Legal Opinion

The legend-removal opinion letter is an opinion letter from the issuer's counsel to a transfer agent. The SEC's investor publications on restricted securities describe it.

The Commission described the role of legal opinions in a 1981 report under Section 21(a) of the Exchange Act, Exchange Act Release No. 17831. In that report the Commission stated that legal opinions are often essential to the completion of the transactions, and that the parties and the investing public look to the opinion as the authoritative statement that the points opined upon are in order.

Bond Counsel Opinion on a Municipal New Issue

According to the MSRB glossary, bond counsel is an attorney or law firm retained, typically by the issuer, to give the traditional bond counsel opinion. The opinion customarily opines that the bonds have been validly issued and, if tax exemption is intended, that the bonds are tax-exempt bonds. It also may address related topics, such as state or local tax exemption and the enforceability of certain security provisions. The glossary entries for approving opinion and for bond counsel opinion each direct the reader to the entry for legal opinion.

Bond counsel also does work beyond the opinion. It may prepare, or review and advise the issuer regarding, authorizing resolutions, bond contracts, official statements, validation proceedings and litigation. The glossary lists three related roles for comparison: disclosure counsel, special tax counsel and underwriter's counsel.

The glossary defines a bond transcript as all legal and financial documents, including bond counsel's legal opinion and other opinions, associated with the offering of a new issue of municipal securities. It defines closing as the exchange of securities for payment in a new issue. Closing generally involves participation of representatives of the issuer, bond counsel, the underwriter and other relevant parties on the date of delivery of a new issue, and on the closing date the issuer delivers the securities and the requisite legal documents in exchange for the purchase price.

The MSRB's page on the tax treatment of municipal securities connects the opinion to the offering document. The official statement also typically includes the opinion of a law firm, usually referred to as bond counsel, addressing, among other things, the federal income tax exemption. The official statement for new issues of municipal securities generally includes a statement on the cover and other detailed information with respect to the tax-exempt status of the issue.

The same page describes limits on the exemption. In some cases interest on a municipal security is not tax-exempt. A bond initially issued as a tax-exempt bond can become a taxable bond if the issuer fails to comply with certain federal tax law requirements, which can have significant adverse consequences to bondholders. Municipal bonds often are referred to as tax-exempt bonds, although not all tax-exempt bonds are municipal securities.

The MSRB's guide to official statements describes an official statement as a document prepared by or on behalf of a state or local government in connection with a new issue of municipal securities. Legal opinions and tax considerations, together with pending proceedings that may affect the securities offered, are among the information it lists as typically included. Investors can obtain official statements on the MSRB's Electronic Municipal Market Access website, known as EMMA.

What the Municipal Tax Exemption Depends On

The MSRB's page on tax treatment describes the federal income tax exemption that the bond counsel opinion addresses. A distinguishing characteristic of most municipal securities is that the interest paid on them is exempt from federal income tax. For interest on a municipal security to be exempt from the investor's gross income for federal income tax purposes, the issuer must meet a number of requirements in the federal income tax code and regulations.

Taxable municipal securities can also be issued if the purpose of the issuer's financing does not meet certain public purpose or public use tests under the federal tax rules. Some taxable municipal securities are issued under special programs, such as the Build America Bonds program adopted as part of the American Recovery and Reinvestment Act of 2009.

A further category pays interest that is exempt from gross income under the ordinary federal income tax calculation but is nonetheless subject to the federal alternative minimum tax, or AMT. The official statement for such an issue normally will state that the securities are subject to the AMT, and in that case some of the benefits of tax-exemption may not be available to taxpayers who are subject to the AMT. For taxpayers subject to the AMT, certain tax preference items otherwise not subject to taxation, including interest on some private activity bonds, are added to the gross income of the taxpayer for purposes of calculating federal income tax liability.

On state tax treatment, the MSRB states that a state may provide an exemption from state income tax for interest on municipal securities in certain cases, that the specific provisions and conditions of such an exemption vary from state to state, and that not all states provide an exemption. In many states, investments by state residents in securities issued by the state or any other municipal issuer within the state will be provided with an exemption, but not investments in out-of-state bonds.

