Mr. HILLS. You might say it's more independent in my new job.

Senator TOWER. Thank you for your testimony. The chairman had to step out a minute, so if you will forebear a minute he would like to ask you some more questions.

Mr. HILLS. Surely.

Senator TOWER. While we are waiting for the chairman, let me run another one by you. Under the proposal in this bill, the SEC would have primary authority to issue rules and regulations on disclosure standards for issues of municipal securities. Would it be better to give sole authority to a board comprised of issuers of the municipal securities rather than the SEC?

Mr. HILLS. Senator, that's a policy judgment that's very hard for me to make. As I said earlier, the SEC in terms of its past experience has a fount of experience that's useful in doing this. Initially, I would say that there's every reason to believe that present SEC staff with the present Commission is as capable, if not more capable, than anybody else of doing it. Beyond that point, regardless of who should establish the rules and policies, it is the responsibility of the SEC to enforce the 1933 and 1934 Acts. Accordingly, it strikes me that there is some soundness in suggesting the SEC for this task; if it is going to enforce the law it will have to have some idea of what disclosure is required. Again, it seems to me, if we are trying to provide certain and fair rules, the bill's approach would generate less confusion. I should say this, that it has been the longstanding practice of our chief accountant, Mr. Burton, who's in the audience, and our staff, to provide financial presentation standards only after a careful consultation with the industry representatives. We have had a long and productive relationship with Financial Accounting Standards Board, the American Institute of Certified Public Accountants, and from time-to-time with the Municipal Finance Officers Association. So any rules that develop would surely only be done after very careful securing of the views of the issuers through that framework. Senator WILLIAMS. Thank you, Senator Tower. I just have a couple of remaining questions, Chairman Hills.

Basically, doesn't S. 2969 follow the ground that was broken way back in 1933 when we asked for and required additional disclosures very similar to those that were granted to the Commission under the Securities Act of 1933 as they pertain to the SEC's powers to require nonstatutory enumerated disclosures through rulemaking authority? We're going over the same ground, aren't we, in that degree?

Mr. HILLS. We are going over ground we have gone over before. As the Senator knows, the Commission has recently launched an effort to rethink the ground we have gone over for 41 years in our disclosure policies and both internally with the Commission staff and externally with a board of outstanding people we are going to rethink some of those things.

This bill has a limitation I might say on the type of disclosure and the type of rules that the Commission would be permitted to make. It's a bit ambiguous but I think nonetheless it's a real limitation. Under sections 7 and 10 of the 1933 Act, as I commented, the

Commission has rather broad authority to promulgate any additional rules that we think are necessary or appropriate. At the present time the Commission thinks that it's perfectly responsible to limit its authority somewhat more with respect to municipal issuers by saying that the Commission would only have the authority to require additional similar and specific information. Given the differences between a private profit making corporation and the structure of a city, that limitation, in our judgment, would not unduly interfere with the protection of investors.

As I say, it's a little bit difficult to say specifically where that would change the Commission's authority, but basically it would recognize that we would be trying to develop rules of disclosure dealing with revenue, expense, and cash flow of a city. We would not be involving ourselves so much in disclosure concerning management as we do in private industry, as we do in our present disclosure policies under the 1933 and 1934 Acts.

Senator WILLIAMS. I won't pursue it any further. I get the impression that more clarification is coming in terms of

Mr. HILLS. Yes. This bill we think is a helpful framework to begin the dialog and our staff will be delighted to deal with any questions that the subcommittee or its staff may have.

Senator WILLIAMS. The Commission has embarked on an investigation of the New York City situation, as I understand it, and I think this can be described as unprecedented. Am I right on that?

Mr. HILLS. It is unprecedented in the sense that there never has been a city so large subject to the scrutiny of the Commission. There have been other investigations and in two cases that I recall the Commission has dealt with municipal issuers, although we have not before had an investigation of this scope.

Senator WILLIAMS. Can you state what the Commission's approach would be if evidence of wrongdoing were found in this investigation? The options, I would assume, are of consent decree or a lawsuit. What is the broad approach and possibilities that you are considering? Mr. HILLS. Well, I should say categorically that I have no idea at this time that any actions will be brought, but one can hypothesize all kinds of things that might be discovered by investigation, and assuming a degree of culpability and degree of misrepresentation or a degree of fraudulent action, as to which I say again we have certainly not made any decisions nor has the investigation been completed or even progressed to a degree that I could speculate if it otherwise would be appropriate to, but there's no reason to think that the same kinds of considerations that the Commission has used in its enforcement with companies of private industry would not be followed.

In short, we would assume that the same types of approaches would be used-lawsuits, injunctive actions, administrative proceedings, consent decrees are all tools that the Commission has used in its enforcement proceedings and all those tools we assume to exist in this type of situation.

Senator WILLIAMS. And those various tools are available under the present authority of the SEC, but what we are doing through this legislation is really upgrading the quality of disclosure and to a

considerable extent protecting against situations you're faced with now in New York City.

