investigation would be unwarranted. Mr. Chairman, I suspect I'm speaking against my interests here-because I think if you provide by implication or directly an obligation on underwriters to conduct an independent investigation of the issuer, you could retitle the bill "The Lawyer Full Employment Act of 1976 Ad infinitem."

Senator WILLIAMS. This puts the responsibility and really the liability back on those who are certifying, doesn't it?

Mr. RATHBUN. Yes, sir.

Senator WILLIAMS. Now the independent auditor, he's the one that is going to have to shoulder the big burden. He will not be able to take figures that are given to him and consider that his only obligation.

Mr. RATHBUN. And he shouldn't.

Senator WILLIAMS. He is going to have to go back and look behind figures to see if there's any reason to doubt their authenticity. Mr. RATHBUN. You're right, Mr. Chairman, and an independent auditor should not accept the figures that are provided him. It's his obligation to

Senator WILLIAMS. Somewhere in the chain someone has to do more than accept as absolutely accurate figures that come to him. Mr. RATHBUN. And I think that's the proper function of the independent auditor.

Mr. KEZER. The presumption also is, if the underwriters had a responsibility to conduct a separate investigation, that they would then have to go back and revisit the numbers behind the numbers again.

Senator WILLIAMS. I gather ultimately the liability goes to the issuer and the individuals that are presenting the material that is to be disclosed. So the municipal official is really the one that faces ultimate liability. Are there constitutional questions here?

Mr. RATHBUN. Mr. Chairman, we have suggested that the public officials individually should not be subject to criminal liability in the absence of a knowing misstatement or omisson. This is essentially the same policy reflected in the securities laws today. But for willful violations, fraud, active fraud, if you will, we think it's appropriate for public officials to be subject to the criminal liabilities. We think that this is another mechanism which adds to investor protection.

As to the constitutionality point, Senator, my firm was recently asked for an opinion as to whether legislation placing these kinds of burdens on State and local officials would be constitutional, and our conclusion was, yes, that it would be.

Senator WILLIAMS. There would be no question where there was actionable fraud involved. What is the situation with respect to civil damages running against the individuals at the municipal level?

Mr. RATHBUN. Mr. Chairman, I have not really focused on that question. I would certainly think that for willful misstatements or omissions

Senator WILLIAMS. That is fraud.

Mr. RATHBUN. Right.

Senator WILLIAMS. But short of fraud, just plain negligence on the part of the individual?

Mr. RATHBUN. I think that liability would go to the issuer but would stop short of attaching to the issuing official.

Senator WILLIAMS. What forum would receive that question of civil damages running against the issuer?

Mr. RATHBUN. Well, typically, it could be brought in a Federal district court, because undoubtedly you would have purchasers of one State suing issuers of another. If that wasn't available, I assume it could be brought in the local courts.

Senator WILLIAMS. Now isn't that an 11th amendment question? I'll tell you, this isn't really the forum to struggle through some of these very, very complex and profound legal questions. You have written opinion letters in some of these areas, haven't you?

Mr. RATHBUN. We have, sir.

Senator WILLIAMS. I wonder if you could focus on this additional authority in terms of the civil liability and whether there are constitutional questions of bringing that into Federal court.

Mr. RATHBUN. We would be glad to.

Senator WILLIAMS. I wonder if you could speculate on whether this bill with its disclosure requirements, if it were to become law, would be another reason to allow banks to underwrite revenue bonds. Mr. KEZER. Most assuredly.

Senator WILLIAMS. You struggled long and hard on this and I thought

Mr. KEZER. I wanted to phrase as positive an answer as I could. Senator WILLIAMS. This would be an additional reason, would it not?

Mr. KEZER. Yes. It seems to me that we have now got the business itself, the markets, being regulated through the Municipal Securities Rulemaking Board. If we have legislative mandate for disclosure, it seems to me there's no reason why banks should not be permitted to underwrite investment quality revenue bonds, even absent this bill.

Senator WILLIAMS. Until this bill comes along, there's some question, isn't there?

Mr. KEZER. Yes.

Senator WILLIAMS. Thank you very much.

Mr. KEZER. Thank you.