Delivery of Municipal Securities Without the Legal Opinion

The legal opinion has a role after the new issue, in the secondary market. MSRB Rule G-12 sets uniform practice for municipal securities transactions. Paragraph (e) of the rule is titled Delivery of Securities, and paragraph (e)(xi) is titled Delivery Without Legal Opinions or Other Documents. It provides that delivery of certificates without legal opinions or other documents legally required to accompany the certificates shall not constitute good delivery unless identified as ex legal at the time of trade.

Ex-legal or ex-legal delivery, as the MSRB glossary defines it, is a delivery of securities in physical form in the secondary market without a copy of the legal opinion being provided. The glossary directs the reader to its entry on good delivery.

Rule G-12 also addresses what follows a delivery that lacks the opinion. Paragraph (g)(iii) is titled Basis for Reclamation and Time Limits. Under paragraph (g)(iii)(A)(3), a reclamation on the ground that the delivery was not good delivery because a legal opinion or other documents referred to in paragraph (e)(xi) were missing shall be made within one business day following the date of delivery.

Legality Opinion in a Registered Offering

Item 601(b)(5)(i) of Regulation S-K requires an opinion of counsel as to the legality of the securities being registered, indicating whether they will, when sold, be legally issued, fully paid and non-assessable, and, if debt securities, whether they will be binding obligations of the registrant.

The Division of Corporation Finance explains the practice in Staff Legal Bulletin No. 19, titled Legality and Tax Opinions in Registered Offerings. The bulletin gives the views of the Division regarding legality and tax opinions filed in connection with registered offerings of securities, and it is not a rule, regulation or statement of the Commission.

According to the bulletin, Item 601(b)(5)(i) requires that all Securities Act filings include an opinion of counsel regarding the legality of the securities being offered and sold pursuant to the registration statement. Counsel's signed legality opinion must be filed as an exhibit to the registration statement before it becomes effective. The bulletin notes an exception for delayed shelf offerings under Rule 415(a)(1)(x).

For a U.S. corporation issuing capital stock, the bulletin lists what the opinion addresses: that the shares are legally, or validly, issued, fully paid, and non-assessable. When a registrant, whether a corporation, limited liability company, limited partnership or statutory trust, issues debt securities, counsel must opine that the debt securities will be binding obligations of the registrant. Counsel must opine on the law of the jurisdiction governing the agreement or instrument, and for foreign corporate registrants counsel must opine on the laws of the registrant's jurisdiction of incorporation.

The wording of the opinion depends on timing. For new issuances, the required opinion addresses whether the securities will be, when sold, legally issued. For resale registrations of already outstanding shares, the opinion should state that the shares are, and not will be, legally issued, fully paid and non-assessable.

The bulletin also limits what counsel may assume. It is inappropriate for counsel to include assumptions that are overly broad or that assume away the relevant issue, and counsel should not assume that the registrant has taken all corporate actions necessary to authorize the issuance of the securities.

For tax opinions, either legal counsel or an independent public or certified accountant can give an Item 601(b)(8) tax opinion supporting the tax consequences to shareholders described in the filing. All counsels providing legality or other legal opinions, and all counsels and accountants providing tax opinions, must consent to the prospectus discussion of the opinion, the reproduction of the opinion as an exhibit, and being named in the registration statement. The bulletin cites Securities Act Rule 436 for this requirement. The one exception to the consent requirement that the bulletin names is Rule 436(f), which addresses the situation in which the local counsel's opinion is relied upon in the primary counsel's opinion.

Opinion Letter for Removing a Restrictive Legend

The SEC's investor publication on Rule 144 states that if you acquire restricted securities, you almost always will receive a certificate stamped with a restrictive legend. The legend indicates that the securities may not be resold in the marketplace unless they are registered with the SEC or are exempt from the registration requirements. Certificates for control securities usually are not stamped with a legend.

The same publication states that even if you have met the conditions of Rule 144, you cannot sell your restricted securities to the public until you have gotten the legend removed from the certificate. Only a transfer agent can remove a restrictive legend, and the transfer agent will not remove the legend unless you have obtained the consent of the issuer, usually in the form of an opinion letter from the issuer's counsel, that the restrictive legend can be removed. Unless this happens, the transfer agent does not have the authority to remove the legend and permit execution of the trade in the marketplace.

