Determining if a Guaranteed Investment Contract was Purchased at Fair Market Value


This issue snapshot addresses the rules applicable to establishing that a guaranteed investment contract was purchased at fair market value.

IRC Section and Treas. Regulation

IRC Section 148

Regulations Section 1.148-1

Regulations Section 1.148-5

Regulations Section 1.148-6

Regulations Section 1.1273-2(f)

Resources (Court Cases, Chief Counsel Advice, Revenue Rulings, Internal Resources)

The two documents below provide a summary of the settlement amounts in some of those cases.

SECDIG 2000-65-7 (S.E.C.), 2000 WL 352575

SEC News Press Release 2011-257



To address concerns that issuers would purchase investments with proceeds at artificially high prices, resulting in artificially lowering investment yields and reducing or avoiding rebate and or yield restriction, the IRS has, over time, established rules relating to the fair market value1 of investments purchased with bond proceeds.

The yield-burning schemes of the 1990’s revealed transaction participants, often an underwriter, who overcharged issuers for open-market Treasury securities sold for refunding escrows. The mark-ups reduced or “burned” the investment yields so that they were below the bond yield. In such cases, the issuer relied on certifications from providers of the securities that the prices paid reflected fair market value. However, an issuer does not have to profit from the arbitrage earnings for a violation to occur. Arbitrage profits can’t simply be given to someone other than the issuer and not create a yield restriction violation.

The yield-burning schemes also demonstrated that the manipulation of security prices was not limited to securities purchases on non-established markets2. Simply put, the availability of market information for investments in well established markets, although helpful, does not provide any guarantee that securities purchased or sold in these markets will be done so without abuse.

The investigation of bid-rigging of guaranteed investment contracts (“GICs”)3 in the municipal market revealed wide-spread price manipulation. The investigations resulted in hundreds of millions of dollars collected and jail time for participants involved in the bid-rigging.

In the GIC bid-rigging cases transaction participants either encouraged or allowed:

  • Courtesy bids;
  • Bids that were purposely non-competitive in order to direct business towards a particular GIC provider;
  • Last look opportunities for preferred bid providers;
  • Kick-backs disguised as some other form of payment; and
  • Tax-exempt status of the bonds put at risk due to misrepresentations provided by the transaction participants.

The arbitrage regulations dealing with establishing fair market value are extensive. In many ways, the arbitrage regulations are aimed at preventing an issuer from making a profit. However, the arbitrage rules also protect issuers from abusive transactions that risk the loss of the tax-exemption. Although the regulations provide many safeguards, no single process or no amount of rules can prevent a bad actor from rigging a bid or misrepresenting a price of a security. The rules and audit tips discussed below can be utilized by an examiner to uncover issues that may be present in a bond transaction when an issuer purchases a GIC.

Fair Market Value Requirement:

Regulation Section 1.148-6(c) provides that the purchase or sale of a nonpurpose investment cannot cause gross proceeds of an issue to be allocated to or away from a bond issue in an amount greater than or less than the fair market value of such nonpurpose investment. The reason for this rule is to prevent the purchase of a nonpurpose investment for an amount that exceeds the fair market value of that nonpurpose investment resulting in an artificially low yield. Similarly, if a nonpurpose investment is sold for a price less than its fair market value the yield would be reduced and what would be potential rebate is avoided.

If an Investment is not traded on an established securities market, as determined by reference to Regulation Section 1.1273-2(f), or if the investment does not qualify under any applicable safe harbor, there is a rebuttable presumption that the purchase of the investment was not made at fair market value.

Safe Harbor for GICS:

The Regulations deal with establishing the fair market value for GICs by providing the issuer a safe harbor. If the conditions of the safe harbor are satisfied, the Regulations ensure that the purchase price of the GIC will be treated as the fair market value of the GIC.

1993 Regulations, as amended in 1998, set forth the requirements an issuer must meet in order to establish fair market value under the safe harbor provisions for GICs. requirements are divided into five categories:

The issuer makes a bona fide solicitation for the purchase of the investment requirements;

  • The issuer receives bids meeting certain requirements;
  • The winning bid meets certain requirements;
  • The investment provider makes certain certifications; and
  • The issuer maintains certain records.

The requirements detailed below for each category listed above can be viewed as a check the box type of requirements that is common to all GICs in a municipal finance transaction. The requirements are a common sense approach to establishing fair market value. However, an examiner should view the requirements set forth in the Treasury regulations as a minimum standard for determining the presumption of fair market value. The audit tips that follow the requirements below are no less important and should be explored even when all the requirements appear to be satisfied.

The issuer must make a bona fide solicitation of bids. Pursuant to Section 1.148-5(d)(6)(iii)(A), to qualify under the safe harbor, a bona fide solicitation of bids must meet the following requirements:

  • The bid specifications are in writing and are timely forwarded to potential providers;
  • The bid specifications include all material terms of the bid, including any term that may directly or indirectly affect the yield or the cost of the investment;
  • The bid specifications must include a statement notifying potential providers that submission of the bids is a representation that the potential providers did not consult with any other potential provider about its bid, that the bid was determined without regard to any other formal or informal agreement and that the bid is not being submitted solely as a courtesy to the issuer or any other person;
  • The terms of the bid specifications must be commercially reasonable. A term is commercially reasonable if there is a legitimate business purpose for the term other than to increase the purchase price or reduce the yield on the investment;
  • The terms of the solicitation must take into account the issuer’s reasonably expected deposit and drawdown schedule for the amounts invested;
  • All potential providers have an equal opportunity to bid, including the requirement that no bidder be given a last look opportunity before providing a bid; and
  • No less than three reasonably competitive providers (providers that have an established industry reputation as a competitive provider of the type of investment being solicited for) are solicited for bids.