Senator WILLIAMS. Mr. Wallace Sellers from Merrill Lynch Pierce, Fenner, & Smith, David Taylor from Continental Illinois National Bank and Trust Co. of Chicago, Gedale Horowitz, from Salomon Brothers, and William Hough, Municipal Federal Legislation Committee, Public Finance Council for the Public Finance Council of the Securities Industry Association.

Gentlemen, you're all present and accounted for and, Mr. Sellers, you appear to be chairman of this group.

STATEMENT OF WALLACE 0. SELLERS, MERRILL, LYNCH, PIERCE, FENNER, & SMITH, INC.; DAVID G. TAYLOR, CONTINENTAL ILLINOIS NATIONAL BANK & TRUST CO. OF CHICAGO; GEDALE B. HOROWITZ, SALOMON BROTHERS, CO-CHAIRMAN, MUNICIPAL FEDERAL LEGISLATION COMMITTEE; AND ARTHUR FLEISCHER, JR., FRIED, FRANK, HARRIS, SHRIVER & JACOBSON; FOR THE PUBLIC FINANCE COUNCIL OF THE SECURITIES INDUSTRY ASSOCIATION

Mr. SELLERS. I'm Wallace Sellers, chairman of the Public Finance Council of the Securities Industry Association, and vice president of Merrill Lynch, Pierce, Fenner, & Smith. With me today are Mr. David Taylor, executive vice president of Continental Illinois National Bank and vice chairman of the Public Finance Council; Mr. Gedale Horowitz, cochairman of the Municipal Federal Legislation Committee of the Public Finance Council, and partner of Salomon Brothers in New York; and Arthur Fleischer, a partner of Fried, Frank, Harris, Shriver, and Jacobson.

We are pleased to have the opportunity to testify before you today on S. 2969, the Municipal Securities Full Disclosure Act of 1976. We have previously submitted for the record a more fully detailed statement on our views of the bill as well as the general need for legislation mandating disclosure with respect to the issuance of municipal securities.

The Public Finance Council supports the concept of a Federal statute that provides a vehicle for creating uniform disclosure standards for offerings of State and municipal securities, and endorses the bill's approach of not simply repealing the exemption of municipal securities from the Securities Act of 1933.

Municipal issuers need a regulatory pattern different from the one applicable to corporate issuers. However, we believe the bill presently before the committee does not reflect all of the basic features which are essential in legislation relating to municipal issuers. Therefore, we recommend the enactment of legislation in accordance with the following principles:

One: Federal legislation should provide a vehicle for the creation of uniform standards for offerings of State and municipal securities. These disclosure guidelines should be set by an organization of State and municipal issuers. Regulation by State and municipal issuers would have several advantages. In the first place, it would enable Federal legislation to take into account very difficult and important questions of Federal-State relations. Second, this structure would give responsibility for writing regulations to the group that is most familiar with the requirements of State and municipal financng. Third, it would help enlist the support of the issuers on behalf of a Federal regulatory scheme. The SEC would still participate in the regulatory process for State and municipal securities through its responsibilities for enforcing the anti-fraud provsions of the Securities Exchange Act. Finally, disclosure guidelines develoned by an organization of issuers would also be more flexible in adapting to different types of issues and issuers and to changing conditions than if disclosure requirements were written into the legislation as the bill attempts to do.

Two: Offering circulars used in connection with the issuance or distribution of municipal securities should contain audited financial statements prepared in accordance with generally accepted accounting standards and certified by either independent public accountant or a duly constituted independent state auditing firm.

Three: One of the most encouraging developments in the field of municipal finance has been a movement by States to assume responsibility for disclosure by their municipal issuers. For example, the

local government commission of the State of North Carolina has recently announced that it is considering a procedure by which officials of municipal issuers would be required to certify information in their disclosure documents and the commission would certify that this information has been confirmed through other data available to the commission. The bill recognizes the benefits of State regulation in providing an exemption from the Federal disclosure system for offerings complying with the State disclosure requirements.

The Public Finance Council recommends enactment of a provision that underwriters and dealers should not be liable for misstatements or omissions in offering materials from municipal securities if they rely in good faith on a State certification that these disclosure terms appear to comply with the requirements of applicable law.

