[House Hearing, 106 Congress]
[From the U.S. Government Publishing Office]



 
                   THE FINANCIAL SERVICES ACT OF 1999

=======================================================================

                                HEARINGS

                               before the

                            SUBCOMMITTEE ON
                    FINANCE AND HAZARDOUS MATERIALS

                                 of the

                         COMMITTEE ON COMMERCE
                        HOUSE OF REPRESENTATIVES

                       ONE HUNDRED SIXTH CONGRESS

                             FIRST SESSION

                                   on

                                H.R. 10

                               __________

                        APRIL 28 and MAY 5, 1999

                               __________

                           Serial No. 106-30

                               __________

            Printed for the use of the Committee on Commerce


                                


                      U.S. GOVERNMENT PRINTING OFFICE
 56-607CC                    WASHINGTON : 1999
------------------------------------------------------------------------------
                   For sale by the U.S. Government Printing Office
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                         COMMITTEE ON COMMERCE

                     TOM BLILEY, Virginia, Chairman

W.J. ``BILLY'' TAUZIN, Louisiana     JOHN D. DINGELL, Michigan
MICHAEL G. OXLEY, Ohio               HENRY A. WAXMAN, California
MICHAEL BILIRAKIS, Florida           EDWARD J. MARKEY, Massachusetts
JOE BARTON, Texas                    RALPH M. HALL, Texas
FRED UPTON, Michigan                 RICK BOUCHER, Virginia
CLIFF STEARNS, Florida               EDOLPHUS TOWNS, New York
PAUL E. GILLMOR, Ohio                FRANK PALLONE, Jr., New Jersey
  Vice Chairman                      SHERROD BROWN, Ohio
JAMES C. GREENWOOD, Pennsylvania     BART GORDON, Tennessee
CHRISTOPHER COX, California          PETER DEUTSCH, Florida
NATHAN DEAL, Georgia                 BOBBY L. RUSH, Illinois
STEVE LARGENT, Oklahoma              ANNA G. ESHOO, California
RICHARD BURR, North Carolina         RON KLINK, Pennsylvania
BRIAN P. BILBRAY, California         BART STUPAK, Michigan
ED WHITFIELD, Kentucky               ELIOT L. ENGEL, New York
GREG GANSKE, Iowa                    THOMAS C. SAWYER, Ohio
CHARLIE NORWOOD, Georgia             ALBERT R. WYNN, Maryland
TOM A. COBURN, Oklahoma              GENE GREEN, Texas
RICK LAZIO, New York                 KAREN McCARTHY, Missouri
BARBARA CUBIN, Wyoming               TED STRICKLAND, Ohio
JAMES E. ROGAN, California           DIANA DeGETTE, Colorado
JOHN SHIMKUS, Illinois               THOMAS M. BARRETT, Wisconsin
HEATHER WILSON, New Mexico           BILL LUTHER, Minnesota
JOHN B. SHADEGG, Arizona             LOIS CAPPS, California
CHARLES W. ``CHIP'' PICKERING, 
Mississippi
VITO FOSSELLA, New York
ROY BLUNT, Missouri
ED BRYANT, Tennessee
ROBERT L. EHRLICH, Jr., Maryland

                   James E. Derderian, Chief of Staff
                   James D. Barnette, General Counsel
      Reid P.F. Stuntz, Minority Staff Director and Chief Counsel

                                 ______

            Subcommittee on Finance and Hazardous Materials

                    MICHAEL G. OXLEY, Ohio, Chairman

W.J. ``BILLY'' TAUZIN, Louisiana     EDOLPHUS TOWNS, New York
  Vice Chairman                      PETER DEUTSCH, Florida
PAUL E. GILLMOR, Ohio                BART STUPAK, Michigan
JAMES C. GREENWOOD, Pennsylvania     ELIOT L. ENGEL, New York
CHRISTOPHER COX, California          DIANA DeGETTE, Colorado
STEVE LARGENT, Oklahoma              THOMAS M. BARRETT, Wisconsin
BRIAN P. BILBRAY, California         BILL LUTHER, Minnesota
GREG GANSKE, Iowa                    LOIS CAPPS, California
RICK LAZIO, New York                 EDWARD J. MARKEY, Massachusetts
JOHN SHIMKUS, Illinois               RALPH M. HALL, Texas
HEATHER WILSON, New Mexico           FRANK PALLONE, Jr., New Jersey
JOHN B. SHADEGG, Arizona             BOBBY L. RUSH, Illinois
VITO FOSSELLA, New York              JOHN D. DINGELL, Michigan,
ROY BLUNT, Missouri                    (Ex Officio)
ROBERT L. EHRLICH, Jr., Maryland
TOM BLILEY, Virginia,
  (Ex Officio)

                                  (ii)


                            C O N T E N T S

                               __________
                                                                   Page

Hearings held:
    April 28, 1999...............................................     1
    May 5, 1999..................................................    49
Testimony of:
    Baker, Hon. Richard H., a Representative in Congress from the 
      State of Louisiana.........................................    76
    Greenspan, Hon. Alan, Chairman, Board of Governors, Federal 
      Reserve System.............................................    24
    Levitt, Hon. Arthur, Chairman, Securities and Exchange 
      Commission.................................................   120
    Nichols, George, III, Chairman, Committee on Financial 
      Services Modernization, National Association of Insurance 
      Commissioners..............................................   109
    Roukema, Hon. Marge, a Representative in Congress from the 
      State of New Jersey........................................    80
    Rubin, Hon. Robert E., Secretary of the Treasury, accompanied 
      by Richard S. Carnell, Assistant Secretary of the Treasury, 
      Department of the Treasury.................................    83
    Schultz, Arnold, Board Chairman, the Grundy National Bank....   163
    Sinder, Scott A., Partner, Baker and Hostetler, LLP, on 
      behalf of Independent Insurance Agents of America, National 
      Association of Life Underwriters, and National Association 
      of Professional Insurance Agents of America................   173
    Sutton, Mark P., President, Private Client Group, PaineWebber 
      Inc........................................................   158
    Zimpher, Craig, Vice President, Government Relations, 
      Nationwide Insurance Corporation...........................   168
Material submitted for the record by:
    Bentsen, Hon. Kenneth E., Jr., a Representative in Congress 
      from the State of Texas, prepared statement of.............   193
    Investment Company Institute, prepared statement of..........   198
    National Association of Independent Insurers, prepared 
      statement of...............................................   195

                                 (iii)



