curities if they rely in good faith on a state certification that these disclosure materials appear to comply with the requirements of applicable law. 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 announced that it is considering requiring municipal officials to certify as to the adequacy and accuracy of their disclosure documents and the Commission would certify that the information in these documents has been confirmed through other data available to the Commission. The provision we have recommended would give underwriters an incentive to encourage states to develop such procedures. Finally, there should be an express recognition of contribution rights, as well as an acknowledgement of the ability of municipal issuers to indemnify underwriters and others. We have further set forth below our views on the responsibilities of underwriters of municipal issues. 7. Section (f) (2) gives the SEC authority to make regulations regarding the delivery of distribution statements to prospective purchasers, while Section (c) (2) incorporates the Securities Act exemptions (Sections 4(1), 4(3) and 4(4)) from the prospectus delivery requirements. The SIA endorses the concept of requiring issuers to provide distribution statements to brokers, dealers and banks acting as agent and the idea of setting legislative limits on the duty of persons other than the issuer to deliver distribution statements to prospective purchasers. The patterns established under the Securities Act for corporate underwritings, however, may not be an appropriate model to follow in state and municipal offerings. Further thought should be given to the distribution statement delivery requirements that would make sense in the context of established patterns of state and municipal government financing, and legislative exemptions should be adopted that reflect this pattern. If the legislation leaves room for administrative rulemaking in this area, we believe the responsibility should be given to the Municipal Securities Rulemaking Board, rather than the SEC, since this is an activity that primarily involves brokers, dealers and bankers which are under the Board's jurisdiction. IV. STANDARDS OF RESPONSIBILITY We believe that any legislation should embody, or provide for the development of, specific standards for state and municipal issuers. At present, Rule 10b-5, the general anti-fraud rule issued under the Securities Exchange Act of 1934, is the source of legal accountability. State and municipal governments appear to be subject to Rule 10b-5, although constitutional questions have been raised concerning the extent of which a state is subject to suit for violation of the federal securities laws. More importantly, since it is so-called "implied" rights of action that have been created under Rule 10b-5, many basic issues remain unanswered. These include the type of conduct that will result in a liability under the Rule (whether the conduct must be wilful or simply negligent); the ability of an underwriter to rely on experts, such as accountants or governmental officials; and the extent of an issuer's or underwriter's liability for damages (whether for out-of-pocket damages or the benefit of the bargain). At this time, the nature of a person's responsibilities is uncertain and depends essentially upon the views of the particular United States Court of Appeals in which his conduct is adjudicated. This kind of uncertainty is undesirable and the Bill represents an appropriate opportunity to remedy it. We subscribe to certain basic principles, many of which Congress has already articulated in the federal securities laws. First, state and municipal issuers should have a degree of liability which reflects the critical factors that it is the state or municipality which receives the proceeds of the offering, and that it is the state or municipality which knows the facts about itself. The officials of the state and municipal governments are the ones who are aware of both the strengths and weaknesses of their governmental units. Their knowledge of the situation is primary and fundamental and not derivative like other participants in the process. Under these circumstances, the state or municipal issuer should have a primary and major accountabi for the disclosure material. We support the Bill's implied recognition that it is inappropriate to imp from the Securities Act the concept of an underwriters' obligation to condu a "due diligence" investigation. While the underwriters' investigation h. played a key role in the disclosure system that has been developed for corp rate offerings, we believe it is inappropriate in state and municipal financ where the institutional setting is different and where the Congress may b less willing than in the corporate area to run the risk of discouraging small to-medium issues through the high costs of disclosure. There should be no mistaking the fact that, if such a responsibility were imposed on underwriters of state and municipal securities, the cost of raising funds for state and local governments would increase substantially. The underwriter's role is further limited by the dominant part that competitive bidding plays in municipal finance. The laws of many states require that general obligation and revenue bonds be sold through competitive bidding. In states where negotiated sales are permitted, negotiated sales are used irpmarily for revenue-type bond issues, as well as by issuers that are infre quent visitors to the market or are relatively small borrowers. During 1975, there were 8,107 public offerings of state and local securities, virtually all of which were by sale to underwriting syndicates. Approximately 21% of these offerings were in negotiated underwritings while some 79% were competitively bid. We estimate that the comparable figures in the corporate field were 13% competitively bid and 87 percent negotiated. Consequently, we estimate that in 1975 there were 6,404 competitivly bid municipal offerings as compared to 110 competitively bid corporate offerings. In a competitive bidding situation the practice has been for the offering documents to be prepared exclusively by the municipal issuer and submitted to the bidding groups. The number of bidding groups will vary with the size of the issue and frequently there are six or more bids for an offering. Moreover underwriters may at any time be a part of several different groups that are bidding on different issues. It has not been the practice for underwriters in competitive bidding situations in the municipal area to participate in the preparation of the offering circular. At the same time, it should be recognized that the underwriters have been involved over several years in repeated financings for the issuer and, in general, are informed as to financial and political developments affecting the municipality. For a variety of reasons, including the typical quality and safety of the security involved, the large number of issues on which an underwriter is bidding, the fact that the bidder does not know whether it will be successful, the general time pressures involved and simple historical tradition, underwriters in competitive bidding situations have believed that their opportunities for inquiry were limited and that they were entitled to rely on documents prepared by responsible public officials. Where these documents on their face did not appear to adquately reflect possible problems known to the underwriters, the underwriters would either not bid or request the issuer to make appropriate revisions in its material. The obligations of an underwriter in a competitive bidding are unclear under present law. Counsel has advised that