Senator WILLIAMS. When you say "rely in good faith," either they rely or they don't. What is "relying in good faith?" That suggests to me that you are inviting more investigation than just reading the attested documents. "Rely in good faith," what does that mean to you?

Mr. SELLERS. No, sir. I think if a State agency had certified that the disclosure document of an issuer is adequate and fulfills the requirements of the law, then I think the underwriters should be able to rely on that, period, unless he has knowledge that it is

Senator WILLIAMS. How would he get it? Does he go out and do his own investigation or does it just, by chance, come to him?

Mr. SELLER. Just by chance. I think if there is State certification

Senator WILLIAMS. No other requirement upon him?

Mr. SELLER. If there is State certification; no.

Mr. TAYLOR. The State has done the certifications.

Mr. SELLERS. And North Carolina will be doing this. They will say that disclosure is adequate.

Underwriters and dealers would, of course, continue to be legally responsible if they are aware of the material misstatements or omissions in the offering materials. An authorization for underwriters to rely on State certification would give underwriters an incentive to press for State regulation and would recognize the ability of the States to assume responsibility for disclosure of municipal issuers. It would also give appropriate recognition to a basic distinction between corporate and municipal underwriters. While corporate underwriters are generally done on a negotiated basis, most municipal offerings are competitively bid. This means that it is usually impracticable for underwriters of municipal securties to participate in the preparation of the offering circular or to make a type of investigation that is customary in negotiated corporate underwritings. Another basic principle applicable to municipal offerings is that issuers who receive the proceeds of any offering and who control and should have knowledge of the material facts should be primarily responsible for the contents of disclosure documents. Hence, in addition to the authorization for underwriters to rely on State certification of offering materials, there should be an express recognition of contribution rights as well as acknowledgement of the ability of municipal issuers to indemnify underwriters and others.

Four: The bill contains a provision limiting the liability for damages of an underwriter of municipal securities to the total price at which it sold securities to the public. This measure, while a desirable clarification of the law, needs to be expanded and refined. The ceiling on liability should apply to actions for rescission as well as suits for damages. It should protect not only underwriters-a Securities Act term which is not defined in the Securities Exchange Actbut any dealer who participates in the distribution process; and there should be a provision similar to the one in the Securities Act limiting the amount recoverable from such participants from the price at which the security was offered in public.

Five: Disclosure materials issued in connection with offerings of municipal securities should not be subject to prior review or approval by the SEC or any other Federal agency. The prior review concept was explicitly rejected by Congress when it enacted the 1975 amendments to the securities laws. We strenuously oppose the provisions of the bill that would appear to permit the SEC to institute such procedures.

Six: We are opposed to any exemption from the disclosure requirements for offerings of municipal securities based upon the size of the issuer. An exemption based on size tends to brand the exempt issue in the marketplace as an inferior class of security. The better way of handling this problem is to prescribe reduced disclosure requirements for these issuers. This committee stated that it was unaware of any abuses which would justify a radical incursion on the States' prerogative by overturning the exemption from the registration and disclosure processes of the Securities Act of 1933 and the Securities Exchange Act of 1934. It is our view that even in the absence of an express statutory disclosure system for municipal issuers, on balance, the financing of our municipalities has historically worked in an extraordinary fashion. Defaults on municipal bonds in the past have been so rare that since 1966 statistics on defaults have not been generally maintained. To be sure the Public Finance Council is concerned by the default of the Urban Development Corporation in New York, the moratorium for certain New York City obligations and evidence of financial instability in other municipal issuers. These factors appear to have affected investor confidence and have caused problems for certain issuers. We applaud the serious efforts which are being made to raise disclosure standards on a voluntary basis. We also clearly recognize that disclosure alone is not the answer to basic financial problems confronting certain municipalities. At the same time, the Public Finance Council would support a proposal for a mandatory disclosure system which does not unnecessarily increase the cost of municipal financing, which establishes reasonable standards of responsibility for the participants, and which produces a national system of minimum disclosure designed to enhance investor confidence in the municipal market.

In the context of the principles that we have outlined, we stand ready for further discussions to help achieve a satisfactory resolution and are willing to work with all interested parties toward this end.

Senator WILLIAMS. Thank you, Mr. Sellers. [Complete statement follows:]