                   THE FINANCIAL SERVICES ACT OF 1999

                              ----------                              


                       WEDNESDAY, APRIL 28, 1999

                  House of Representatives,
                             Committee on Commerce,
           Subcommittee on Finance and Hazardous Materials,
                                                    Washington, DC.
    The subcommittee met, pursuant to notice, at 10:17 a.m., in 
room 2123, Rayburn House Office Building, Hon. Michael G. Oxley 
(chairman) presiding.
    Members present: Representatives Oxley, Gillmor, Largent, 
Bilbray, Ganske, Lazio, Shimkus, Wilson, Shadegg, Fossella, 
Bliley (ex officio), Towns, Deutsch, Stupak, Barrett, Luther, 
Capps, Markey, Rush, and Dingell (ex officio).
    Staff present: David Cavicke, majority counsel; Robert 
Gordon, majority counsel; Linda Dallas Rich, majority counsel; 
Brian McCullough, professional staff member; Robert Simison, 
legislative clerk; Consuela Washington, minority counsel; Bruce 
Gwinn, minority professional staff member; and Christian Fjeld, 
minority legislative intern.
    Mr. Oxley. The subcommittee will come to order. Today is 
our first of two scheduled hearings this year on H.R. 10, the 
Financial Services Act of 1999. For this first hearing, we are 
fortunate to have with us our good friend, the Chairman of the 
Board of Governors of the Federal Reserve System, Alan 
Greenspan.
    Chairman Greenspan will hopefully enlighten us on how 
financial holding companies would be regulated under H.R. 10 
and describe the structural problems we still need to address. 
In particular, I look forward to a thorough education on 
operating subsidiaries and the dangers of expanding taxpayer 
subsidies under a new financial system.
    The House spoke clearly on this issue last term, rejecting 
two floor amendments to expand the powers of bank operating 
subsidiaries. But the operating subsidiary has more lives than 
Freddie Krueger, and I am sure it will continue to revisit us 
at every step in this process.
    I also expect to hear more about the operating subsidiary 
at the second hearing on May 5, to which we have invited 
Treasury Secretary Rubin and other financial regulators, as 
well as various industry representatives. H.R. 10 is a 
continual learning process for the members, and we appreciate 
the testimony of all of our witnesses.
    Last term this subcommittee took a bill that was opposed by 
almost every financial regulator and industry group and forged 
a series of bipartisan agreements to create consensus 
protections for consumers. We continued to work on the bill as 
it went to the House floor, and we passed Glass-Steagall reform 
in the House for the first time in 65 years. Unfortunately, 
despite a series of overwhelming votes for the bill in the 
Senate, H.R. 10 just barely missed crossing the finish line, 
and American consumers were left empty-handed yet again.
    This term we must renew our commitment to enacting 
financial services reform, building on the bipartisan solutions 
of our last effort. Our committee will exercise its 
jurisdiction to make continued improvements in the bill to 
ensure consistent regulation of financial activities and 
appropriate consumer protections. But like last term, we will 
work in a bipartisan manner with an eye toward increasing 
consensus on a number of very volatile issues.
    I would again like to thank our good friend Chairman 
Greenspan for agreeing to appear before us today, and express 
our continued appreciation for the assistance and support of 
the Federal Reserve in working toward enactment of financial 
services reform.
    Now I would turn to our ranking member, the gentleman from 
New York, Mr. Towns, for an opening statement.
    Mr. Towns. Thank you, Mr. Chairman. Congress has been 
working on this legislation for a long, long time. I think it 
was Chairman Bliley who indicated that this was the 11th 
attempt to repeal Glass-Steagall since 1979. I am hopeful that 
we can produce a bill in the 106th Congress that finally gets 
the job done, but it must be done properly.
    New York is the home to our most important securities firms 
like Goldman Sachs and Merrill Lynch, major money center banks 
like Citibank and J.P. Morgan, and important insurance 
companies like New York Life, Metropolitan Life, and the list 
goes on and on. The financial services industry is an important 
catalyst for economic growth in our country. Repealing Glass-
Steagall will improve competition in financial services, it 
will help consumers, and it will maintain our global leadership 
in the financial community.
    In the last Congress, this committee rescued Glass-Steagall 
repeal. We took legislation that had little support when 
reported to the Banking Committee, and we made changes that 
enabled the legislation to pass the House for the first time in 
65 years. I would like to take this opportunity to commend the 
Chair of this committee Mr. Oxley, and, of course, the Chair of 
the full committee Mr. Bliley, and the ranking member Mr. 
Dingell, for their hard work and the leadership that they 
demonstrated in those days and times.
    Today we will hear testimony from the Chairman of the 
Federal Reserve, Mr. Greenspan. Chairman Greenspan's reputation 
is legendary. We are pleased to have the opportunity to hear 
his views on improvements we can make in H.R. 10.
    There are two issues that I hope our committee will 
address. The first is the operating subsidiary. In the last 
Congress we decided that we should not expand taxpayer 
subsidies by having securities or insurance underwriting in 
operating subsidiaries. Chairman Greenspan pointed out that the 
affiliate structure provides companies with everything they 
need with no risk to taxpayers.
    The second issue we need to address is functional 
regulation. I expect that securities and insurance should be 
regulated the same way, no matter who is selling the product. I 
have long held this view. I believe that functional regulation 
is simply common sense.
    In the last Congress, the House acted, but the Senate 
failed to act when faced with the issue of Glass-Steagall 
repeal. It is my hope that the Senate will resolve their 
differences, reconsider the committee's elimination of CRA 
protections, and move this important legislation forward.
    Mr. Chairman, I look forward to this morning's testimony in 
the hopes that we can fashion legislation in the 106th Congress 
which will modernize the financial services industry without 
overriding the principles of consistency, safety and soundness 
as well as judicial jurisdictional roles that have been so 
important for this committee for years and years.
    I yield back.
    Mr. Oxley. The gentleman yields back.
    The Chair now recognizes the chairman of the full 
committee, the gentleman from Virginia, Mr. Bliley.
    Mr. Bliley. I thank you, Mr. Chairman. In the 105th 
Congress for the first time in history, the House of 
Representatives approved legislation to repeal Glass-Steagall 
and modernize the laws that govern our Nation's financial 
markets. Unfortunately, unlike horseshoes, we don't score any 
points with the American people for almost getting an important 
bill signed into law. H.R. 10 never made it to the Senate last 
year, otherwise we wouldn't be sitting here today to consider 
H.R. 10 once again.
    This time around we are going to let the Senate go first 
before we move this bill in the Commerce Committee. I look 
forward to seeing the Senate succeed at the task that we were 
able to accomplish last Congress in the House. I still believe 
that the gentleman from Virginia, who first tried to repeal the 
law he coauthored, was right. The attempts of Carter Glass and 
many others over the years to repeal Glass-Steagall is still a 
good idea, but there are two very bad ideas that I intend to do 
everything in my power to ensure that this legislation does not 
include as we proceed in this Congress. One is threatening 
American taxpayers by expanding bank operating subsidiary 
powers. The other is undermining fair competition in the 
protection of investors and consumers by thwarting consistent 
regulation of securities and insurance activities engaged in by 
different entities.
    Today we will hear from a very esteemed witness, our 
friend, the Chairman of the Board of Governors of the Federal 
Reserve System, Alan Greenspan. Chairman Greenspan will address 
the first of these very fundamental issues, that is the dangers 
of expanding bank powers through operating subsidiaries.
    Welcome, Chairman, and thank you for joining us today to 
educate us about this extremely important, some would say the 
most important, aspect of the legislation that is now before 
this committee.
    The House Banking Committee has worked very hard to forge 
compromises on this difficult legislation. Unfortunately, I 
feel these compromises would compromise the integrity of our 
financial markets. H.R. 10 as reported by the House Banking 
Committee contains both of the bad ideas I am most concerned 
about. It expands the taxpayer-funded government subsidy to 
bank operating subsidiaries that can engage in not only 
securities underwriting, but also merchant banking. It does not 
provide for consistent regulations of securities activities by 
banks and securities firms.
    I look forward to learning from Chairman Greenspan about 
the implications of the legislation before us and how we might 
improve the bill. I also look forward to learning more about 
both of these issues at our upcoming hearing next month when we 
will hear from regulators, including the Treasury, as well as 
industry participants.
    I want to thank Chairman Oxley for his continued leadership 
on this issue of such vast importance to the Commerce Committee 
and for holding this first hearing on financial services reform 
this Congress. I also thank my friend, the ranking member of 
the committee, John Dingell, for his steadfast principles of 
protecting the taxpayer and ensuring consistent regulation as 
we continue our bipartisan work on this legislation. I look 
forward to working with both of you, as well as the ranking 
member of the subcommittee Ed Towns all of the members on the 
committee as we once again take on the challenge of modernizing 
our financial service regulations for the next century and 
beyond. Thank you, Mr. Chairman.
    Mr. Oxley. The gentleman's time has expired.
    The Chair now recognizes the ranking member, the gentleman 