Once the bids are solicited, the bids received by the issuer must meet the following requirements:

  • The issuer must receive at least three bids from providers that do not have a material financial interest in the bond issue. A person or party with a material financial interest included:
    • A lead underwriter in a negotiated underwriting transaction until 15 days after the date of issue of the bonds;
    • Any entity acting in a financial advisory capacity with respect to the purchase of the investment; and
    • A provider that is a related party to a provider with a material financial interest in the bond issue.

Of the three bids received, one must be from a reasonably competitive provider as previously defined above; and

If the issuer uses a bidding agent in the solicitation process, the bidding agent must not bid to provide the investment.

For GICs, the winning bid requirement is satisfied if the winning bid is the highest yielding bona fide bid. For purposes of determining the highest yielding bid, the yield should be determined net of any broker’s fees. Therefore, the issuer must purchase the highest yielding GIC for which a qualifying bid is made.

The winning bidder must disclose if it is paying or expects to pay any administrative costs to third parties in connection with supplying the investment.

To satisfy the record keeping requirements, the issuer must maintain the following records with the bond issue transcript:

  • For a GIC, a copy of the investment contract;
  • The receipt or other record of the amount actually paid, including any administrative costs, by the issuer for the investments;
  • For each bid submitted, the name of the person and entity submitting the bid, the time and date of the bid, and the bid results;
  • The bid solicitation form. If the terms of the winning bid deviate from the bid solicitation form, the issuer must provide a statement explaining the deviation and the purpose for the deviation; and
  • The issuer must maintain the above noted items for no less than three years after the last outstanding bond is retired.

Upon satisfying the requirements noted above, the purchase price of the GIC will be treated as the fair market value of the GIC. Failure to satisfy the requirements above results in a rebuttable presumption that the GIC was not purchased at its fair market value.

REG-106143-07 (72 F.R. 54606) published on September 26, 2007 (“2007 Proposed Regulations”) amended the fair market value safe harbor for GICs. The amendments were made to accommodate for electronic bidding procedures and to amend the no last look rule.

Treasury Decision 9777 (81 F.R. 46582) published on July 18, 2016 (“Final Regulations”) adopted the changes to Regulation Section 1.148-5(d)(6) by revising paragraphs Section 1.148-5(d)(6)(iii)(A)(1) and Section 1.148-5(d)(6)(iii)(A)(6). The Final Regulations clarify that, for purposes of meeting the safe harbor for establishing fair market value for guaranteed investment contracts, bid specifications will be “in writing and timely forwarded to potential providers” if they are made available to providers on an internet website or other similar electronic media that is regularly used to post bid specifications. The Final Regulations clarify that a “writing” includes hard copy, fax, or e-mail.

Another proposed change from the 2007 Proposed Regulations that was adopted by the Final Regulations is that the no last look requirement will not fail to be satisfied by a potential provider reviewing other bids, so long as all potential providers have an equal opportunity to review all other bids.

Issue Indicators or Audit Tips

As noted above, even when all the requirements above appear to be satisfied, the potential for mispricing or abuse still exists. The presence of the following may present a compliance problem:

  • A standard bid sheet containing the following was not used for the bidding process;
    • Material terms stated;
    • Expected deposit amount;
    • Expected drawdown schedule; and
    • Any fee paid or received.
    • All parties to the transaction were given the same bid spec sheet.
  • Bid sheets with terms that are unclear;
  • Unusual terms that appear to be anything but standard when compared to other bid sheets;
    • This could be an attempt to manipulate the pool of potential bid providers.
  • Unusual terms that are not explained or justified;
  • Anomalies with bid dates and time;
    • Winning bidder placed the last bid;
    • Bids received over an unusual length of time; and
    • Missing details about the dates and time bids were received.
  • Wide variances in the bids received;
    • Were bid yields for long term investments less than short-term market rates?
  • Settlement sheet does not vary from spec sheet unless documented and the justification appears reasonable;
  • Failure to respond to bid requests;
  • Conflicts of interest:
    • Provider of the GIC is a related party to a party already involved in the transaction;
    • Parties with multiple roles;
    • Specialist brought in at the request of a party involved in the transaction;
    • Contingency fees; and
    • Parties to the transaction whose role is not clear.
  • The winning bidder was not the provider of the maximum yield;
  • Yield on the winning bid does not appear reasonable given the available market information;
    • If no information is available, compare yield on the GIC to the yield curve for United States Treasury Securities.
  • All the requirements for establishing fair market value were not satisfied;
  • The issuer does not have an established investment policy; and
  • The issuer does not have written post-issuance compliance procedures for arbitrage compliance.

1 Regulation Section 1.148-5(d)(6) defines the fair market value of an investment to mean the price at which a willing buyer would purchase an investment from a willing seller in a bona fide arms’ length transaction. Fair market value is usually determined on the date of sale (i.e., the trade date) or the date in which a contract to purchase or sell becomes binding. This date may differ from the closing date or the date of delivery of the investment.

2 Whether an investment is or is not traded on an established securities market, is determined by reference to Regulation Section 1.1273-2(f).

3 Regulation Section 1.148-1 defined a GIC as any nonpurpose investment that has a specifically negotiated withdrawal or reinvestment provisions and a specifically negotiated interest rate, and also includes any agreement to supply investments on two or more future dates (e.g. a forward supply contract).