Municipal Markets

BY Nixon Peabody LLP

Guiding Securities Law Principles in Municipal Securities Tender and Exchange Offers

With the elimination of advance refundings, the municipal securities market has seen an increase in tender and exchange offer transactions that serve as a work-around to advance refundings. In these transactions, issuers make a tender or exchange offer to existing holders of target bonds that it would have otherwise advance refunded (usually target bonds that it would otherwise advance refund on a taxable basis). Since the target bonds are being exchanged or sold for cash to the issuer, the transaction does not implicate the prohibition on advance refundings. In this article, we outline some of the securities law considerations that we have worked through in these transactions, which oftentimes we found not intuitive to our market.

What are these transactions?

The municipal securities market has now seen a number of these tender and exchange offer transactions that work around the advance refunding prohibition. Usually, they involve a series of target bonds that (1) would have otherwise been financially feasible to advance refund and (2) are predominately held by institutional investors with an interest in participating in a tender or exchange offer transaction. The transactions vary between pure tender offers—where the issuer offers a cash payment for any tendered target bonds—or an exchange offer—where the issuer offers to issue new tax-exempt bonds that serve to refund the target bonds. In addition, some transactions offer both options. These transactions are accompanied by one or both of an issuance of tax exempt bonds to pay any cash tender price or an issuance of taxable bonds to advance refund any target bonds not tendered or exchanged in the offer.
In these transactions, the issuer disseminates a tender offer or exchange offer solicitation, which sets forth the terms and conditions of the offer, including the consideration offered and the expiration date of the offer. In addition to the solicitation materials, the issuer disseminates disclosure materials concerning the financial and operating condition of the issuer, which can be as simple as attaching a preliminary official statement pursuant to which the transaction is offered.
The Depository Trust Company has established specific procedures for tender offers and exchange offers (as well as other decisions by security holders) that allow bondholders to elect to participate in the tender offer or exchange offer.

What are the laws that govern tender and exchange offers in the municipal securities market?

Tender and exchange offers in the municipal securities market are governed by federal antifraud laws like other offers of municipal securities. In ordinary offerings of municipal securities, Rule 10b-5 and Section 17(a) apply to the statements made in connection with those offerings and, very generally speaking, prohibit the issuer from making materially inaccurate or misleading statements and ban fraudulent and manipulative devices. These rules also apply to tender and exchange offers. Section 14(e) of the Securities Exchange Act of 1934 contains comparable prohibitions as Rule 10b-5 and Section 17(a) specific to tender offers.
Tender offers in the municipal securities market, however, are specifically exempt from the fairly proscriptive requirements governing tender offers in the corporate securities market under Regulation 14D and Regulation 14E. Those requirements include: The bidder must hold the tender offer open for twenty business days;
  • The bidder must extend the tender offer for ten business days if there are material changes to the tender offer;
  • The bidder must make specific disclosures to security holders focused on the terms of the offer and information about the bidder; and
  • The tender offer is required to contain procedural protections, such as the right to withdraw tendered securities during the offer, requiring tendered securities to be accepted on a pro-rata basis, and provisions protecting the equal treatment of security holders.
In 2015, the Division of Corporation Finance of the United States Securities and Exchange Commission (SEC) issued a no-action letter (Abbreviated Tender Offer Letter), permitting tender or exchange offers for non-convertible debt securities in the corporate securities market to be open for only five business days (instead of the twenty business days required by Regulation 14E) as long as a number of conditions and requirements are met to ensure the tender or exchange offer does not have any of the potential threats to security holders the longer time period aims to eliminate. We refer a lot to the Abbreviated Tender Offer Letter in this article for two reasons. First, since it applies to debt securities, it serves as a helpful guide to understanding which requirements of Regulation 14E the SEC do not believe are necessary to apply to debt securities in the corporate securities market. This can be a helpful analog to the municipal securities market (which only consists of debt securities). Second, the conditions and requirements specified in the letter detail the SEC’s concerns that underlie the more proscriptive rules and provide valuable insight into what tender and exchange offer practices might trigger potential federal antifraud law concerns from the SEC’s perspective.
In the corporate securities market, the general federal antifraud principles work in tandem with the specific proscriptions of Regulation 14D and Regulation 14E. The specific proscriptions explain and detail SEC expectations under the federal antifraud principles. The Abbreviated Tender Offer Letter is an effort by the SEC to reduce the burden of some of the proscriptive requirements of Regulation 14E because it does not view them as necessary from an anti-fraud perspective in the transactions described in the letter. The point is that the proscriptive rules exist for a reason—they largely represent what the SEC considers necessary to ensure full disclosure and fair treatment of security holders, which are the heart of the federal antifraud laws. Accordingly, the proscriptive rules from the corporate securities tender offer regime give valuable insight into how the SEC views the application of the federal antifraud laws in tender and exchange offer transactions.
In the municipal securities market, not being subject to Regulation 14D and Regulation 14E has positives and negatives. On the positive side, if we do not follow one of the specific rules in Regulation 14D or Regulation 14E, it is not a specific violation of law. On the negative side, unlike those in the corporate securities market, we do not have the interpretative framework for understanding how federal antifraud principles operate in our tender or exchange offer transactions. Accordingly, much of the “art” of determining a sound course of action for tender and exchange offers in the municipal securities market comes down to (1) understanding the driving concerns of the SEC in tender and exchange offer transactions, (2) using Regulation 14D and Regulation 14E (including the Abbreviated Tender Offer Letter) as guidance for understanding how the SEC will view our transactions, and (3) understanding how our transactions may be similar or different than the corporate securities transactions that are much more heavily regulated.