from Detroit.
    Mr. Dingell. Mr. Chairman, I thank you. Mr. Chairman, I 
commend you for holding this hearing on H.R. 10, the Financial 
Services Act of 1999, the legislation reported by the Banking 
Committee to modernize the U.S. financial regulatory system, to 
enhance competition in the financial services industry, to 
provide protections for investors and consumers, and to 
increase the availability of financial services to citizens of 
all economic circumstances and for other purposes.
    I also want to welcome my good friend Mr. Greenspan to the 
committee. Welcome. We are delighted to see you here. Your good 
works are widely known on many matters, including the operating 
of the economy, but your leadership is not appreciated as well 
as it should be. So I am delighted to see you here, and maybe 
people can get a better understanding of the real leadership 
you have shown on this matter also. In any event, welcome to 
you, Mr. Chairman.
    Mr. Chairman, the Banking Committee's mark falls short of 
many of the goals that I am concerned with, and I must inform 
you that in its current form I will be regrettably compelled to 
oppose it vigorously.
    I want to thank my old friend Mr. Bliley, the chairman of 
the committee, for his kind remarks and also for the fine 
leadership which he has shown in difficult times in addressing 
this legislation, not just in the last Congress and this 
Congress, but also in other years. His effort on this has made 
for a better and stronger economy.
    Mr. Chairman, key consumer protection provisions that the 
chairman of this committee and the chairman and ranking member 
of the House Banking Committee joined me in adding to last 
year's bill are not in H.R. 10 this year. The SEC opposes the 
bill because it eviscerates consumer and investor protection. 
Yesterday the North American Securities Administrators 
Association submitted a 10-page memorandum outlining serious 
concern with this bill. Last week the National Association of 
Insurance Commissioners sent us a strong letter stating that 
the State insurance commissioners oppose H.R. 10 as passed by 
the House Banking Committee because the bill is hostile to 
consumers, to the States, and to purchasers of insurance 
polices. I ask unanimous consent to include these documents in 
the hearing record along with my statement.
    Mr. Oxley. Without objection.
    Mr. Dingell. At the same time, Mr. Chairman, we received 
letters from American Bankers Association, Securities 
Association and the ABA Insurance Association telling us not to 
change a word in the securities and insurance language of the 
Banking Committee bill. In response it should come as no 
surprise that I have requested the staff on this side to go 
over every word with a magnifying glass because this tells me 
there is a skunk in the wood pile somewhere. The last time I 
checked, the rules of the House blessed this committee with 
jurisdiction over securities and the business of insurance and 
responsibilities for reviewing and addressing these matters. No 
matter how difficult, we must do so, and it is clearly in the 
public interest that we should.
    I want to welcome, as I said, my good friend Chairman 
Greenspan. Like all of us, I am an admirer of his because of 
his outstanding period of public service going back so many 
years. I thank him for joining us today to share with us his 
wisdom on matters in which he is the Nation's most foremost 
expert.
    I may also be the only man in this room old enough to 
remember the banking crisis of the early 1930's. Those were 
grim times. I remember what it did to the economy and the 
people of the country and what was necessary to restore the 
confidence of the American people in the Nation's banking 
system and in the securities markets. Moreover, the thrift 
debacle of the 1980's should serve as a much more fresh and 
current reminder.
    My colleagues, I will not support a regulatory structure 
that imposes upon the American public the danger of a 
repetition of these terrible events and the possibility of a 
similar raid on the U.S. Treasury by banks which have not 
engaged in the necessary standard of responsible behavior. 
Congress should be anxious to prevent the loss of public 
confidence and prevent large losses to the public treasury. I 
am hopeful that Chairman Greenspan can share with us some of 
the relevant lessons of the recent Asian financial crisis and 
the decision of the Japanese to adopt a holding company format 
in their financial structure on a going-forward basis.
    Absent significant changes in H.R. 10, and that is one of 
the responsibilities of this government, to protect consumers, 
to protect depositors, and to protect, of course, the taxpayers 
to whom we have a paramount responsibility, I would be 
compelled to oppose this bill with every bit of strength that I 
have. Like the President, I will also be compelled to oppose 
any legislation that weakens our commitment to the Community 
Reinvestment Act.
    In Greco-Roman mythology, Sisyphus was the cruel king of 
Corinth. His punishment in Hades was to run up a hill with a 
stone that constantly rolled down upon him again. As we enter 
banking Hades this year and attempt to roll H.R. 10 up the 
legislative hill to the Senate again, I would urge my 
colleagues to keep faith that this can be done, but only if we 
do it the right way. Passing no bill is better than passing a 
bad bill.
    I just would like to hold up for everybody to look at, 
there is an article in the Wednesday, today, April 28, 1999, 
Wall Street Journal. ``Sitting pretty,'' it says. It's on the 
left-hand side of the page, ``Strong banking system helps 
Australia prosper as neighbors struggle.'' Neighbors 
disregarded the lessons that the Australians have observed. 
Bankers have complained to me for years about the fact that the 
Japanese and other banks in that area were large, and that ours 
were smaller. I observed that it is better to have smaller, 
better, stronger banks than large, weak banks which impose 
danger on the American people. The warnings are there before 
all. I hope they will see them, and I look forward to the 
testimony of my good friend.
    [The prepared statement of Hon. John D. Dingell follows:]
    Prepared Statement of Hon. John D. Dingell, a Representative in 
                  Congress from the State of Michigan
    Mr. Chairman, I commend you for holding this hearing on H.R. 10, 
the Financial Services Act of 1999, legislation reported by the House 
Banking Committee to modernize the U.S. financial regulatory system, to 
enhance competition in the financial services industry, to provide 
protections for investors and consumers, to increase the availability 
of financial services to citizens of all economic circumstances, and 
for other purposes.
    Mr. Chairman, the Banking Committee's mark falls short of many of 
these goals and I must inform you that, in its current form, I would be 
compelled to oppose it vigorously .
    Key consumer protection provisions that the chairman of this 
committee and the chairman and ranking member of the House Banking 
Committee joined me in adding to last year's bill are not in H.R. 10 
this year. The SEC opposes the bill because it eviscerates investor 
protection. Yesterday, the North American Securities Administrators 
Association submitted a 10-page memorandum outlining their concerns 
with this bill. Last week the National Association of Insurance 
Commissioners sent us a letter stating that the state insurance 
regulators oppose H.R. 10 as passed by House Banking because the bill 
is hostile to consumers and the States. I ask unanimous consent to 
include these documents in the hearing record with my statement.
    At the same time, we have received letters from the American 
Bankers Association Securities Association and the ABA Insurance 
Association telling us not to change a word in the securities and 
insurance language of the Banking Committee bill. In response, it 
should come as no surprise that I have instructed the staff to go over 
every word with a magnifying glass. The last time I checked, the rules 
of the House vest the Commerce Committee with jurisdiction over 
securities and the business of insurance and the responsibility for 
reviewing and addressing these matters. No matter how difficult, we 
must do so, and do so in the public interest.
    I warmly welcome my good friend Chairman Greenspan and thank him 
for his years of excellent public service and for appearing before us 
today to share with us his wisdom on matters in which he is most 
expert.
    I may be the only man in this room old enough to remember the 
aftermath of the banking crisis of the early 1930s. I remember what it 
did to the economy and people of this country and what was necessary to 
restore the American public's confidence in the Nation's banking system 
and the securities markets. Moreover, surely the thrift debacle of the 
1980s should still be fresh in our minds.
    My colleagues, I will not support a regulatory structure that 
exposes the American public to a repetition of those terrible events 
and a similar raid on the U.S. Treasury. Congress should be anxious to 
prevent the loss of public confidence and to prevent large losses to 
the public treasury. I am hopeful that Chairman Greenspan can share 
with us some of the relevant lessons of the recent Asian financial 
crisis, and the decision of the Japanese to adopt a holding-company 
format for their financial structure on a going-forward basis.
    Absent significant changes to H.R. 10--and that is one of the 
responsibilities of this government, to protect consumers, to protect 
depositors and to protect, of course, the taxpayers to whom we have a 
paramount responsibility--I will be compelled to oppose this bill with 
every bit of strength I have. Like the President, I also will be 
compelled to oppose any legislation that weakens our commitment to the 
Community Reinvestment Act.
    In Greco-Roman mythology, Sisyphus was the cruel king of Corinth 
whose punishment in Hades was to roll up a hill a heavy stone that 
constantly rolled down again. As we enter banking Hades this year and 
attempt to roll H.R. 10 up the legislative hill to the Senate again, I 
urge my colleagues to keep faith that this can be done, but only if we 
do it the right way. Passing no bill is better than a bad bill.
    Mr. Chairman, I thank you.
                                 ______
                                 
