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Commission has instituted at least five such actions. At no time has the commission stated a public concern in respect of a lack of power under the Federal securities laws except to the extent that they sought and received additional statutory authority with respect to regulation of brokers and dealers who dealt in municipal securities. Those powers were granted to them in the Securities Acts Amendments of 1975. In addition, this Committee in its report dated April 14, 1975 with respect to such legislation stated at p. 43: “The Committee believes the municipal securities markets have, in the main, performed their debt financing functions for state and local governments with commendable efficiency and integrity". The Securities Acts Amendments of 1975 were enacted to provide additional enforcement tools to the Commission to help combat those few abuses which did exist. In fact the Committee stated in the report at page 44 :
"The Committee is mindful of the historical relationship between the federal securities laws and issuers of municipal securities. Apart from the general antifraud provision, municipal securities are exempt from all substantive requirements. Most significantly, this means that state and local governments do not have to comply with the registration and disclosure requirements of the Securities Act of 1933. The bill does not in any way change this pattern, for the Committee is not aware of any abuses which would justify such a radical incursion on states' prerogatives".
The antifraud provisions require adequate and full disclosure of all material facts necessary for an investor to make an investment decision with respect to the proposed purchase of municipal securities. Neither of the two bills before you changes that requirement nor does either add to the protection afforded proposed investors from that presently prevailing as aforementioned. Full disclosure is full disclosure without more. The proposed legislation before you accomplishes nothing more than to provide further Federal involvement and governmental decisions with respect to what it considers to be material or adequate disclosure. Also involved in the process is the possibility of substantial red tape and additional costs involved in the registration of or reporting requirements related to municipal securities. The concept of full disclosure which had its foundations in the above-mentioned antifraud provisions is a fair and flexible standard and is now fully adequate for the protection of investors. Therefore, in my opinion there is no need for the enactment of the legislation before you.
There will also be some very practical problems if either piece of legislation is enacted. These problems arise because of the diversity of types of municipal securities and governmental units. The U.S. Bureau of Census reported in 1972 that there were 78,267 state and local governmental units classified in the following categories :
50 3, 044 16, 991 18, 516 15, 780 23, 886
The number of local governmental units varies considerably from state to state because there is a greater proliferation of units in some jurisdictions than in others. The characteristics of such units and the varied types of municipal securities they are empowered to issue usually differ from state to state and differ from each other within each state. The figures shown and the differing characteristics make unified disclosure requirements extremely difficult if not impossible.
Attempts are being made for improvements in the disclosure made in connection with municipal issuers. As you are aware, a project has been underway for over a year that is designed to assist in satisfying the increased needs for investor information and the increased concern of issuers as to achieving compliance with the antifraud provisions of the Federal securities laws. The project, involving a broad cross section of bond participants and professionals, has been sponsored by the Municipal Finance Officers Association, whose
participation has been financed, in part, by a grant from the National Science Foundation.
A major product of the project has been the preparation and dissemination of suggested guidelines for information documents used in municipal securities offerings. While the guidelines are not intended to be legally binding they are suggestions of information which may be disclosed in offerings of municipal securities. They are not intended to create disclosure requirements or a legal obligation to disclose any or all items of information suggested. The guidelines have been submitted for comment to municipal issuers and other interested parties and comments are being received by the Municipal Finance Officers Association at the present time.
In any case, municipal issuers are preparing full disclosure documents which surpass the level of disclosure suggested in S. 2969. In short, the problem this Subcommittee is focusing upon is being fully solved by municipal issuers and the securities industry without any Federal supervision.
I would also like to point out to the Subcommittee that the sovereign states have Constitutionally protected powers and that the Federal government should be cautious in any approach to limiting these powers.
I suggest that adequate protection for investors can continue to be achieved by (a) the continued enforcement of the antifraud provisions by the Securities and Exchange Commission, which continued enforcement constitutes a substantial inducement for adequate and full disclosure in connection with the offer and sale of municipal securities; and (b) the adoption of the guideline approach proposed by the Municipal Finance Officers Association with the support of the securities industry. Such support would have a prophylactic effect on municipal issuers. The securities industry would refrain from underwriting obligations of municipal issuers where it has been furnished inadequate information on when there has not been full disclosure. Where there is full and fair disclosure of material facts in connection with a municipal issue, the securities industry would fully support and underwrite such an issue.