A second SEC page, titled Restricted Securities: Removing the Restrictive Legend, gives the same sequence: the transfer agent will not remove the legend unless the issuer consents, usually in the form of an opinion letter from the issuer's counsel to the transfer agent. Removal of a legend is a matter solely in the discretion of the issuer. If a dispute arises about whether a restrictive legend can be removed, the SEC will not normally intervene, and state law, not federal law, covers disputes about the removal of legends.

The Rule 144 publication adds that removing the legend can be a complicated process requiring you to work with an attorney who specializes in securities law, and that to begin the process an investor should contact the company that issued the securities, or the transfer agent for the securities, to ask about the procedures for removing a legend. Both pages state that they are neither a legal interpretation nor a statement of SEC policy.

What Counsel Must Do Before Giving an Opinion

The 1981 Commission report on opinion letters describes American Bar Association Formal Opinion 335, issued in 1974, as relating to opinions written as the basis for transactions involving sales of unregistered securities. The report states that Formal Opinion 335 establishes that, as a matter of professional standards, a lawyer must make a preliminary inquiry of the client as to the relevant facts before rendering an opinion as to compliance with the federal securities laws.

Staff Legal Bulletin No. 19 makes a related point in its treatment of tax opinions: it is inappropriate to assume any legal conclusion underlying the opinion.

Common Misunderstandings

A legal opinion is not one standard document. The bond counsel opinion covers validity and tax exemption of a municipal new issue, the legality opinion covers the securities being registered, and the opinion letter to a transfer agent covers removal of a restrictive legend.

The bond counsel opinion is not the only opinion in a municipal new issue. The MSRB glossary lists disclosure counsel, special tax counsel and underwriter's counsel as related roles, and defines the bond transcript as including bond counsel's legal opinion and other opinions.

A bond's tax-exempt status can change after issuance. A bond initially issued as a tax-exempt bond can become a taxable bond if the issuer fails to comply with certain federal tax law requirements.

Municipal bonds and tax-exempt bonds overlap but are not the same group. Municipal bonds often are referred to as tax-exempt bonds, although not all tax-exempt bonds are municipal securities.

Delivery without the legal opinion has an exception in MSRB Rule G-12. Under paragraph (e)(xi), delivery of certificates without legal opinions or other documents legally required to accompany them does not constitute good delivery unless identified as ex legal at the time of trade. The glossary defines ex-legal delivery as a delivery without a copy of the legal opinion being provided.

Meeting the conditions of Rule 144 does not by itself allow a sale of restricted securities to the public. The legend must also be removed from the certificate first.

The SEC does not decide whether a restrictive legend comes off. Only a transfer agent can remove it, the transfer agent will not remove it without the issuer's consent, and removal is a matter solely in the discretion of the issuer.

The legality opinion in a registration statement is not optional. Item 601(b)(5)(i) of Regulation S-K requires it, with an exception noted in the staff bulletin for delayed shelf offerings.

Counsel may not assume the point being opined on. The staff bulletin states that it is inappropriate for counsel to include assumptions that assume away the relevant issue.

Key Points

The term legal opinion covers three different opinions: bond counsel's opinion on a municipal new issue, the opinion on legality of securities in a registration statement, and the opinion letter from an issuer's counsel on removing a restrictive legend.

The MSRB glossary states that the bond counsel opinion customarily opines that the bonds have been validly issued and, if tax exemption is intended, that the bonds are tax-exempt bonds.

MSRB Rule G-12(e)(xi) provides that delivery of certificates without legal opinions or other documents legally required to accompany them is not good delivery unless identified as ex legal at the time of trade.

Item 601(b)(5)(i) of Regulation S-K requires an opinion of counsel on whether the securities being registered will, when sold, be legally issued, fully paid and non-assessable and, for debt securities, whether they will be binding obligations of the registrant.

A transfer agent removes a restrictive legend only when the issuer consents, usually through an opinion letter from the issuer's counsel, according to the SEC's investor publications.

The Commission stated in 1981 that a lawyer must make a preliminary inquiry of the client as to the relevant facts before rendering an opinion as to compliance with the federal securities laws.