                         Securities and Exchange Commission
                                                   February 4, 1999
The Honorable Thomas J. Bliley
Chairman
Committee on Commerce
U.S. House of Representatives
2125 Rayburn House Office Building
Washington, DC 20515

The Honorable John D. Dingell
Ranking Member
Committee on Commerce
U.S. House of Representatives
2322 Rayburn House Office Building
Washington, DC 20515
    Dear Chairman Bliley and Congressman Dingell: I am writing to share 
the Commission's views on financial services modernization as the 
Congress begins to considers pending legislation.
    Last year, Commission staff worked with Congress in an effort to 
develop legislation that would preserve principles that are fundamental 
to effective oversight of the securities markets. Unfortunately, the 
extended negotiations so eroded these basic principles that the 
Commission cannot support the latest version of H.R. 10, as introduced 
in the 106th Congress.
    Rather than attempt to address all the specific provisions in this 
particular bill, I believe it would be more useful, at this time, to 
step back and outline the broader concepts we feel should be 
incorporated in any financial modernization bill. I have attached a 
brief discussion of the Commission's overall objectives for financial 
services reform. My staff and I are readily available to discuss these 
objectives further with you or your staff.
    I applaud the Congress' efforts to advance financial services 
modernization and look forward to working with you and the Committee on 
this important legislation.
            Sincerely,
                                              Arthur Levitt
                                                           Chairman
Enclosure
cc: The Honorable Michael G. Oxley
     Chairman, Subcommittee on Finance and Hazardous Materials
   The Honorable Edolphus Towns
     Ranking Member, Subcommittee on Finance and Hazardous Materials
               SEC Objectives for Financial Modernization
    The SEC's mandate is to protect investors and ensure the integrity 
of the U.S. securities markets. In order to keep our markets the 
fairest, safest, most transparent and most liquid in the world, the SEC 
must oversee all U.S. securities activities, irrespective of location, 
and continue to determine how they are defined.
    Focusing on market integrity and investor protection, the SEC will 
work with the Congress to include the following key safeguards in any 
financial modernization legislation:

 Maintain aggressive SEC policing and oversight of all 
        securities activities. Public confidence in our securities 
        markets hinges on their integrity. The SEC has an active 
        enforcement program committed to fighting securities fraud. 
        Banking regulators have a different mandate--protecting the 
        safety and soundness of institutions and their deposits--which 
        does not consider the interests of defrauded investors. To 
        continue its effective policing of the markets, the SEC must be 
        able to monitor securities activities through regular 
        examinations and inspections, including access to books and 
        records of all activities.
 Safeguard customers by enabling the SEC to set net capital 
        rules for all securities businesses. Securities positions are 
        generally more volatile than banking activities. The SEC's 
        capital and segregation requirements recognize this fact and 
        are more rigorous in addressing market risk than those imposed 
        by bank regulators. During recent turmoil in the financial 
        markets, SEC-regulated entities were well-collateralized and 
        none was ever at risk of failure. We must continue to protect 
        our markets from systemic risk by ensuring that there is enough 
        capital backing securities transactions to protect customers.
 Protect investors by applying the SEC sales practice rules to 
        all securities activities. All investors deserve the same 
        protections when buying securities, regardless of where they 
        choose to do so, but gaps in the current scheme leave investors 
        at risk. For example, banks are not required to recommend only 
        suitable investments or provide a system for arbitrating 
        customer disputes. The high, uniform standard of the Federal 
        securities laws should apply to all sales of securities.
 Protect mutual fund investors with uniform adviser regulations 
        and conflict-of-interest rules. Mutual fired investors should 
        always receive the protections of the federal securities laws. 
        Accordingly, all parties that provide investment advice to 
        mutual funds should be subject to the same oversight, including 
        SEC inspections and examinations. In addition, any type of 
        entity that has a relationship with a mutual fund should be 
        subject to the SEC conflict-of-interest rules.
 Enhance global competitiveness through voluntary broker-dealer 
        holding companies. U.S. broker-dealers are at a competitive 
        disadvantage overseas because they lack the global, 
        consolidated supervision that foreign regulators often require. 
        To address this concern, a U.S. broker-dealer predominantly in 
        the securities business should have the option of SEC holding 
        company supervision. This structure would impose risk-based 
        supervision, consistent with the firm's principal business, and 
        would help protect market integrity by. overseeing the entire 
        corporate entity, not just an isolated domestic unit.