In conclusion, I recommend that Congress not enact either of the two bills before you. Full disclosure, which we all favor, is presently being provided for by the issuers themselves, as well as by the underwriters of their securities. To require the Commission to set the standards for disclosure in this very complex and sensitive area would be to complicate rather than simplify the problem.
Thank you very much.
Senator WILLIAMS. I would like to turn to a former eminent member of the Securities and Exchange Commission, Mr. Smith.
STATEMENT OF RICHARD B. SMITH, DAVIS, POLK, & WARDWELL,
NEW YORK CITY
Mr. SMITH. Good afternoon, Mr. Chairman. My name is Richard B. Smith. I am a lawyer practicing in New York City, a member of the firm of Davis, Polk & Wardwell. I also serve as chairman of the Subcommittee on Municipal and Governmental Obligations of the American Bar Association's Committee on Federal Regulation of Securities, the capacity in which I have been invited to testify. My remarks, however, are my own individually, since I have not had an opportunity to review my testimony with the members of either the committee or the subcommittee and my comments in no way reflect an official position of the American Bar Association.
Because of the short period of time between my being asked to appear on this panel and today's hearing, it was not possible for me to comply with the committee's usual 48-hour procedure. I would, with the permission of the chairman, like to submit for the record following the hearings my prepared statement and touch on several of the items today.
Senator WILLIAMS. Very well.
[Mr. Smith's prepared statement is not substantially different from his testimony and with his permission is not printed here.]
Mr. SMITH. If time permits, I would also like to canvass my committee members for comments on the legislation for the assistance of the staff.
I should also like to point out that unlike the two witnesses appearing with me, I am not a municipal bond attorney. However, I have had some background and experience on the corporate side of the securities market and in the course of counseling with a major underwriter of municipal securities have been giving thought to municipal securities matters. Perhaps that perspective may be of some assistance to the committee in considering the legislation before it. I should also point out that from 1967 until 1971 I was a Commissioner on the Securities and Exchange Commission, which may account somewhat for some difference in viewpoint among us about the legislation.
I shall address my comments to S. 2969 and hope they will be viewed as constructive for I want to say at the outset that I am strongly in favor of requiring increased disclosure in the municipal securities market and removing a number of the uncertainties now plaguing issuers, underwriters, and investors in that market. Feeling that a framework of Federal legislation is probably necessary to achieve those objectives, I am in sympathy with the legislative effort. The threshold question in considering the desirability of legislation in this area is whether a system for uniform and comparable disclosure about municipal issuers is sufficiently valuable considering its expense. On the heels of that question comes the question whether it is necessary to make such a system mandatory at the Federal level. Somehow, there doesn't seem to me to be an alternative to developing a new system of required disclosure once the market develops a perception of risk from the absence of information, and since the municipal securities market is nationwide, a framework of Federal legislation seems needed to reach across State lines.
First, a subsidiary comment on the bill. S. 2969, in addition to its main purpose of adding a new section 13A to the Securities Exchange Act of 1934 that would require disclosure by municipal issuers, would also effect amendments to existing provisions of the act. I am somewhat perplexed about the need for at least one of those proposed amendments.
The bill would amend section 15B (d)(1) of the 1934 act, the so-called Tower amendment, by deleting the prohibition against the Commission's requiring any issuer of municipal securities to make a filing with the Commission “prior to the sale of such securities." Proposed section 13A, as contained in the bill, however, gives no express power to the Commission to require any filing with it by a municipal issuer either prior to or after a sale. Therefore, the deletion of the prohibition seems ambiguous. It may be that the bill intends to confer on the Commission that power by the language in its sections (a)(1) and (b)(1) requiring an issuer of municipal securities to prepare either an annual report or a distribution statement in accordance with such rules and regulations as the Commission may prescribe as being necessary or appropriate in the public interest or for the protection of investors.