What are some of the guiding principles we should consider in tender and exchange offers of municipal securities?

Municipal securities transactions are different from corporate securities transactions, but both implicate similar sensitivities. Many of the specific tender offer rules promulgated for the corporate securities market have been developed with tender offers of equity securities, which involve a host of potential incentives and related potential abuses that are very different from the debt securities in the municipal securities market. One simple example is that a tender offer for equity securities can dramatically move the price of equity securities, which can represent an incentive and potential abuse that can be the focus of the SEC. In our experience, developing a sound legal approach to managing tender and exchange offers in the municipal securities market comes down to extracting the key sensitivities by which the SEC evaluates corporate tender and exchange offers and, then, considering those sensitivities in light of the specific municipal securities transaction. Here are some of the sensitivities that we have focused on in our municipal securities tender and exchange offer transactions:
  • Timing: do investors have enough time to receive and absorb the offering?
One of the principal SEC concerns reflected in the corporate securities tender offer regime is the amount of time an investor has to receive and consider a tender or exchange offer. The Abbreviated Tender Offer Letter sheds light on how the SEC decides whether the timing affords investors enough time to consider the offer. As long as the issuer is just making a tender offer in cash to investors, the letter allows issuers to shorten the time frame to five business days. But if the issuer is offering exchange securities, then the issuer may only use the abbreviated timeframe to make offers to qualified institutional buyers (QIBs) and not retail investors or other institutional investors. If the issuer is making such an offer to QIBs and non-QIBs are also security holders, the issuer can offer the non-QIBs cash even though it offers QIBs an opportunity to exchange securities. The point to this appears to be that the SEC does not want investors who may not be in the position to consider the merits of an exchange security to be forced to make a decision in this shortened timeframe. In addition, the Abbreviated Tender Offer Letter also addresses timing for amendments (changes to a consideration offered requires a new five-business-day period and other material changes just require a three-business-day extension). Thus, for the SEC timing involves a number of considerations. What kind of investors are being solicited? How complicated is the consideration they would receive? And, is there potential for investors to be forced to accept or reject an offer they do not really understand?
In municipal securities tender and exchange offer transactions, timing is oftentimes an important discussion point for a couple of reasons. First, once the issuer launches the tender or exchange offer, any change to the consideration will result in an amendment, which once again implicates timing concerns (under the Abbreviated Tender Offer Letter, changes in the consideration re-starts the five business day time period). That subjects the tender or exchange offer to shifting market conditions—the market can move in both directions, which can fundamentally alter how much the offer benefits the issuer or investors. Second, tender or exchange offers as an advance refunding solution are usually accompanied by a separate bond transaction that also needs to price and can only do so after the tender or exchange offer period has ended. While municipal securities tender and exchange offers are not subject to the specific timing rules of Regulation 14E, the SEC will likely interpret the federal antifraud law rules that apply in light of the same guiding principles. If issuers are going to shorten timeframes from those in Regulation 14E and the Abbreviated Tender Offer Letter, they should consider how these principles will operate and keep in mind that the SEC considers the corporate securities timing constraints to represent what it views as fair and necessary for comparable transactions. It is important for transaction participants to keep in mind that if the SEC concludes that investors were not given sufficient time to consider the offer, it could conclude that the federal antifraud law concerns to which even municipal securities are subject are implicated.
  • No duress: we need to be careful not to put investors in a position where there could be perceived coercion.
Another important SEC concern with tender and exchange offers is that investors are not placed in a coercive position. Much of the corporate securities tender offer regime arises from bidders using tender offers as a means to coerce investors into accepting tender offers or risk ending up in a much worse position if they don’t. These concerns are reflected in the Abbreviated Tender Offer Letter in that care has been developed to ensure that the Abbreviated Tender Offer Letter cannot be used in a coercive fashion. For example, the Abbreviated Tender Offer Letter cannot be used to finance the tender offer from the proceeds of senior indebtedness. It appears that this requirement arises from the concern that it could place investors who are subordinate creditors in the position of accepting the tender offer or risk holding onto the security with more senior debt above that position. The Abbreviated Tender Offer Letter contains other examples that evaluate the position of the investors before and after the tender or exchange offer and ensures that investors are not placed in a position of having to accept the tender or exchange offer out of fear of the consequences of being a security holder who did not accept the offer.
To the municipal securities market, refundings usually are routine transactions that we would not usually perceive as coercive. But it is important to keep in mind that the SEC will view the transaction from its perspective and not from ours. If an investor who does not accept a tender or exchange offer ends up with a small portion of an undefeased bond series that may suffer from liquidity concerns, the SEC may see the investor as financially compelled to accept the offer. As can be seen in the Abbreviated Tender Offer Letter, the SEC will scrutinize a tender or exchange offer far more if investors feel forced to accept the offer or end up in a deteriorated position. In our experience, there are usually ways of making the offer clearly devoid of any such duress—such as ensuring that any bonds not tendered or exchanged will be defeased or otherwise addressed appropriately. The important point is for transaction participants to view the tender or exchange offer through this lens.