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                                ------                                

            National Association of Insurance Commissioners
                                                     April 22, 1999
Honorable Tom Bliley
Chairman
Committee on Commerce
2125 Rayburn HOB
Washington, DC 20515

Honorable John D. Dingell
Ranking Minority Member
Committee on Commerce
2328 Rayburn HOB
Washington, DC 20515
State Insurance Regulators Oppose HR 10 as Passed by the House Banking 
   Committee Because the Bill Is Hostile to Consumers and the States
    Gentlemen: HR 10, as passed by the House Committee on Banking and 
Financial Services, is very harmful to insurance consumers and the 
States. Consequently, we believe it is absolutely essential that the 
Committee on Commerce exercise its jurisdiction over insurance matters 
to fix HR 10, and protect the American public from the dangers of 
unregulated insurance products in the marketplace.
    In its current form, HR 10 needlessly sweeps away State authority 
used to regulate the solvency and market conduct of insurance 
activities conducted by banks and traditional insurers that affiliate 
with them. If the Federal government prevents the States from 
supervising those insurance activities, they will not be regulated at 
all. There is no Federal guarantee program for insurance losses, so the 
costs of such regulatory failures will fall directly upon 
policyholders, claimants, State guarantee funds, and State taxpayers.
    The NAIC requests that the Committee on Commerce correct the 
insurance regulatory problems in HR 10. To help accomplish that goal, 
State regulators are undertaking two important initiatives--(1) NAIC is 
providing the Commerce Committee with a package of amendments to HR 10 
that, if adopted, will adequately protect insurance consumers and the 
States without impairing the goals of the bill's sponsors; and (2) NAIC 
and State regulators are commencing an intensive, public cam-

paign to inform consumers, State officials, and Members of Congress 
regarding the harm that passage of HR 10 will cause.
    As an organization of State officials responsible for protecting 
the public, the National Association of Insurance Commissioners (NAIC) 
pointed out the following serious flaws in HR 10 during our testimony 
before the House Banking and Financial Services Committee on February 
11, 1999.

 HR 10 flatly prohibits States from regulating the insurance 
        activities of banks, except for certain sales practices. There 
        is no justification for giving banks an exemption from proper 
        regulations that apply to other insurance providers.
 HR 10 prohibits States from doing anything that might 
        ``prevent or restrict'' banks from affiliating with traditional 
        insurers or engaging in insurance activities other than sales. 
        This exceedingly broad standard undercuts ALL State supervisory 
        authority because every regulation restricts business activity 
        to some degree. HR 10's total preemption of State consumer 
        protection powers goes far beyond current law, and casts a 
        dangerous cloud over the legitimacy of State authority in 
        countless situations having nothing to do with easing financial 
        integration for commercial interests. It could also throw into 
        question the regulatory cooperation between State insurance 
        regulators and Federal banking agencies being achieved under 
        current law.
 HR 10 uses an ``adverse impact'' test to determine if State 
        laws or regulations are preempted because they discriminate 
        against banks. This unrealistic standard fails to recognize 
        that banks are government-insured institutions which are 
        fundamentally different from other insurance providers. Sound 
        laws and regulations that are neutral on their face and neutral 
        in their intent would still be subject to preemption under such 
        a standard.
 HR 10 does not guarantee that State regulators will always 
        have equal standing in Federal court for disputes which may 
        arise with Federal regulators.
    Frankly, we are quite disappointed and concerned that the House 
Banking and Financial Services Committee chose not to fix these and 
other problems pointed out by NAIC. We were told that all parties 
affected by HR 10 will suffer a certain amount of pain, but nobody has 
informed insurance consumers that they are among the groups who will 
suffer when State laws and regulations are preempted.
    The NAIC and State insurance regulators strongly oppose HR 10 as 
passed by the Banking and Financial Services Committee. Nor do we 
believe the public will be complacent about the negative impact that HR 
10 will have upon the safety and soundness of financial products 
involving insurance, a unique product which is purchased to protect 
people during the times in their lives when they are most vulnerable.
    The NAIC looks forward to working positively and cooperatively with 
the Commerce Committee and its Members as you perform your 
responsibilities on HR 10. We cannot--and will not--stand by silently 
if the push for HR 10 becomes a means for effectively deregulating the 
insurance activities of banks and the traditional insurance providers 
who affiliate with them. The public interest would not be served with 
that outcome.
            Sincerely,
                                      George M. Reider, Jr.
                                                    President, NAIC
                                        George Nichols, III
       Chairman, NAIC Committee on Financial Services Modernization
cc: Honorable Michael G. Oxley, Chairman
   Honorable Edolphus Towns, Ranking Minority Member
     Subcommittee on Finance and Hazardous Materials
   Members of the Committee on Commerce
                                 ______
                                 
                                 ABA Securities Association
                                                     April 21, 1999
The Honorable Thomas J. Bliley, Chairman
The Committee on Commerce
2125 Rayburn House Office Building
U.S. House of Representatives
Washington, DC 20515
    Dear Chairman Bliley: In this letter, the ABA Securities 
Association (``ABASA'') respectfully submits its views on the capital 
markets provisions in H.R. 10, the ``Financial Services Act of 1999,'' 
which the Commerce Committee is scheduled to consider during the next 
month. ABASA is a separately-chartered subsidiary of the American 
Bankers Association (``ABA'') that represents the banking organizations 
that are most actively involved in securities and capital markets.
    In general, ABASA strongly supports the existing capital markets 
provisions of H.R. 10. Among its many positive provisions are full 
securities underwriting and dealing authority for affiliates and 
subsidiaries of banks; removal of the existing prohibition on director, 
officer, and employee interlocks between banks and securities firms; 
broadened ``merchant banking'' investment authority; increased 
authority for banks to underwrite and deal in municipal bonds; and an 
expanded definition of the types of financial activities in which bank 
holding companies would be permitted to engage.
    At the same time, H.R. 10 would significantly roll back the 
existing securities law exemption from broker-dealer regulation that is 
now expressly applicable to all banks. The result would be that certain 
lawful banking activities would be ``pushed out,'' or exposed to push-
out, from the bank to a separate affiliate that was registered and 
regulated as a securities broker-dealer. However, H.R. 10 recognizes 
that many of the traditional banking activities should not trigger 
brokerage registration. H.R. 10 does this through a series of narrowly 
drawn exemptions from push-out for specific types of activities in 
which banks currently engage.
    ABASA has long opposed push-out provisions as costly, unnecessary, 
and inconsistent with the fundamental purposes of financial services 
modernization. Despite this long-held position, ABASA has continually 
worked hard and in good faith to support a constructive compromise on 
push-outs that would help lead to passage of an overall bill that 
included the positive capital markets provisions described above. These 
efforts have included many worthwhile exchanges with your Committee, 
the House Banking Committee, the Senate Banking Committee, the federal 
banking regulators, the Securities and Exchange Commission, and the 
Treasury Department. In addition, at the request of House leadership in 
the 105th Congress, ABASA participated with our colleagues at the 
Securities Industry Association (``SIA'') in compromise discussions 
regarding this same issue.
    After many years of these intensive discussions and negotiations, 
the result has been an extremely hard-fought and carefully-balanced 
compromise involving substantial concessions from all parties involved. 
The compromise replaces the existing blanket exemption from push-out 
for all banking activities with a set of specific statutory exemptions 
for particular types of banking activities that have been and will 
continue to be more appropriately regulated under the banking laws than 
the securities laws. Other existing banking activities not covered by 
the exemptions--such as retail securities brokerage--would be pushed 
out to a broker-dealer. All of these new exemptions are spelled out in 
detail in statutory language in order to provide market participants 
with some high degree of certainty.
    In this context, ABASA strongly supports the push-out provisions in 
the Senate Banking Committee's version of financial reform legislation. 
ABASA also continues to support the push-out provisions of H.R. 10 as 
reported by the House Banking, which, although involving more push-outs 
than the Senate version, is nevertheless consistent with the 
fundamental compromise described above. Indeed, it is our understanding 
that the H.R. 10 provisions are nearly identical to those included in 
the financial services legislative compromise that resulted at the end 
of 1998 from last year's negotiations among you and the Chairmen of the 
House and Senate Banking Committees, and that the SEC, while not 
agreeing to this version, made clear at the end of last year's debate 
that they would not strongly oppose the final compromise bill that 
included these provisions.
    Accordingly, ABASA urges the Commerce Committee to adopt the 
securities and capital markets provisions in H.R. 10, including the 
push-out provisions reflecting the compromise discussions from last 
year. We firmly believe that the hard-fought compromise it reflects is 
an extremely delicate one, and that any significant departure from it 
would jeopardize critical support for the overall legislation.
    Thank you for considering our views. We look forward to working 
with you and your staff, and answering any questions you may have.
            Sincerely,
                                     The ABA Securities Association