69-141 O. 76 - 16
Now, if the legislative intention is thereby to empower the Commission to require the filing with it of municipal disclosure documents at any time, this language seems a somewhat disingenuous way to do it. Filing with the Commission does not seem particularly consistent with the issuer document maintenance and central repository concepts contained in paragraph (f) (3) of the bill. Moreover, the 1934 act's only process for preusage filing with the Commission is the review of proxy material, clearly not applicable to municipal issuers. The only other process of preusage filings that have been developed by the SEC exists under the 1933 act which the bill does not touch. If preusage filings are to be required of municipal issuers, or indeed filing at any time with the Commission, this should be provided explicitly in the bill as it is obviously a sensitive issue. If the bill does not intend to empower the Commission to require filings with it, then the proposed change in the Tower amendment seems unnecessary.
Now as to proposed section 13A, which is S. 2969's principal purpose, I shall comment briefly on seven aspects.
First, annual reports provided for in paragraph (a) of section 13A. The bill, in my judgment, properly focuses on systematic annual reporting by municipal issuers. I know of no governmental unit that is not already required to provide an annual accounting of some kind for the unit's financial affairs. So the bill simply recognizes that fact, albeit putting more structure into the process. But the point is, that this should be done anyway and a number of sound governmental purposes, in addition to disclosure to investors, will be enhanced by the development of a comprehensible annual report. [Indeed, so as not to throw bricks, one might be useful at the Federal Government level.] The bill is silent as to the time within which such an annual report is to be provided. This can be a troublesome point. Is the SEC to be guided by the 90-day requirement for corporate issuers? Or the 120-day requirement that preceded it? Should there not be congressional direction in this respect? How is it contemplated that the Commission would enforce noncompliance?
The bill is not explicit on whether the distribution statement can simply incorporate by reference material in the annual report. I trust this is what the bill intends, because every effort should be made to keep down expense and delay of offerings. The distribution statement could well be kept limited to a description of the terms of the security, the underwriting arrangements and an updating of material information since the last annual report. It would be helpful if the statute made clear that an issuer and underwriter would be protected from liability in the use of such an abbreviated distribution statement so long as the last annual report has been
given reasonable prior circulation, complies with the disclosure requirements applicable to it, and is readily available to a prospective purchaser upon request from the issuer and the underwriters.
The second point I'd like to comment on is, while the bill specifies a minimum of $50 million of debt outstanding to trigger the annual report requirement and a $5 million of debt being offered to trigger the distribution statement requirement, it then empowers the Commission to change those amounts, presumably either up or down, with no meaningful standards to guide it in exercising that power. The only basis I can think of for exercising that power is a cost-benefit analysis of the broadest sort, and I wonder whether that is not a decision that the Congress itself should fish or cut bait on.
In terms of investor protection theory, it's difficult to say that 100 institutions purchasing $50 million of municipal debt require disclosure, but 100 individuals purchasing $1 million do not. Yet I appreciate that rough practical judgments may have to be made as to the reach of the statute. These seem to me to be more properly legislative determinations rather than delegated administrative ones. Congress has not heretofore delegated this type of judgment to the Commission. For example, the so-called Reg A exemption of $500,000 is set out in the 1933 act.
The third point I'd like to comment on is the bill's requirements of annual audits by independent public accountants and the application of appropriate generally accepted accounting principles to municipal issuers. They seem like highly desirable provisions. Such requirements would serve to assure that the preparation and presentation of public issued financial statements would be designed for investor usage.
The fourth point I'd like to comment on is the State agency approval provision in paragraph (c)(1). If Congress thinks that the particular disclosures the bill requires for distribution statements are necessary in the public interest—and I agree with Mr. Robinson's comment and the comments of some others that I don't consider that a necessarily adequate or desirable list to be fixed in stone--it's difficult to understand why State approval of something else should be a basis for exemption. (If distribution statements, why not also annual reports which are not referred to in paragraph (c)(1) ?)
The bill should make clear that the issuer has the responsibility and liability for disclosure under Federal law, and State agency approval rather than providing an exemption from the disclosure requirements would instead be a process that the state might choose to employ to assure compliance with the requirements. The bill might also provide, in order to encourage states to undertake such approvals, that when issues are so approved underwriters are relieved of any liability for a deficiency in disclosure of which they did not have actual knowledge, thereby improving the price and yield at which issues so approved could be sold. Such state review and approval should be ample protection to investors, and would be a way to assure that underwriters could economically continue