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- - - ~~ __...... .. ~ ~-~+ronn n~ ~cetln 1 ' ! ' 1 ' Ftom; "Edward Einowski" <eeinowski@STOEL.COM> To: GWM1.M-MAR1(BWASSON) Date: Tue, Jul 25, 2000 10:07 AM Subject: Re: Arbitrage question There are two sets of arbitrage rules applicable to the two questions you posed. One set (relating to your first question and called the "Spend down rules") governs whether or not the County has to rebate positive arbitrage to the federal government. The second set (relating to your second question and called the "Temporary Period Rules") governs how you may invest the CoP proceeds without causing the CoPs to become taxable. The two sets are often confused, and iYs important to keep in mind that they govern different aspects of the federal tax-exempt of the CoPs. Here's how they play out in the context of the questions you raised: (1) Spend down Rules: Under the spend down rules, IF the County actually spends 100% of the CoP proceeds PLUS all investment earnings on the CoPs proceeds within a two year period commencing on the date the CoPs were issued, AND IF during that two year period the County met certain spend down bench marks, THEN if the County can keep all positive arbitrage earnings on the CoP proceeds. If the County fails to meet the two year spend down requirement, OR if the County fails to meet one or more of the spend down benchmarks, THEN the County must pay to the federall government all positive arbitrage it earned from the CoP proceeds. The benchmarks that must be met are: the County must have spent 10°/a of the CoP proceeds (and investment earnings thereon) within the first six month; 45% within the first year; 75% within the first 18 months; and 100% within 2 years. IT SHOULD BE NOTED THAT USING UNSPENT COP PROCEEDS TO PAY OFF PRINCIPAL OF THE COPS DOES NOT CONSTITUTE THE EXPENDITURE OF THOSE PROCEEDS FOR PURPOSES OF THE SPEND DOWN EXEMPTION. Thus, using unspent proceeds to pay off the principal of the CoPs will mean that the County will NOT qualify for the spend down exemption, but will be required to pay any positive arbitrage to thefederal government. There is a modest exception to these spend down requirements whereby the County can still meet the 2 year spend down exemption if, at the end of the 2 year period, it has 5% or less of the CoP proceeds (and investment earnings thereon) that have not been spend AND such unspent amount pertains to a"reasonable retainage" (i.e, a retainage to ensure compliance with the terms of a construction contract). There are also a number of finrists to these rules in various respects, which are too complicated to be set forth here but that will no doubt be taken into account by any competent arbitrage rebate consultant the County retains to determine whether it meets the spend down rules. In any event, the County's desire to use a portion of the unspent proceeds to pay down principal means that if the County implements this plan, it will not qualify for the spend down exemption and thus will have to pay any positive rebate to the federal government. Thus, I encourage the County to retain a rebate company to prepare a rebate report in order to determine whether there will be any positive arbitrage owing to the federal government. (2) The Temporary Period Rules: Totally separate from the Spend down rules are the Temporary Period Rules. If the County qualifies for the benefit of these rules (which it does, based on the County's expectations at the time the CoPs were issued), then it can invest the CoP proceeds at an UNRESTRICTED YIELD during a three year temporary period that began on the date the CoPs were issued. After the end of that three year period, any unspent proceeds can only be invested at a yeild that does not exceed the yield on the CoPs by more than 1/8th of one percent (a so-called "Restricted Yield"). Compliance with these Temporary Period Rules has NO EFFECT on whether the County must pay any positive arbitrage to the federal government. If the County fully complies with the Temporary Period Rules, it will still have to pay the positive arbitrage to the federal government if it fails to meet the requirements of the Spend Down Rules. (3) Rebate Analysts: While Stoel Rives can review the County's investments and spend down of CoP proceeds and prepare for the County a rebate report showing whether the County owes any positive arbitrage to the federal government, frankly we tend to be more expensive than other alternatives. This is because the arbitrage rebate calculations are primarily an accounting function, not a legal function. Thus,