cc: The Honorable John D. Dingell, Ranking Minority Member,
     Committee on Commerce
   The Honorable Michael G. Oxley, Chairman,
     Subcommittee on Finance and Hazardous Materials
   The Honorable Edolphus Towns, Ranking Minority Member,
     Subcommittee on Finance and Hazardous Materials
                                 ______
                                 
                                  ABA Insurance Association
                                                      April 15,1999
The Honorable John D. Dingell
Ranking Minority Member
The Committee on Commerce
2322 RHOB
U.S. House of Representatives
Washington, DC 20515
    Dear Rep. Dingell: The American Bankers Association Insurance 
Association, Inc., is writing regarding the insurance provisions in 
H.R. 10, which has been approved by the House Banking and Financial 
Services Committee and is now pending in the House Commerce Committee. 
The ABA Insurance Association (ABAIA) is an affiliate of the American 
Bankers Association. Its members are the leading banking organizations 
in the United States involved in the business of insurance.
    While the insurance provisions in H.R. 10 are not perfect, ABAIA 
supports them. As approved by the House Banking Committee, the bill 
would permit banks to affiliate with an insurance company or insurance 
agency. Such affiliates would be regulated principally by the states, 
subject to an anti-discrimination standard intended to ensure that 
banks and their insurance affiliates are treated fairly. States would 
have the right to review affiliations between banks and insurance 
firms, and the federal banking regulators would be required to defer to 
the states in the examination and supervision of insurance affiliates.
    The insurance provisions in H.R. 10 reflect a fragile compromise 
between the interests of the banking and insurance industries, state 
and federal regulators, and consumers. These provisions, particularly 
Section 104, reflect months of negotiations between interested parties, 
including ABAIA, and we fear that a departure from them could cause the 
entire bill to unravel. Therefore, we urge you to maintain the 
compromise as it stands.
    We would, however, like to raise two matters, which are not within 
the scope of the insurance compromise. First, Section 176 of the bill 
directs the federal banking regulators to establish an 
``appropriateness'' standard applicable to the sale of insurance by a 
bank. This is an undefined standard, which we fear could lead to 
significant litigation. Furthermore, it is a standard that would be 
applicable only to banks engaged in the sale of insurance, not to 
insurance companies or agencies unaffiliated with banks. Consumer 
confusion would be inevitable. Therefore, we recommend the elimination 
of this requirement.
    Second, Section 305 prohibits a national bank or a subsidiary of a 
national bank from underwriting or selling title insurance, unless the 
bank or subsidiary was engaged in the activity prior to the date of 
enactment of the bill. This is an anti-competitive provision that 
simply has no place in a financial modernization bill. Title insurance 
sales, in particular, pose no safety and soundness threat to a bank or 
its depositors. With this provision in place, a mortgage banking 
subsidiary of a national bank could not sell title insurance lawfully 
underwritten by a holding company affiliate. We urge the elimination of 
this anti-competitive, anti-consumer provision.
    Thank you for your consideration of these views.
            Sincerely,
                                          ABA Insurance Association
                                 ______
                                 

          [Wednesday, April 28, 1999--The Wall Street Journal]