Mr. HILLS. Not only protecting against it, Senator, but as a matter of good government it strikes us that it is not appropriate in matters of such significance as municipal securities to set disclosure policies by litigation and consent decrees.

Senator WILLIAMS. I haven't anything further. Thank you very much.

[Complete statement of Mr. Hills follows:]

STATEMENT OF RODERICK M. HILLS, CHAIRMAN, SECURITIES AND EXCHANGE COMMISSION

Legislation providing disclosure requirements for municipal securities should have two principle objectives. First, to provide adequate information to investors to guide their investment decisions and to protect them against losses caused by inadequate or inaccurate information. Second, to assist the issuers and underwriters of municipal securities by eliminating possible confusion as to their legal responsibilities.

In current debates about the regulation of municipal securities the second point has not had sufficient attention. Presently, the Securities and Exchange Commission enforces the antifraud provisions of the Securities Act of 1933 and the Securities Exchange Act of 1934 against issuers and underwriters of municipal securities. In addition, some question may be raised in private litigation as to the effect, if any, of sovereign immunity. There has to date been very little litigation involving such issuers and, as a result, there exists no well-established body of judicial precedent defining the obligations of these persons. We believe the establishment of specific disclosure requirements in the proposed legislation will provide some valuable guidance to issuers and underwriters in discharging their responsibilities under the federal securities laws, although the nature of the investigation necessary to avoid liability will remain undefined.

In short, S.2969 would not expand the enforcement responsibility of the Commission. Rather, by prescribing specific disclosure responsibility on the part of issuers of municipal securities, it may well enable the Commission to clarify the bases underlying its use of enforcement procedures in this area. In any event, in view of the Commission's general mission to prevent fraud in connecwith the sale of securities, the limited expansion of its powers with respect to municipal disclosure is not out of keeping with its existing authority over private issuers.

The proposed legislation must also be viewed in the context of the long standing exemption from the registration and reporting requirements of the securities laws which have applied to municipal securities. The underlying basis for the adoption of these exemptions consisted of a desire for governmental comity and the absence of recurrent abuses. In addition, there has been a belief on the part of some that the typical purchaser of municipal securities is the sort of investor that does not need the protections of the federal securities laws-banks, insurance companies and other institutions. Over the years, the typical purchasers of municipal securities have been institutional investors with only limited individual participation. Further, the number of defaults on municipal securities has been very limited.

Towards the end of the 1960's, those patterns began to change significantly. As an escalating economy pushed more people into tax brackets which made the tax-free characteristic of municipal securities desirable, there occurred a great increase in public participation in the purchase of municipal securities. Unfortunately, this increase in public participation was accompanied by the development of questionable marketing practices in municipal security dealings and the unexpected occurrence of serious municipal issuer financial problems.

As a result of these problems in the trading of municipal securities, the Securities Acts Amendments of 1975 were enacted to create a new and com

prehensive scheme of regulation of the trading markets in municipal securities and of municipal securities professionals.

The principle feature of these amendments was the creation of the Municipal Securities Rulemaking Board which has authority to prescribe rules governing trading in municipal securities, among its other responsibilities. Of course, if S.2969 is enacted into law, the Municipal Securities Rulemaking Board will be able to exercise its rulemaking authority as to underwriters in order to ensure effective use of the information prepared by municipal issuers.

The New York City financial dilemma and similar situations involving other municipal issuers, raises even new questions concerning municipal financing. These concerns are not only with the kind of fraudulent trading activity which spawned Congressional enactment of the 1975 Amendments, rather the questions now center on the accuracy of municipal financial statements and the extent to which municipal issuers are properly informing investors in both the primary and secondary markets with regard to their affairs.

Investors and underwriters are now alert to the inadequacies of the past disclosure practices and appear to be more demanding of adequate information. The failure of issuers to provide such data will impair their ability to secure the funds essential for community development.

It will, we believe, become increasingly apparent to municipal and other public officials that they seriously jeopardize their future financing opportunities if they resolutely resist efforts by underwriters, dealers and investors to gain greater insight and information.

To stimulate an appropriate reexamination of the long standing exemption of municipal issuers from the discosure requirements of the federal securities laws, Senator Thomas F. Eagleton recently introduced a bill that would subject municipal securities to the registration requirements of the Securities Act of 1933. That bill, S.2574, has properly focused attention on an important problem-the less than adequate information now available to those who invest and trade in municipal securities. The solution S.2574 suggests, however, creates a number of disadvantages which are not needed to achieve its basic objectives.

While we are not presently aware of the exact number of Securities Act filings that would be made by municipal issuers under S.2574, it is probable that there would be a great many more than the corporate filings now processed. Even if the Commission could obtain a much larger staff, it is unlikely that the threatened harm to investors justifies so drastic a proposal.

