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to bid on the many municipal issues being noticed for competitive sale each week.

Fifth, briefly, I would suggest that the language in paragraph (g) of the bill purporting to limit liability of underwriters, could be clarified. I think the language in section 11(e) of the 1933 Act is somewhat more clear and that could also be improved upon. I think the point is that any liability of an underwriter should be limited to the dollar amount of sales actually made by it.

The sixth point I'd like to comment on involves the Municipal Securities Rulemaking Board which is noticeable by its absence from reference in the bill. Since the Congress recently added section 15B to the 1934 act giving the rulemaking Board, with SEC oversight, rulemaking power with respect to practices of municipal securities brokers and dealers, the bill should not the next year forget it. I agree that the Board is probably not the appropriate body to deal with the content of disclosure documents, but it does seem to me to be the logical body to promulgate any rules with respect to delivery of distribution statements and so I would urge the substitution of the Board for the Commission in paragraph (f) (2) of section 13A.

My last comment deals with federal-state relationships. The bill would give the job of determining disclosure standards to the SEC. Given the premises of the bill that mandatory disclosure is ciesirable for all municipal issues of any size and that the disclosure standards should be uniform and comparable nationwide, with which I agree, it may seem that the existing federal disclosure agency should be assigned to that job. While I personally have no difficulty with that conclusion, I think we should recognize that it is not a necessary conclusion. The SEC has not had occasion to develop as yet an expertise in municipal finance comparable to that which it has in corporate financial matters, even though foreign municipal issuers offering securities in the United States have been required to register with the SEC since 1934. The more important reason to pause is the deference that must be paid to very sensitive aspects of Federal-State relationships, and for that reason alternatives might be considered.

If sovereign States are enormously resistant to their subdivisions being subjected to standards enunciated, and presumably enforced, by a Federal bureaucracy, or if there are sufficient Members of Congress who would find it distasteful as a further step toward central Government power it is at least conceivable that some other mechanism could be created to achieve the salutory objectives of the bill. In other words, I don't think the bill should be scuttled because of concern that the SEC's role would do violence to FederalState relationships. I repeat, for myself, I don't think it would. After all, we're talking only about disclosure, not what the states can or cannot do in financing themselves. But I am also conscious and respectful of what I know are deeply held feelings on the part of others.

One alternative might be, in effect, a system of state “blue sky” laws hopefully made as uniform as possible, applicable to municipal securities. But I think that would be impractical for national underwriters and a confusing burden on what is essentially a national marketplace. Anyone who has had contact with the com

plicated system of State securities blue sky laws could hardly be disposed to wish that system upon the municipal securities market.

Another alternative would be to provide a Federal statutory framework—and hence the national jurisdiction—to the States themselves to establish uniform standards. I appreciate this would be a rather innovative approach to federalism, but it would seem to me to be worth trying rather than not to have a bill or having rebellious States. The statute could provide for a national council appointed by the President composed solely of State and local government officials, and possibly a chairman who is a former such official, to implement the general municipal disclosure and accounting standards called for in the statute. The President could be required to consult with appropriate State and local government organizations in making his appointments. The Council could be assisted by advisory committees and the SEC in performing its functions. Thus, the sovereign States could be said to be jointly establishing their own uniform disclosure standards with the benefit of Federal jurisdiction.

Thank you.

Senator WILLIAMS. Thank you very much.

I have not been exposed to this suggestion of a Presidentially appointed council in any other areas of approaching uniformity of State laws. Is this indigenous to

Mr. SMITH. It was an idea that sprang out of a discussion that I had with some other people interested in the subject of municipal disclosure and I guess I carried it along in my own thinking, beyond this rather brief statement of it. If you're driven to it or interested in it I would be quite prepared to talk to your staff about it as an alternative.

Senator Williams. Thank you. It's a very helpful statement in its detailed analysis of some of the problems. Of course, the ambiguity problem that you mentioned, preusage filings—there's been no intfient of that authority here and that should be clarified, obviously. Some of the other areas of ambiguity that you have raised we will also be mindful of. We appreciate it, the whole statement.

