Cities Gain, Lose in Yield Burning's First Settlements

Article excerpt

Years of efforts paid off for some cities this month when the federal government shared big settlement agreements with cities that had been overcharged in refunding their municipal capital debts. The city of Birmingham, however, was not so lucky.

Birmingham, Ala., last week agreed to pay the Internal Revenue Service nearly $175,000 in the first-known settlement of yield-burning charges by a city or town.

The IRS, when it issued its initial proposed rules on yield burning, had projected it would collect in excess of $1 billion in charges from cities and towns who had paid too much when they refunded outstanding tax-exempt general obligation and revenue bonds earlier this decade to take advantage of sharp drops in interest rates.

The IRS agreed that in most instances cities were innocent victims themselves, but specifically chose not to work in partnership with cities to go after wrongdoers. Instead the IRS insisted cities turn around and sue investment advisors and securities firms in federal courts to both secure compensation for the overcharges they were forced to pay to the IRS, as well as to recover court costs and overcharges they sustained themselves.

Birmingham acted in the face of threats by the federal government to impose taxes on the interest on nearly $40 million in outstanding tax-exempt municipal refunding bonds the city issued in 1993. Birmingham Mayor Richard Arrington in February announced that the IRS had determined that the bonds could be declared taxable and said the city would "take all steps necessary" to preserve the tax-exempt status and protect its bondholders. As part of the settlement, the city's statement on the settlement stated that the IRS, the U.S Securities and Exchange Commission (SEC), and the NASD Regulation Inc. "all believe that the United States Treasury Securities, purchased in a negotiated transaction from Raymond James and Associates, were excessively marked up in a practice commonly known as "yield-burning. …