exempts interest on municipal securities in computing individual or corporate taxable income, a tendency on the part of smaller corporate taxpayers (including banks) to invest in such securities without all the data required to protect earnings could have a serious impact on our entire society.

Since certain constitutional questions have been raised, we have obtained from two law firms an opinion that the Congress of the United States has the power under the Commerce Clause of the United States Constitution to subject issuers of municipal securities to requirements of registering such securities and to the reporting requirements comparable to those included in the Securities Act of 1933 and the Securities Exchange Act of 1934 in respect of other domestic issuers. These opinions, which also cover other related matters, are attached to my statement and I will not refer to them in this particular presentation.

The basic purpose of the securities acts has been to provide adequate information to investors. The original exemption for municipal securities was logical since they were not significant in amount. In 1933, the expenditures for State and local government approximated $7 billion. In 1976, such expenditures will exceed $200 billion, without including the Federal grants-in-aid to State and local governments, which have also grown in importance. The long-term municipal securities presently being sold each year are in the general magnitude of $25 billion to $30 billion. These securities are now much more important in relation to total securities being issued and outstanding. The interests of investors cannot be separated since all securities tend to compete for investor dollars.

There is a tendency to refer to municipal securities as a single classification, and this of course is inappropriate since a wide variety of types of securities are included. However, without the availability of adequate and extensive data, there can be a tendency on the part of investors to consider all securities as having the same risk. In fact, a general review of official statements from municipal securities leaves me with the impression that in many cases the greater the amount of risk the less information there is provided. This situation suggests a great need for legislation to achieve more uniformity and quality in the information given to investors.

Municipal securities today are an important component in the financial health of our national economy, particularly that of the commercial banks. During 1960 to 1975, outstanding municipal securities grew by $145 billion, 58 percent of which went to commercial banks, with many of them being smaller banks. Municipal securities owned by commercial banks have now reached a level somewhat equivalent to the U.S. Government securities owned.

Not only did the State and local government securities held increase from $4 billion in 1945 to $101 billion in 1975, but the percentage that such securities represented in relation to total assets increased from 2.93 percent to 12.36 percent during that same period.

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In addition, these securities were about twice the total capital for such banks at the end of 1975. Thus, in my opinion. liquidity and safety are essential. However, liquidity can only be achieved if others are willing to buy. Safety can only be evaluated if the investor has adequate information on which to base a decision.

Our political and economic systems are also being undermined by the lack of adequate and uniform information with respect to State and municipal securities. While knowledgeable investors should carry the burden of risk of loss on their investments, there is no excuse for investors not being given adequate data. If the data are inadequate, we all end up sharing in the responsibility when problems surface. State and municipal securities should be placed in the same position as that of corporations. Investors should be given the facts upon which to make their evaluation, and their decisions then become their own responsibility. Under such circumstances, society should not have to bail out the losers. The primary reason that New York City was not allowed to fail was not the impact on the man in the street, but its implication to the owners of the bonds-the banks, retirees, insurance companies, and others who would have taken the loss in the cancellation or restructuring of the debt. How could they be held accountable since they bought them under circumstances of trust in a system that is inadequate?

In many of our governmental units, there are today significant hidden future costs that have not been identified either to investors or taxpayers. One of the most significant of these is the unrecognized pension costs, but they also include other amounts for services rendered that have not been recognized and recorded. Sooner or later, these hidden costs must lead to crises when they become unmanageable by the community and can no longer be avoided.

Financial reporting and accounting standards and the accounting systems and controls of many State and local governmental units are deficient. Many State and local governmental entities either do not publish financial statements for investors or the public in general or the statements that they do publish are not very complete or informative. Neither the investor, the taxpayer, nor municipal management receive the kind of reporting that would be useful to them in the performance of their roles in our society. I believe that only through the kind of regulation proposed in this bill, and modified as I am suggesting, can we see an early correction to the situation.

Financial reporting is an essential part of holding public officials and employees responsible for the proper stewardship of the funds and for the trust that has been placed in them for the performance of their functions. Historically, there has been an excessive preoccupation with legal compliance permeating the entire field of governmental accounting. Legal compliance is important, of course, and there is no inconsistency between sound accounting and legal compliance.

There is considerable debate in accounting circles over whether the necessary upgrading of the accounting and reporting can be ac

complished on a timely basis. I do not view this as an overwhelming task because the experience of the private sector should be helpful. To aid in this effort, our firm has commissioned the Center for the Management of Public and Nonprofit Enterprise in the Graduate School of Business of the University of Chicago to carry out a study of the standards of accounting and financial disclosure for State and local governments. This research is scheduled to commence during the spring of this year and to be concluded by October 1, 1976. This study will cover not only current practices, but also recommendations for what the practices can and should be. The findings of this study will be published and available to the SEC, the Congress, and other interested parties without cost.

In conclusion, I want to emphasize that as a general proposition I do not favor any more regulation by the Federal Government than is necessary. Further, I am well aware of the traditional prerogatives of the State and local governments with respect to the issuance of municipal securities. However, there is an urgent need for improvements with respect to financial and other data related to the issuances of of municipal securities; and, therefore, I believe that the Municipal Securities Full Disclosure Act of 1976 should be enacted.

In my opinion, the only way that sufficient progress can be made in a reasonable time is for a central authority with the necessary statutory power to take the lead with respect to the many thousands of issuing entities. The SEC is the only logical place for this responsibility. The welfare not only of investors but also of the citizens of the various governmental entities is importantly at stake. The ability of many of these entities to borrow adequate amounts for schools, police, fire, and other governmental services on a reasonable basis may also be at stake. Those from the States and cities who may oppose any type of Federal regulation and are in favor of a continuation of the do-it-yourself approach are actually performing a disservice to the citizens they represent.