                             Sitting Pretty
   By S. Karene and David Wessel, Staff Reporters of The Wall Street 
                                Journal
    When Asia's economies hit the skids nearly two years ago, it looked 
like Down Under was soon to be down and out.
    After all, 60% of Australia's export goods were bound for Asia, 
many of them commodities such as copper, nickel and aluminum, whose 
prices were tumbling. Asians also accounted for about half the nation's 
foreign tourists, and hotels like the Radisson Resort, along the beach-
strewn Gold Coast of Australia's eastern shore, soon reeled from a 
decline in arrivals. Several private economists looked around and cut 
their growth forecasts.
    But Australia hasn't just avoided the Asian-Pacific downturn; it 
has roared ahead. While the economies of most of its Asian trading 
partners contracted last year, Australia's expanded 5.1%, surpassing 
the U.S.'s 3.9% pace and making it one of the fastest-growing economies 
in the developed world. And 1999 is likely to be its eighth consecutive 
year of growth.
    After a decade of unflattering comparisons to Asia's once-booming 
economies, Australia now is basking in praise from the most unlikely 
sources--including the proud Singaporeans who had looked down on 
Australians as poor cousins.
Tortoise vs. Hare
    During a visit to Australia last month, Singapore Prime Minister 
Goh Chok Tong recalled the fable of the tortoise and the hare, likening 
Australia to the tortoise who surprises the Asian hares by winning the 
race. ``Australia has a good record over the past 15 years or so'' of 
policies that ``have given an underpinning to the country,'' Mr. Goh 
said. ``In many parts of Asia, we were concentrating on fast growth, 
quick infrastructure, but forgetting the fundamentals.''
    What accounts for Australia's success? Equal parts good fortune and 
good management.
    Australia's central bank had begun cutting interest rates for 
domestic reasons a year before the Asian crisis began in July 1997, so 
there was a strong dose of stimulus in the country's economic pipeline. 
Moreover, the nation had weathered an Asian-style banking aft in the 
1980s; by the mid-1990s, Its banks had been rebuilt and its regulators 
were battle-hardened.
    ``The one, two and three main reasons that Australia isn't in the 
contagion is because of the strength and soundness of the banking 
system.'' says Robert Joss, an American banker recruited in 1993 to 
turn around Westpac Banking Corp., one of Australia's biggest banks, 
after it nearly collapsed under bad debt.
    On the management front, Australia let its dollar float freely back 
in 1983, so it had no rigid exchange rate to defend, as did such 
countries as South Korea and Thailand, which tried unsuccessfully and 
expensively to tie their currencies to the U.S. dollar. Once the Asian 
crisis was afoot, its central bank--in contrast to that of neighboring 
New Zealand--read the situation correctly, and didn't tighten monetary 
policy to shore up its currency.
    Meanwhile, Australian exporters--which deregulation and 
privatization had forced to become more nimble--diverted their wares 
from sinking Asian economies to healthier ones elsewhere. When the 
South Korean market went sour, for example, Qantas Airways redeployed 
aircraft on more promising Indian routes. As Indonesia's economic crash 
hammered sales of live cattle there, Australian producers began wooing 
buyers In Mexico and Libya. All told, Australia's sales of goods to 
Asia, including Japan, slid 6% last year, in value terms, from 1997, 
while exports to the U.S. and Europe climbed 34% and 42%, respectively. 
And its total exports of goods and services rose in 1998, by a modest 
2%, to 114.9 billion Australian dollars (US$74.56 billion).
    Australia's floating dollar apparently has allowed it ``to sail 
almost unscathed through the Asian crisis,'' says Paul Krugman, an 
international economist at the Massachusetts Institute of Technology. 
In a new book, he asks: ``If Australia could so easily avoid getting 
caught up in its neighbors' economic catastrophe, why couldn't 
Indonesia or South Korea do the same?''
    His controversial answer: The financial markets have a double 
standard. When the currency of a country in which they have confidence, 
say Australia, plunges, they see it as an excuse to buy; the country 
benefits, and the market's good opinion is confirmed. When the same 
thing happens elsewhere--in Indonesia, for example--investors flee, the 
country suffers, and the market's bad opinion is ratified.
    But John Edwards, chief economist of HongkongBank of Australia 
Ltd., contends that the answer lies in the structural changes Australia 
has made. ``They weren't the reason we grew, but they were the reason 
we weren't a victim of the Asian crisis, although we shared a number of 
characteristics of countries that were victims.'' These include a heavy 
foreign-debt load and a relatively big deficit in the current account, 
a gauge of trade in goods and services, plus certain fund transfers.
    Though ``you can't just take a template from somewhere else and 
slap it on,'' Australia is ``an inspiration for implementing tough 
economic reforms,'' because it has overcome ``a number of challenges 
that Asian economies are going to face,'' says Alex Erskine, who 
watched the Asian crisis unfold as Citibank's regional market 
strategist in Singapore.
    Of course, the story isn't over yet. Economic growth is likely to 
slow in the months ahead, though the IMF is predicting better than 3% 
growth for 1999, and Australia's already large trade deficit is 
widening.
    However, for all their differences in geography, natural resources, 
history and culture, Asia's economies might have learned something by 
studying Australia's mistakes of the 1980s.
    Long before Asia overdosed on easy credit, Australia had done much 
the same thing, though on a smaller scale. It deregulated its financial 
sector and, in 1985, opened the doors to 16 foreign banks. Hungry for 
market share, the new competitors from abroad lent readily, which 
spurred lending at the four big domestic banks, including Westpac. 
Real-estate prices soared, and a crop of highflying entrepreneurs 
emerged, including Perth businessman Alan Bond, with his flagship Bond 
Corp. Holdings Ltd. By the early 1990s, a recession had pricked the 
asset bubbles. Mr. Bond's empire collapsed, owing creditors $10 
billion, and he now is in jail for corporate misdeeds. Regulators say 
troubled debt now amounts to 1% of the outstanding loans of all banks 
in Australia, down sharply from a 1992 peak of 10%.
    Before the 1980s crisis, the science of assessing credit risk 
``just didn't exist'' in Australian banking, says Les Phelps, executive 
general manager of the nation's bank regulator. In its wake, banks such 
as Westpac moved to implement a better risk-management system and 
provide greater disclosure, and regulators added staff, increased the 
frequency of bank visits, and standardized and tightened definitions of 
such things as troubled assets.
    ``After the disasters of the cowboy era, everybody got religion,'' 
says Mr. Joss, who recently left Westpac to become dean of Stanford 
University's business school. ``Corporate balance sheets are much 
healthier in Australia today than they were six or eight years ago.'' 
As both equity and debt capital got scarcer, Australian companies had 
to manage resources better, something that Asian companies must learn 
to do, he says. The government, too, is in better financial shape 
today, having recorded a budget surplus, excluding asset sales, last 
year and predicting another surplus for the fiscal year ending in June.
    As a result, Australia was better prepared than some other 
economies when Thailand's 1997 devaluation set off a chain reaction 
that turned growth in Asia into recession. Not surprisingly, the 
Australian dollar fell, losing 25% of its value as. the crisis 
deepened. The currency, which had been at 80 U.S. cents in late 1996, 
weakened to 74 cents after Thailand devalued, and touched bottom at 55 
cents after Russia's default and devaluation in August 1998.
    Inside the Australian central bank, however, policy makers 
concluded that the country's dollar would have to stay weak for at 
least six months before a resulting rise in import prices would stoke 
inflation. Betting correctly that the currency would rebound, the bank, 
unlike many of its counterparts, didn't tighten monetary policy, though 
it spent US$2.5 billion, 20% of its hard-currency hoard, to buy the 
Australian dollar in an effort to stem selling that was deemed mostly 
``speculative.'' Its wager paid off; the Australian dollar has been 
hovering around 63 U.S. cents, and inflation has been steady at around 
1.6%.
    Central bank chief Ian Macfarlane remains cautious, however. ``We 
had been expecting a noticeable slowdown, and we still are,'' he says. 
``But it will be a slowing off a much higher basis than we formerly 
thought.''
    What happened in New Zealand, which also overhauled its economy in 
the 1980s, underscores the importance of Mr. Macfarlane's policy 
decision. New Zealand's central bankers had been tightening monetary 
policy through the end of 1996 to cool inflationary pressures, and 
began easing in early 1997. But partly out of fear that the weakening 
New Zealand dollar would stir up inflation, It didn't ease quickly 
enough--and a recession ensued.
    ``We'd probably have eased more if we'd actually had a realistic 
understanding'' of the magnitude of both the Asian crisis and a drought 
that hurt local agricultural production, says Donald Brash, New 
Zealand's central banker. Still, Mr. Brash thinks that because of the 
time it takes for such changes to affect an economy, monetary policy 
would have needed to be ``much easier in 1996'' to stop New Zealand--
whose economy now is growing again--from sliding into recession in 
early 1998.
    But propelling a capitalist economy forward takes more than strong 
banks and central bankers who are prepared to risk a weakening 
currency. It also takes businesses that can and do respond when the 
world around them changes.
    For years, Australian businesses and workers had struggled to cope 
with the dismantling of policies that, in the government's view, were 
restraining the Australian economy. Tariff barriers protecting 
Australian industries were stripped away. The rigid national wage-
setting structure that had governed pay has moved toward a 
productivity-based system of labor agreements reached at individual, 
companies. Air travel, electricity and telecommunications have been 
opened to competition.
    The changes were painful and controversial, but the resulting 
flexibility now is yielding benefits.
    Take, for example, Zip Heaters (Aust) Pty. Ltd., Sydney, which 
makes instant water heaters for hot drinks. Like many other Australian 
manufacturers, Michael Crouch, chairman of the closely held company, 
which employs about 200, decided in the mid-1980s to look outside 
Australia to build his business. Zip now exports to about 20 countries, 
deriving 65% of its earnings from overseas. Indeed, Mr. Crouch boasts 
that several world leaders, including British Prime Minister Tony 
Blair, use Zips; Mr. Blair's office wouldn't comment, citing a standing 
policy.
    Before the Asian crisis, Zip was exporting about 10% of its output 
to Asia. That figure has been halved, but Zip has shifted its focus to 
the buoyant British market, where Mr. Crouch says sales have more than 
offset the Asian slump.
    Over the past five years, deregulation has cut his business costs--
helping trim 20% off Zip's energy bills, for example. But Mr. Crouch 
credits Australia's low interest rates--Australian companies can borrow 
at about 5% to 6%--and its flexible exchange rate as the biggest 
factors in his company's favor. ``I can't emphasize enough how 
important that has been to Australian manufacturers,'' he adds.

