8 know whether the resources of the community will support the services? How does the investor identify the risk in a security issue? How can the individual citizen make rational choices concerning where to live and when to move? The subject of consolidation is a complex one, but I am convinced that it has not been dealt with properly in the past. Where there are interrelationships between the funds, and where direct and indirect guarantees or obligations with respect to debt exist between funds, only consolidation will give an understandable picture of what the situation really is. In some cases, financial statements both for individual funds and consolidated funds would be appropriate. A common-sense approach is needed to determine what financial information is the most useful and meaningful. Accrual Accounting. The financial statements should portray how the current citizens are faring. Are they bearing their costs currently for the services rendered? Are these costs being deferred to the future or are the current citizens bearing a greater than equitable share of the cost? Only full accrual accounting will adequately answer these and other questions. Present governmental accounting relies either on a cash basis or a modified accrual basis of accounting. In the case of New York City, revenues were in most cases accrued but expenses were recorded on a cash basis. The widely used modified accrual basis of accounting has been an approach whereby expenditures other than accrued interest on general long-term debt are recorded at the time liabilities are incurred, and revenues are recorded when received in cash. A significant point here is that under this common practice, expenditures are recorded when liabilities are incurred, not necessarily when services are rendered and costs incurred. Some accountants apparently believe that state and local governmental units need not record such costs as vacation and sick leave at the time benefits are accumulated. This omission, which commonly exists, is just another of the many examples of costs not being recognized and currently reported in governmental financial statements. Pension Plans. One of the major areas of deficiency in the financial affairs of many state and local governmental units relates to pension plans, which have been estimated to be about 80,000 in number and which involve many billions of dollars. These plans frequently are not adequately funded, are not based on appropriate actuarial assumptions, and are not accounted for in a proper manner. In addition, the real condition of the plans and the actual or potential liabilities involved usually are not properly disclosed in financial data published by the affected governmental unit. A proper recording of pension costs might well double the amounts presently being recorded. The current area of your Committee's concern is the accounting for, and reporting of, costs and liabilities and the pertinent disclosure thereof as a part of financial reports of state and local governmental units. Although some exceptions exist among pension plans of state and local governmental units, considerable improvement in the accounting and financial 9 reporting is needed, because costs and liabilities frequently not being accurately reflected and do not meet the standards presently being followed in the accounting for business enterprises. Recording these costs currently is extremely important to the public employees who must be assured that their pensions will be paid. My comments would be incomplete, however, if I did not point out that deficiencies exist in many of these plans not only in the recording of realistic costs by the governmental unit, but also in funding. These are very serious, not only to the participants in the plans but also to the citizens and taxpayers of the governmental units who may be adversely affected in the future. While the Congress in the Employee Retirement Income Security Act of 1974 exempted the pension plans of state and local governmental units, it must be recognized that this exemption relates to pension plans in an area where perhaps the greatest need for reform has existed. While the condition of these plans is not the subject of this hearing, this matter should be of concern to the Congress. Depreciable Property. The recording of property and the related depreciation are necessary to secure a full costing of the services to the current citizens. Since property is a part of the services received, it should be considered in the costs, as an essential aspect of accrual accounting. Research Project for Accounting and Disclosure Requirements There is considerable debate in accounting circles over whether the necessary upgrading of the accounting and reporting can be accomplished 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. This study will be an interdisciplinary project, incorporating accounting, law, finance, and public administration. The guidance and cooperation of representatives of the Municipal Finance Officers Association as well as the accounting and legal professions and the investment banking community will be elicited. Areas to be covered by the study will include: 1. Reconciliation for financial reporting purposes of generally accepted accounting principles and various accounting requirements for legal compliance. 2. Adoption of accrual accounting (as opposed to modified accrual accounting) in financial reports. 10 3. Appropriateness of financial statements consolidating financial data for various funds and/or divisions within a governmental entity. 4. Current and continuing financial disclosure requirements in official statements for bond offerings. Conclusion 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 issuance 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. You have requested our views with respect to the power of the United States Congress under the Constitution of the United States to enact a law with respect to securities issued by a State of the United States or a political subdivision or public instrumentality of a State ("municipal securities") which would contain provisions comparable to those contained in the Securities Act of 1933 ("1933 Act") and the Securities Exchange Act of 1934 ("1934 Act") requiring the registration of securities and the filing of reports, and imposing criminal and civil sanctions. In our opinion the Congress of the United States has the power under the Commerce Clause of the United States Constitution (Article I, Section 8, Clause 3) to subject issuers of municipal securities to requirements of registering the same and to reporting requirements comparable to those included in the 1933 and 1934 Acts in respect of other domestic issuers. (See, Maryland v. Wirtz, 392 U.S. 183 (1968); Fry v. United States, 421 U.S. 542 (1975)). In view of the dual sovereignty which exists in our system of government, we are of the opinion that the Federal Constitution would not permit enforcement of criminal provisions against an 12 WILSON & MCILVAINE - 2 issuer of municipal securities, and it is doubtful whether In our opinion the Federal Constitution would permit the We doubt whether civil provisions comparable to those of the 1933 and 1934 Acts, other than injunctive relief against future violations, could be enforced in most cases against an issuer of municipal securities or an elected or appointed official thereof unless such official's conduct were so aggravated as to place him beyond the scope of his official capacity. Cf., O'Connor v. Donaldson, U.S. 95 S.Ct. 2486 (1975); Scheuer v. Rhodes, 416 U.S. 232 (1974); Wood v. Strickland, 420 U.S. 308 (1975). Enforcement of civil liability provisions comparable to The Judicial power of the United States shall The 1934 Act vests in the Federal courts exclusive jurisdiction |