IV. Suggestions for Permanent Relief
Neither the regulatory nor legislative relief from the AHYDO rules is sufficiently retroactive or long-lasting to cover the likely span of the economic crisis. Also, because these efforts were intended as temporary emergency responses to the crisis, neither was designed to prevent the rules from applying inappropriately in the future. However, the current relief does provide time to develop a more systematic solution to ensure that the rules function as intended in the future.
Both the regulatory and legislative relief provisions are designed to apply to a narrow period of time. Both sources of relief were made effective from dates during the third quarter of 2008: the revenue procedure from August 8, 2008, and the legislative relief from September 1, 2008. However, while the spread between corporate and federal borrowing rates diverged most dramatically after those dates, the spread had been widening throughout the year. Issuers caught by the AHYDO rules earlier in that year are not eligible for relief. Particularly vulnerable were less creditworthy borrowers who generally faced even higher interest rates and lower market values
for their debt instruments — the companies least able to absorb extra costs from the inappropriate operation of the rules.
Also, both sources of relief are designed to expire soon: the legislative provision through an explicit expiration date at the end of 2009, and the revenue procedure through the natural operation of its terms. These tight
expirations put pressure on corporate debtors to renegotiate their debt in 2009, although they may not know whether an amendment would ultimately be necessary for them. Any such negotiations impose additional costs on issuers and holders, and could alter the parties’ bargaining positions.
A. Suggested Treasury Guidance
1.Further suspension of AHYDO rules. Congress extends to Treasury broad powers to further suspend the AHYDO rules. In the newly created section
163(a)(5)(F)(iii), Treasury is permitted to suspend the AHYDO rules after the end of the congressional suspension (December 31, 2009) if ‘‘the Secretary determines that such application is appropriate in light of distressed conditions in the debt capital markets.’’ This provides Treasury the opportunity to suspend the rules not only in connection with the current crisis, but into the future as well. Neither the statute nor the legislative history limit Treasury’s ability to determine when ‘‘distressed conditions’’ exist.
With debt capital markets still fragile, the simplest intervention Treasury could make is to suspend the AHYDO rules for another year. This would not require complex drafting or resolution of authority questions. Moreover, it is highly unlikely that any 1980s-style mischief could be engineered in such a short time period.
2. Adjusting interest rate triggers. Congress also grants authority to use a rate higher than the AFR for purposes of determining the application of the AHYDO rules — but only on a temporary basis — if that rate is appropriate in light of distressed conditions in the debt capital markets. Treasury had authority under the original statute to permit a rate higher than the AFR to be used for debt instruments, but only if the rate were based on the same principles as the AFR. The new law permits Treasury to depart from the principles underlying government lending rates, but only on a temporary basis.
This new power granted Treasury is more difficult to exercise than the broader suspension power. It requires Treasury to monitor corporate borrowing rates relative to the federal government borrowing rates, and to issue guidance periodically advising taxpayers on some appropriate rate for the application of the AHYDO rules. The benefit of this power is that it allows Treasury to develop a formula, rather than a simple arithmetical relationship, to determine the AHYDO rate. But it does involve more
complicated policy decisions and timeliness in decision making. The experience from 2008 shows that neither of those resources may be available in an economic crisis.
3. Definition of issue price. The most egregious, and unexpected, source of distress from operation of the AHYDO rules results from the amendment of existing debt instruments. The ‘‘issue price’’ of the amended instrument is determined under rules that were written before the tremendous increase in electronic services providing information for the debt markets. Treasury needs to modernize the rules in reg. section 1.1273-2 setting the issue price of debt instruments. Those rules define market price in the broadest possible way. Issuers must consider even exploratory activity of holders who offer to sell, or third-party dealers who seek to buy, debt instruments, whether or not trades subject to the bid or offer terms actually take place. The current rules assume that markets for corporate debt securities are efficient in that market prices can be relied on to reflect the fundamental value of instruments. However, market prices reflect more than just the fundamentals of a particular security, and can be dramatically affected by swings in the demand for entire classes of assets.
One permanent solution would be for Treasury to update the issue price rules to narrow the definition of publicly traded property in reg. section 1.1273-2(f). Currently, an instrument is publicly traded if it merely appears on a quotation medium. Instead, the definition could be confined to relatively large, more liquid markets like the market for SEC-registered securities. The new definition could be modeled on the definition of publicly offered debt instruments in reg. section 1.1275-1(h): instruments that are registered with the SEC or would be required to be registered but for certain exemptions from registration. This approach has the advantage of requiring participation by the issuer for an instrument to meet the definition, creating more predictability for issuers.
B. Suggested Congressional Rulemaking
1. In general. For those who have arrived this far in the discussion, it should be clear that the AHYDO rules are diabolically complex. Congress did not have the time to revisit the rules in their entirety as the stimulus act
developed in 2009. In calmer times, there may be some value in developing less obtuse rules. Knowing that small wishes are more likely to be granted than grand ones, we suggest below a humble change in the code that would avoid many of the problems encountered in 2008.