"The Municipal Securities Full Disclosure Act of 1976", S.2969, would provide a far more limited form of disclosure regulation for municipal securities one that is more commensurate with the risks involved.

8.2969 does not, in contradistinction to S.2574, embody any amendment to the Securities Act of 1933. As a consequence, municipal securities would continue to be exempt from the registration requirements of the Securities Act. S.2969 would amend the Securities Exchange Act of 1934 to add a new Section 13A which would provide disclosure requirements for "municipal securities" as defined in Section 3(a) (29) of the Exchange Act.

The disclosure requirements of Section 13A are different and considerably more limited in scope than the requirements of the Securities. Act and Exchange Act. In particular no information required of municipal issuers would be filed with or reviewed by the Commission

Section 13A would require an issuer with more than $50 million of municipal securities outstanding during any portion of a fiscal year to prepare for each fiscal year an annual report and reports of events of default (if such events of default occur). The annual report would contain material financial and other information regarding the issuer, including financial statements audited and reported on by independent public or certified accountants. The reports

1 It appears that defaults or payment problems involving municipal bonds have not been significant except in severe depression periods. Even in the Great Depression it has been estimated that only 15 percent of all outstanding municipal debt was directly or indirectly involved in some manner. Since World War II, the experience has been reasonably good. For instance, in the period from 1945 through 1969, it has been estimated that the number of actual defaults in this area was 431, of which 300 were considered of a technical or temporary nature. The total amount of these defaults is estimated at approximately $450 million-about 4% of the total amount of municipal debt outstanding at the end of the 25 year period.

of events of default would contain material information regarding any default

on, or postponement or delay of, principal or interest payments on the issuer's securities. The issuer would be required to make the annual report and reports of events of default available to the public upon request.

Section 13A would also require an issuer that offers or sells an issue of municipal securities exceeding $5 million to prepare a distribution statement prior to such offer or sale. The distribution statement would contain such of the information required in the annual report as the Commission prescribed and material information concerning the particular offering. The issuer would be required to make the distribution statement available to the underwriters of the security offering for delivery to prospective purchasers.

An exemption from the distribution statement requirements would be provided for municipal securities offerings that meet the criteria of certain specified exemptive provisions of the Securities Act, and offerings the disclosure for which are approved by a State governmental authority as adequate for the protection of investors. As contemplated by the Commission, this exemption would be available to offerings the disclosure for which, in the view of the State authority, is substantially similar to the disclosure required by Section 13A.

The items of information to be required in the annual report and distribution statement are set forth in Section 13A and the Commission would have only limited authority to require additional similar and specific information. Such information is similar to that called for by the Municipal Finance Officers Association's Proposed "Disclosure Guidelines for Offerings of Securities by State and Local Governments" and that which is required of foreign governmental entities under Schedule B of the Securities Act. The forms in which the required information is to be set forth, and the accounting methods to be followed in the preparation of financial statements, would be prescribed by the Commission to ensure the consistency, comparability, reliability and sufficiency of such data.

The disclosure requirements of Section 13A would not constitute an undue burden for municipal issuers of a responsible character. Most of the required information would be, or at least should be, presently available. It is our understanding that issuers that have their securities rated are required by the rating agencies to supply much of the information called for by Section 13A. In addition, some state law and conscientious underwriters demand that municipal issuers make available to the public material information comparable to that required by Section 13A. The Proposed Disclosure Guidelines of the Municipal Finance Officers Association call for information similar to that required by Section 13A. And, in cases where the disclosure requirements of Section 13A would impose a demonstrably unreasonable burden on a municipal issuer, the Commission would have authority under S.2969 to exempt such issuer from those disclosure requirements.

It is important to emphasize the point that this legislature does not expand the existing liability of municipal issuers. As I said eariler, the antifraud provisions of the Securities Act and Exchange Act presently apply to the purchase and sale of municipal securities. S.2969 contemplates their continued applicability. The effective date of S.2969 is January 1, 1977. Audited financial statements, however, would be required only for fiscal years commencing on or after December 31, 1978. The Commission believes that this time frame would afford issuers of municipal securities an adequate opportunity to "gear-up" for compliance with the new disclosure requirements of Section 13A.

Before closing, let me note that there are three areas where information obtained through these hearings will be helpful in refining S.2969. The first issue is whether establishing the threshold amounts of $50 million and $5 million in Section 13A is appropriate. The Commission does not now have any data indicative of the number of municipal issuers that would be subject to the disclosure requirements of Section 13A. Relevant empirical data developed through these hearings should enable the Committee to make any appropriate adjustments.

Secondly, the Committee may wish to consider issues relating to the scope of underwriter liability. Our bill contains one limitation in Section 13A (g) borrowed from a similar provision in Section 11 of the Securities Act. Municipal securities underwriters and their counsel will undoubtedly wish to comment not only on that limitation but also to make additional suggestions. We will be pleased to offer any assistance we can to the Committee and its staff

69-141 - 76 - 3