The Internal Revenue Service is kicking off the first round of audits of Build America Bonds and is asking issuers if any potentially related entities, such as pension plans, are buying their BABs, according to issuers and IRS officials.

The IRS is notifying several BAB issuers that their bonds are being audited and is asking them to provide information about their pricing, including who is purchasing them and how the proceeds are being allocated to expenditures.

Between 15 and 20 BAB audits are currently underway, Clifford Gannett, the IRS’ tax-exempt bond office director, said Friday.

“This year, we had planned to begin some audit activity” on BABs, he said. “It shouldn’t be viewed as singling out BABs. It’s just a part of the program that is functioning with respect to the muni bond market.”

The audits are not sufficient to constitute a targeted initiative from the IRS just yet, but could reach that point depending on what the agency finds in this initial group of audits, he added.

Gannett indicated that  the audits “for the most part” are random and that there is no reason at this point to believe the BABs have violated tax-law requirements.

San Antonio disclosed Wednesday that $375 million of its BABs, issued to finance capital improvements to its electric and gas systems, were under audit by the IRS.

The Texas city, which stressed the audit appears to be routine, said it is in the process of providing the IRS with its requested information.

The disclosures were made in a material event notice the city filed with the Municipal Securities Rulemaking Board’s EMMA system.

The IRS is attaching a four-page information document request to its letters announcing the audits, asking issuers to provide a number of documents tied to the BABs, including those relating to the pricing and sale of the bonds, as well as the names of each primary market purchaser, according to market participants.

But the question drawing the most attention from bond attorneys asks issuers to provide a record of any acquisition of the BABs in the primary or secondary market by or on behalf of the issuer; any agency, instrumentality, fund or affiliated person related to the issuer; or any pension plan sponsored by the issuer or in which the issuer participates.

The inclusion of pension plans is particularly raising eyebrows.

The BAB program has been touted as allowing municipal issuers to access new investors, including pension plans.

But now attorneys are wondering whether the IRS is concerned about pension plans in which issuer employees participate buying BABs from that issuer.

“This thing we saw in the [information document request] is the first thing we’ve seen … the IRS raise anything like this for BABs,” said Chas Cardall, a partner at Orrick, Herrington & Sutcliffe.

“Are they saying that there’s some issue if, unbeknownst to the issuer, some pension plan in which some of its employees are involved buys the bonds after they’ve been issued?” asked Perry Israel, an attorney with his own firm in Sacramento who chairs the National Association of Bond Lawyers’ tax committee.

“It’s not intended to indicate an infraction,” Gannett  said. “What we’re interested in is how transactions between related parties could affect the legal status of the bonds and potentially also impact how the bonds are priced.”

“It’s absolutely too early to conclude that everything they’re asking about in that question is a problem,” said Cardall.

“They wouldn’t have asked the question at all if they didn’t think at least something about it was a concern. They must be thinking that some closely related investor in some cases could be a problem,” he said. “Where that line ends up being drawn, they may not even have an idea at this point.”

Nevertheless, Cardall confirmed that Orrick is advising issuers for the time being to tell “potentially related investor entities” to not acquire any new or existing BABs, recovery zone economic development bonds, or tax-credit bonds sold by the issuer.

Fulbright & Jaworksi LLP and Shelton & Valadez PC served as co-bond counsel on the San Antonio deal. Public Financial Management Inc. and Estrada Hinojosa & Co. were co-financial advisers. McCall, Parkhurt & Horton LLP and Escamilla & Poneck Inc. were co-underwriters counsel.

The team of underwriters was led by Goldman, Sachs & Co. and included Barclays Capital, Morgan Keegan & Co., Ramirez & Co., RBC Capital Markets, Samco Capital Markets Inc., and Southwestern Capital Markets Inc.

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