there is no authority on the subject. At the same it is possible that the courts may impose, under both Section 11 of the Securities Act of 1933 and Rule 10b-5 of the Securities Exchange Act of 1934, a standard of conduct on underwriters that takes into account the competitive bidding context. Thus, the reasonableness of the underwriter's conduct would be measured by such factors as its analysis of the offering documents, its past familiarity with the municipality, its lack of opportunity for inquiry and the relative safety of the security being offered. Moreover, the fact that it is a municipal security and not a corporate security is highly relevant. Unlike corporate officers that are employed by profit-making organizations and who may have a self interest in promoting their securities. public officials do not appear to have the same incentive. Underwriters and others, thus, should be entitled to rely on the statements of public officials. Congress has already recognized, in Section 11(b) (3) (D) of the Securities Act of 1933, the principle that statements made by an official person or pur porting to be an extract from a public official document may be relied on in the same manner as information furnished by an expert, such as an асcountant. We think that this acknowledgment of an ability to rely on the integrity and credibility of public officials is particularly appropriate in the circumstances of competitive bidding for municipal securities. Finally, we believe that any legislation should expressly set forth the measure and scope of damages. We have indicated in our analysis of the Bill the type of provisions that should be included in the legislation. V. REGULATORY STRUCTURE The regulatory framework in respect of administration, rulemaking and enforcement under a disclosure statute for municipal issuers raises, in our judgment, most difficult and sensitive questions of federal-state relations. These considerations underlay in part our previously articulated opposition to any requirement that municipalities pre-file their offering materials for review and "clearance" by the Commission. We do not have a fixed vision as to an appropriate structure. However, we do oppose the provisions of the Bill vesting the regulatory authority in the Securities and Exchange Commission. We believe that the disclosure rules and guidelines should be established initially, and subsequently interpreted, by a representative group of municipal issuers. These are the people most familiar with the problems of municipal finance and sensitive to its uniqueness and nuances; these are the people who must abide by the rules promulgated; and these are the representatives of the taxpayers who have a direct interest in the raising of capital and the cost of capital. We observe that the Commission would, in any case, be involved in the municipal issuer disclosure process since it would continue to have its authority to promulgate and enforce rules in respect of municipal securities dealers and rules under the anti-fraud provisions of the Federal Securities laws. Moreover, the Commission may be able to proceed against issuers who violate the anti-fraud provisions. One possibility would be to add a group of issuer representatives to the Municipal Securities Rulemaking Board, giving the issuer representatives responsibility for developing disclosure guidelines for state and municipal securities. These guidelines could be subject to review by the SEC in accordance with the existing legislative framework of the Rulemaking Board. We also believe that any regulatory structure should seek to effect a system of uniform regulation throughout the 50 states. The municipal securities market is a national market. It would be highly undesirable if different standards applied to the marketing of a single issue. Finally, we believe that every effort should be made to keep the costs of the regulatory structure to the necessary minimum. All additional costs will be passed on to the municipal issuers and render more expensive their raising of funds. Ultimately, these greater costs will be passed on to our citizens in terms of greater taxes. As we stated at the outset, the Securities Industry Association recognizes the benefits of legislation respecting municipal issuer disclosure. We also believe that this is not a situation where there is an immediate call to action, but an environment in which minimum disclosure standards may improve investor confidence and the ability of municipalities to market their securities at appropriate rates. Although there have been certain unfortunate developments in the municipal area, these cannot be blamed on the absence of disclosure laws alone. It should be clearly understood that a disclosure statute will not provide market access to financially unstable state or local governments. Moreover, the municipal securities markets have, in general, worked well to raise substantial sums for state and local governments at reasonable costs. This is clearly evidenced by the record level of financing that occurred in 1975. Thus, we must proceed cautiously so that costs and benefits are in balance. In conclusion, the Public Finance Council of the Securities Industry Association expresses its support for legislation that would produce improved and more uniform disclosure for municipal securities offerings. We offer our support in the context of the principles that we have outlined. We stand ready for further discussion to help achieve a satisfactory resolution. Sources: Short-term: Federal Reserve bulletin, Bank of America quote sheet; intermediate: Daily Bond Buyer. Rand and Co., "Yields on Municipal Issues''; Long-term: Moody's Bond Survey. 60.1 64.0 62.8 51.5 74.1 76.4 73.5 57.5 67.5 69.3 70.4 77.9 65.7 71.8 73.5 69.2 72.0 75.9 62.9 54.0 72.9 75.9 80.9 65.2 48.0 70.8 72.4 78.0 71.5 65.8 55.1 69.5 75.8 78.4 67.6 Senator WILLIAMS. The conclusion in the last paragraph describes this legislation and then indicates that this is what the Public Finance Council supports. That is the way I read your statement. Mr. SELLERS. Senator Williams, I think we have basically two problems with the bill as drafted. First, we think that State and local governments should have a greater voice in setting guidelines for their own issuers and that can be accomplished in any number of ways. I think our second problem is that we do not believe that the bill addresses fully the question of underwriters' liability. I think the problem in the marketplace is not just investors losing confidence because of inadequate disclosure, but of underwriters losing confidence because of too much liability. Senator WILLIAMS. Put aside for a moment the very complex liability questions, and deal with the guts of something new in the marketplace for municipals. That is a requirement for the disclosure of those essential elements for intelligent decisions by the underwriter and by the investor, and we do this mindful of the fact that there is not anything in existence now uniform throughout the country. There are spotty examples of very worthy requirements of disclosure at the State level. Everybody has mentioned North Carolina and evidently that State is the model that everybody applauds. Even they are in evolution and are about to impose additional requirements on the issuer. They are considering saying to the municipal officials or to their commission, rather, that the commission certify what comes to them from the local units government. Is that right? Mr. SELLERS. That's right, and in effect they are saying they have performed due diligence. We think if they say it that there should not be an additional requirement for us to perform it. |