The proposed bill, in my opinion, is a practical and minimum. step at this time, and as indicated earlier, I fully support it. However, I do believe that a modification to provide for a monitoring function by the SEC and an annual report to the Congress would add a great deal in accomplishing the objectives and should be adopted. No area is more important for our elected leaders to be concerned than with the viability of our local communities where we reside and work and raise our families.

Mr. Chairman, I thank you for this opportunity to present my views.

Senator WILLIAMS. Thank you very much, Mr. Kapnick, and we certainly applaud you and your organization that has a name of such distinction and all that you are doing in a leadership role in trying to bring a new order out of what I would colloquially describe as chaos in municipal financing.

[Complete statement follows:]

STATEMENT BY HARVEY KAPNICK

My name is Harvey Kapnick. I am Chairman and Chief Executive of Arthur Andersen & Co., an international firm of public accountants. We have 49 offices in the United States and Puerto Rico and 57 offices in 34 other countries. We have approximately 14,000 personnel in our firm.

Many of our clients file financial statements with the Securities and Exchange Commission under the Securities Acts, and we report on such financial statements in accordance with the Acts and the applicable rules and regulations. Therefore, we have considerable experience and knowledge about the financial accounting and reporting of corporations and the financial data in prospectuses that go to investors in connection with the issuance of corporate securities.

Our firm has performed professional work for various departments of the Federal government. As a public service, and at our own expense, we prepared in 1975 a booklet, "Sound Financial Reporting in the Public Sector-A Prerequisite to Fiscal Responsibility," which has created considerable interest and has been entered in the Congressional Record. Secretary of the Treasury Simon has announced that the Treasury plans to publish consolidated financial statements on the accrual basis for the Federal government as a whole for the fiscal year ending September 30,1977.

During our fiscal year ended August 31, 1975, our firm performed professional work for: (1) 54 departments, agencies, authorities, and other entities of state governments in 25 states, and (2) 124 cities, districts, authorities, and other local governmental units in 25 states and the District of Columbia.

At the request of the Secretary of the Treasury, we prepared a special report in December, 1975, regarding information relating to financial requirements under the New York City Seasonal Financing Act of 1975. We have also been recently engaged to survey the accounting and financial management practices of the District of Columbia. The purpose of this survey is to define and analyze existing problems and to develop a plan that would lead to the implementation of generally accepted accounting principles and an eventual auditors' opinion. The results of the survey are to be reported to the Senate Committee on the District of Columbia.

My purpose in testifying today is to present my views on the accounting and financial reporting of state and local governmental entities and their systems and controls, particularly as these matters relate to the issuance of securities by those entities. My comments are made for use by your Committee and the Congress in considering the proposed legislation in the area of municipal securities. In my opinion, this issue is of utmost importance to all citizens of the United States. I am pleased that the Senate of the United States is considering legislation to protect citizens from abuses that have or could have occurred in this area.

Support for S. 2969

I fully support The Municipal Securities Full Disclosure Act of 1976 (S. 2969) as it has been introduced in the Senate of the United States. There is an urgent need for legislation to give investors more adequate information, to place greater responsibility on the issuers for the information disseminated, to achieve more uniformity, and to establish better standards for information to be presented, all of which I believe will add more credibility to the market for municipal securities. This Act's concept of requiring an annual report and a distribution statement for issuance of new securities under the prescribed conditions is, in my view, the minimum required at this time.

In addition, there is a need for uniform standards applicable to these documents from the standpoint of everyone concerned. The Securities Acts have been designed to protect investors. Investors in municipal securities need the same quality of information as investors in corporate securities. The concern of the Congress and the public interest should be the same for both types of securities. Until recently, a clear case may not have existed for specific requirements covering municipal securities. However, with recent events casting serious doubts on whether certain governmental units can obtain the funds required for needed programs or for refinancing existing obligations, immediate action is required to assist such governmental units and to protect potential investors.

In my view, the program contemplated by the proposed bill would be greatly strengthened and enhanced in the view of investors, if the annual reports and distribution statements were to be filed with the Securities and Exchange Commission subsequent to their issuance. The SEC could then perform a monitoring function with respect to such documents, perhaps on a test basis. Such a function would enable the SEC to review compliance with the provisions of the bill, and the rules and regulations to be prescribed thereunder, in order to determine the general level of compliance and any changes in regulations or legislation that should be considered. To file the annual reports and distribution statements in a central repository only, with no review by the SEC, would seem to be missing an opportunity for monitoring by the SEC. Such a review would result in benefits far in excess of the costs. Also, an annual report by the SEC to the Congress concerning the results of this subsequent review would be beneficial in evaluating the success of this program.

I realize that the Securities Reform Act of 1975 contains a specific provision prohibiting any requirement for the issuer of municipal securities to file any documents with the SEC or the Municipal Securities Rulemaking Board prior to the offering of the securities. Nevertheless, a question continues to exist about whether registration of certain municipal securities under the Securities Act of 1933 would be in the public interest. The question of whether prior filing of documents is required will not be answered until experience is gained with the proposed program. This step could be omitted now, but this is one of the reasons that I suggest a monitoring function for the SEC to observe what is being done by the issuers of municipal securities and to make an annual report to the Congress reporting

• The proposed bill and the related comments by Senator Williams and Senator Tower are included herein as Appendix C.