  • Transparency
Transparency in a tender or exchange offer is a crucial SEC consideration. This comes in a couple of forms. First, much of the corporate securities tender offer regime focuses on the wide dissemination of the offer to all investors. In the Abbreviated Tender Offer Letter, this is addressed through a condition of immediate widespread dissemination. The SEC wants to ensure that all investors have equal opportunity to consider the offer and that investors are not trading in the security without knowing about the offer. Accordingly, the SEC is very focused on ensuring that all investors immediately know about the offer. In our transactions, we work to ensure that any tender or exchange offer is properly posted to all applicable CUSIP numbers on the Municipal Securities Rulemaking Board’s Electronic Municipal Market Access system to ensure fair and widespread dissemination of the offer.
In addition to widespread dissemination, the SEC is also concerned that all factors—both in favor of acceptance and rejection of the offer—are disclosed to investors. In our municipal securities offerings, we tend to focus on the facts that investors should consider when deciding to purchase the municipal securities and not on what to consider if they do not purchase the municipal securities since that is outside of the purview of the disclosure purposes of an offering. That makes disclosure and transparency in the context of a tender or exchange offer somewhat counterintuitive at times. As a security holder, the investor may have an improved position if it rejects the offer, which may be an important consideration that the investor should be aware of. In our tender or exchange offers as advance refunding solutions, an investor who does not accept the tender or exchange offer may end up with a defeased municipal security, which it may prefer. Further, in other tender or exchange offers, the issuer may have intentions post-offer that depend on the success or failure of the tender or exchange offer or other intentions that may favor acceptance or rejection of the offer. It is important that municipal securities participants understand that these other considerations may be counterintuitive, and it helps to intentionally think through whether these other factors are appropriately disclosed in a transaction.
  • Treat similar security holders similarly.
The SEC is also concerned that similar security holders are treated similarly. For example, per the Abbreviated Tender Offer Letter, the issuer must make the offer to all holders of the debt securities. Now, the SEC also recognizes that other considerations may argue in favor of establishing differences, such as we discuss above between QIBs and retail investors. But the SEC would likely be concerned if some investors are treated better than others when they are similarly situated security holders.
By way of example, our municipal securities tender offers that serve as advance refunding solutions can be more exposed to this concern than it appears at the surface. Usually, there are some specific institutional holders with an interest in exchanging securities instead of being defeased through a taxable refunding. It can intuitively make sense to make an offer just to those institutional holders, and maybe that produces sufficient savings that a taxable advance refunding is not even necessary at that point. As a result, we might treat those few institutional holders very differently than other holders of the same series of municipal securities. We believe it is important to develop a plan to similarly deal with all investors of the same class with comparable impact. This may result in offering exchange securities to some institutional holders and cash to retail and other institutional holders—but the total result of the offer should be fair and even to all holders of the same series or class of municipal securities.
  • Be careful of manipulative impacts on the market
As mentioned above, the SEC does not want offers to have manipulative impacts on the market for the securities. For example, all tender or exchange offers should be good-faith offers because any offer (especially for equity securities) will likely move the pricing of the securities and impact trading in the securities. The SEC would be especially concerned if a bidder ostensibly launches an offer, pricing of the target securities moves, the bidder benefits from that pricing move, and then the bidder withdraws the offer.
In the municipal securities market, we may not be as focused on how our transactions can move the pricing of municipal securities in the market. But with tender and exchange offers, we need to evaluate the totality of the offer with this in mind. For example, it may intuitively make sense for an issuer to launch a tender or exchange offer to test the market without the full intention of completing the tender or exchange offer. However, with the backdrop of its corporate securities experience and perspective, the SEC could consider this under the right facts as a violation of the federal antifraud laws if it gave the impression to investors that it was a good-faith offer when the SEC concludes it is not. Accordingly, transaction participants should consider whether the offer may impact pricing or give that appearance of such and whether the offer is appropriately launched given the issuer’s intentions and other factors.

Concluding Thoughts

While tender and exchange offers may implicate a host of counterintuitive considerations, they are not, for the most part, complicated. For us in the municipal securities market, it is important that we not view the proscriptive rules as irrelevant to our transactions simply because we are exempt from Regulation 14D and Regulation 14E. We have found those rules helpful in understanding the underlying concerns of the SEC and how the SEC may see a transaction as violating federal antifraud laws.
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