. Treasury Reg. 1.148-5. The Treasurer has retained Grant Thornton LLP, certified public accountants, to determine the yield on each offer and to verify that the Escrow Securities together with the uninvested cash deposit associated with each proposal will produce the amount of funds at the times required, as set forth in the above table. If two or more offers produce the highest yield, the Treasurer will accept one of those offers chosen by lot.

Place of Delivery and Expenses

[16] The Escrow Securities must be delivered to an account of the Trustee at the Federal Reserve Bank of Cleveland on October 30, 1996 at the expense of the seller. The Trustee will provide the seller with delivery instructions. Subject to the condition set forth above regarding the Treasurer's obligation to purchase the Escrow Securities, payment for the Escrow Securities shall be made on the delivery date by wire transfer of immediately available funds.

Form of Proposal

[17] Proposals must be submitted on the form attached as Exhibit A (the "Offer Form") to this Notice of Escrow Purchase. Persons desiring to submit proposals by facsimile may do so at (614) 466-2499, but a person submitting a proposal by facsimile shall assume all risks associated with such form of submission. The Treasurer reserves the right to reject any or all of the proposals and will not accept a proposal if the purchase of the Escrow Securities contained therein and the application of those Escrow Securities to the defeasance of the 1989 Bonds would cause the 1989 Bonds to become arbitrage bonds within the meaning of Section 148 of the Internal Revenue Code of 1986, as amended, and the regulations promulgated thereunder.

[18] Copies of this Notice of Escrow Purchase and Offer Form may be obtained from James L. Summers, Chief Investment Officer, Office of the Treasurer of State of the State of Ohio, 9th Floor, 30 East Broad Street, Columbus, Ohio 43215, (614) 466-3511.

J. KENNETH BLACKWELL

October 9, 1996

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EXHIBIT A

OFFER TO

Offer Date: October 16, 1996, 2:00 p.m. Columbus, Ohio time

[19] Subject to the terms and conditions of the Treasurer of Ohio's Notice of Escrow Purchase, dated October 9, 1996 (the "Notice"), which terms and conditions are incorporated in this offer by reference, the undersigned hereby offers to sell to the Treasurer of State of the State of Ohio on October 30, 1996 the following DIRECT OBLIGATIONS OF THE UNITED STATES OF AMERICA, each at the price set forth in the following table:

                                       Security    Accrued     Total

     Total Cost of Escrow Securities                   _____________

_____________________

     (2) Accrued interest to October 30, 1996

[20] With respect to each security described above, the undersigned represents and warrants that (i) the Yield on the security, based on the price set forth above for such security, is significantly less than the yield then available from the undersigned on reasonably comparable direct obligations of the United States of America offered by the undersigned to other persons for purchase on terms comparable to those contained in the Notice from a source of funds other than Gross Proceeds of Tax-exempt Bonds; and (ii) the Yield on the security is not less than the highest yield available on the date hereof on a United States Treasury security -- State and Local Government Series from the United States Department of the Treasury, Bureau of Public Debt, with the same maturity. Terms used in this paragraph and not otherwise defined shall have the meanings set forth for such terms in the Internal Revenue Code of 1986, as amended and the regulations promulgated thereunder.

                                   Respectfully submitted,

                                By _______________________________

                                   Person to be contacted if this is

                                   _______________________________