Mr. Hodgman, do you have a statement?
Mr. HODGMAN. Yes, I do, Senator.

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Mr. HODGMAN. I filed a statement. I do not wish to read it. My name is Don Hodgman of the law firm of O’Melveny and Meyers in Los Angeles. I function primarily as a bond counsel.

I think, Mr. Chairman, if you asked three attorneys, you are liable to get three different points of view. My point of view is colored by two factors. One, I think bond counsel generally have clients on both sides of the fence. In our case, I think about half of our clients are underwriters and about half are municipal issuers. So if I appear to be sitting on the fence, I have good reason. I want to avoid disgruntled clients.

Senator WILLIAMS. That's full disclosure. Very good.

Mr. HODGMAN. There's another point that has been alluded to and is continually lurking in the background in this discussion and you will say, well, why bring it up if it's that apparent, but it's this question of the antifraud sections of the federal securities laws. I think these are all pervasive in any analysis of this problem. I make this point particularly because, like Mr. Smith, I happen to be a chairman of a subcommittee on disclosure of the American Bar Association. This is from a different section, the local government law section. Our conclusions are really not complete as yet. We have circulated a draft position, a comment letter for the ŠFOA. Our primary focus has been to attempt to respond to their request for comment.

However, in doing that, I think we have tried to grapple with the problem generally of what is the appropriate solution as far as the regulation of municipal issuers, particularly in view of the fact that they are already inserted in the federal securities laws. In my prepared remarks I'emphasize the fact that the sinner is already seated in the cathedral and this pervades all of our deliberation on the MFOA guidelines. I think it's also necessary to bear in mind in giving consideration to S. 2969.

You have to have as a focus of your discussion the underlying fact that you're included within the Federal securities laws and that there is a certain amount of liability that is there already. I think it's very important to categorize that liability and one of the issues that I would like to cover in my remarks is this question of liability, but I think it's very important to emphasize that in defining what this liability is and what is the test to determine liability under the anti-fraud sections, the U.S. Supreme Court in its definition of "material" under the federal securities laws, has used a very broad and non-common law definition. It's not common law where you need scienter knowledge and so forth.

Their definition is material items that "might”- (I emphasize that "might”) be important to an investor in making his decision to purchase a security.

Well, bearing this in mind, our committee—and I want to point out as Mr. Smith did that I'm not permitted to speak as a member of the Bar Association—we considered four tests in trying to evaluate the disclosure problem. I think I'd like to pass quickly over the first two and emphasize the last two because they haven't received as much discussion in the testimony thus far.

The first test is that issuer compliance should be voluntary if this is possible. Now this is just another way of stating the prerogatives of state and local governments in the federal system. I think the real question here is whether it's possible to recognize this voluntary approach and still have a workable municipal securities market. Certainly, the standards suggested by S. 2969 is an intermediate position. It's carefully articulated in terms of non review, nonfiling. Subject to the technical comments that Mr. Smith made in which I concur regarding the amendment of 15B (a) (1), it seems like a position that attempts to make a compromise in this regard.

There is another advantage. Again, I'm on the fence on this one. I applaud the fact that S. 2969 has a definite standard, contrary to Mr. Robinson, who says, well, after all, we have these antifraud sections and they should be sufficient. Senator Williams, you mentioned in your remarks introducing S. 2969 why you go beyond the antifraud sections, and I think our deliberation in our Bar Association Subcommittee points out the necessity to get guidance beyond the antifraud sections and to have some more specific basis for being sure that you have complied with this definition of materiality in the antifraud sections.

This leads to my next test. Although bond counsel traditionally likes to find a safe harbor, after almost a year of deliberations in our subcommittee, we are unable to conclude that a safe harbor would be possible, given the structure of the federal securities laws.

I'd like to move on then to the two really hard questions from the lawyers' standpoint. I think the testimony so far has shown the issues that are really troubling certainly the underwriters and I think, to some extent, the municipal issuers as well are duty and liability. This is really a double-sided coin. I think you can look at one side of the coin and say, well, now that we have inserted municipal issuers into the federal securities laws structure, what duties and what investigation incentives are there? Are they the same as the usual incentives under the Federal securities laws? I think that this has been explored by the testimony, particularly the SIA written testimony goes into this in some detail

. They have and others have examined the due diligence defense, the so-called section 11 defense, which if you're talking in terms of a 1933 act registration permits the underwriter who makes the investigation required by the statute to avoid liability.

I think testimony has shown that the difficulty here is that it is not clear in the case of an exempt municipal issuer (although in 1975 we have now expressly required the broker-dealer who deals in municipal securities to register under the 1934 act), how the due diligence defense works. I think even more important and a point that is not made expressly so far is the fact that a municipal issuer may be in quite a different position as far as his incentive for investigation.

Now you can say, well, of course, he has the incentive. He has the incentive of the marketplace. They won't buy his municipal securities unless he adequately provides disclosure material for the investors. But I don't think this is quite the same situation as in the case of the private issuer. He is charged expressly under the 1933 act with a level of responsibility that I would colloquially denominate that of an insurer. I don't want to be misunderstood in this. I don't think he's an insurer in the sense that he writes a policy that the materials in the registration statement are absolutely true, but it approaches that level of liability where his investigation, is inadequate or materials are incorrect. There's no question of establishing negligence or establishing scienter.

Another feature in this investigation incentive that has not been discussed is the question “how does a bond counsel function where municipal underwriters on one side of the equation are now expressly covered by the Federal securities laws.

Suggestions have been made and I think properly that we should give consideration to changing the historical pattern. Historically, the bond counsel has been the only lawyer functioning in the process of marketing and preparing disclosure materials for municipal securities. We should shift from the one-counsel pattern to the two-counsel pattern that is common in private securities. The model that's been suggested is that used in the public utility field where competitive bidding is usually followed as is the rule in the municipal area. I think it's going to be necessary to make some shift in the role of the bond counsel. I think if we don't have additional attorneys, we at least have to add the fact that the bond counsel will have to expand his role to cover the area of disclosure under the Federal securities laws. Whether this is done by having two counsel or having the bond counsel be employed by the underwriter and having the public attorney, who in many cases is already of course on the payroll of the issuer take care of the issuer's problems under the Federal securities laws, only more experience in the marketplace will tell.

I think my final point then would be the hard question of what is the liability of the issuer. Can you reach—and the question has been asked a number of times—can an investor in New York City bonds sue the issuer of the securities? There is a pending suit, the Abrams suit, in the Federal courts that raises that very situation. I think this is one of the reasons for the apprehension of whether the present disclosure process is adequate. But I think it's this other side of the coin-does the underwriter now have all the liability and is the municipal issuer exempt from a suit by a private investor for damages because of the usual defenses that are suggested: (1) sovereign immunity; (2) the 11th amendment to the Federal Constitution or other protections that are afforded the State and local governments from liability. I think this is a very difficult constitutional question for the lawyers.

I attended a PLI seminar in New Orleans last week at a number of cases were cited in this area. We received the opinion yesterday from Mr. Rathbun that he felt that properly drawn the Federal statute could reach the municipal issuer even if it was a private investor suing.

I think my conclusion in reviewing these materials since PLI is that of Mr. Rathbun-in fact, I spent part of yesterday afternoon in the Wilmer, Cutler library on the theory that it would provide the proper atmosphere to get the right answer. My authority just to cite one case (that I didn't see in Mr. Doty's materials who lists the other cases), would be the Edelman case, 415 U.S. 651 (1974). This is the most recent case. As has been pointed out, the present legislation does not attempt to reach the municipal issuer in a suit of the type mentioned. I think this is, however, a very tricky issue. The Edelman case points out that there is an element requiring the municipal issuer consent to the liability. Consent presupposes an activity that is undertaken voluntarily. Social security payments were involved in that case.

Earlier cases had involved different activities. The Pardon, case, a prior cited case, was a case where Alabama operated a railroad

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