    Mr. Oxley. I thank the gentleman.
    The gentleman from Oklahoma, Mr. Largent.
    The gentleman from Illinois, Mr. Shimkus.
    The gentleman from New York, Mr. Lazio.
    Mr. Lazio. Just briefly, Mr. Chairman. I want to thank you 
for the wonderful work you did last year for removing the H.R. 
10. This is another significant opportunity for the committee 
to step forward and to affirm the evolution of the marketplace. 
I think in many ways that is exactly what H.R. 10 is. We are 
affirming the evolution of the marketplace. The demand is 
driving the integration of financial services, and if there is 
any doubt about that, certainly the Citigroup merger was a 
reaffirmation of the fact that there is enormous demand for 
risk products through the insurance affiliates, securities 
products to fulfill the hunger for the capital needs throughout 
the world, and banking products which in many ways are defying 
our ability to define them in pure terms. What is a derivative? 
What is a mortgage-backed security? It is partly a risk 
instrument, partly an investment instrument; certainly in many 
ways a security instrument.
    So I want to compliment you, Mr. Chairman, and I want to 
compliment Chairman Greenspan for his constructive and 
sustained efforts both in the Banking Committee and Commerce 
Committee. This has developed into an important partnership and 
has brought us to where we are on the verge of providing the 
framework for the 21st century for our American financial 
services enterprises to thrive throughout the world and to meet 
the demand in insurance and securities and banking.
    Mr. Oxley. I thank the gentleman.
    [Additional statements submitted for the record follow:]
 Prepared Statement of Hon. John Shadegg, a Representative in Congress 
                       from the State of Arizona
    Thank you Mr. Chairman. I am pleased that Federal Reserve Chairman 
Greenspan is able to join us today to discuss financial services 
modernization, an issue that has become a perennial topic for this 
committee.
    I am an ardent supporter of financial modernization and believe 
this legislation is necessary to allow America's banking and financial 
services to compete in the global market. Financial services 
legislation is needed to repeal the Depression-era banking laws created 
in response to a decade of financial loss, the crash of the stock 
market, and numerous bank closures. These laws, including the Bank 
Holding Company Act and the Glass-Steagall Act, separated banking and 
insurance activities, and banking and securities activities, 
respectively.
    It was believed that banks, whose main function is to protect the 
customer's financial holdings, should not engage in risk-oriented 
financial services such as securities and insurance. At the time, this 
separation of activities was expected to prevent future bank failures 
incorrectly attributed to involvement in securities. In fact, many bank 
failures during this era were not a direct result of securities 
activity but rather this mishandling of deposits by the banks 
themselves. Mr. Glass recognized this and attempted to repeal his own 
legislation only one year later.
    There is now widespread consensus that banks, securities firms, and 
insurance companies should be afforded the opportunity to consolidate 
their services to provide customers one-stop shopping for financial 
products. However, I share Chairman Greenspan's reservations about 
allowing these services to be provided through an operating subsidiary 
of a bank holding company.
    Although the banking laws of the 1930's may have been misguided in 
their attempts to rectify the economic crisis that existed, I believe 
the financial services legislation approved by the this subcommittee 
should provide consumers protection against any future financial 
crisis. This can best be achieved through affiliates of a financial 
holding company. A financial holding company provides multiple 
financial services to consumers while separating the high risk 
securities and insurance activities from the federally insured banking 
activity.
    Furthermore, if we are to maintain the current regulatory standards 
over banking, securities and insurance products, functional regulation 
must be a key component of financial services legislation. 
Specifically, the regulation of securities by the Securities and 
Exchange Commission and the regulation of insurance products by state 
insurance agencies is vital to providing consumers the most sound 
financial services available.
    Again, I thank Chairman Greenspan for appearing before this 
subcommittee today and I commend Chairman Bliley and Chairman Oxley for 
their leadership on this issue. As a new member of the House Commerce 
Committee, I look forward to addressing H.R. 10, the Financial Services 
Act of 1999, more closely and creating a reform package that will 
provide consumers comprehensive and affordable financial services.
                                 ______
                                 
 Prepared Statement of Hon. Tom Barrett, a Representative in Congress 
                      from the State of Wisconsin
    Mr. Chairman and Democratic Ranking Member Dingell, I appreciate 
the opportunity to submit opening remarks for today's hearing on H.R. 
10, the Financial Modernization Act.
    Nearly 70 years has passed since Congress enacted laws governing 
the financial services industry. Although these laws have served our 
country well for many years, no one could have envisioned the global 
and technologically sophisticated financial marketplace that exists 
today.
    The financial services marketplace is evolving at a fast and 
furious pace, and the complexity of services offered by financial 
institutions challenges the capacity of the existing regulatory 
structure to meet market needs while safeguarding consumers.
    After many years of debate on this issue, I hope that this Congress 
will enact a financial modernization bill that will benefit consumers 
while ensuring that our financial services industry can operate 
efficiently, competitively and securely in the 21st century.
    H.R. 10 is now before this committee. As we move this legislation 
forward, I hope that the members of this committee will not lose sight 
of the needs of local communities, especially underserved urban and 
rural neighborhoods. In our pursuit to modernize the financial services 
system, we need to make sure it works for all communities.
    As we all know, the future of our local communities, and the 
Community Reinvestment Act (CRA) in particular, has been a key issue in 
legislative efforts to overhaul our nation's outdated laws governing 
the financial services industry.
    I am very pleased that the House Banking Committee reported out a 
bill that preserves CRA and expands it to cover the new wholesale 
financial institutions established in H.R. 10. CRA has proven to be 
necessary and effective. This law has channeled over $680 billion in 
reinvestment dollars for home loans, small business development and 
economic revitalization programs in low-income urban and rural 
neighborhoods across our country.
    I thank Chairman Alan Greenspan for being here today, and I also 
want to take this opportunity to applaud him for his testimony about 
the success of CRA before the House Banking Committee in February. To 
quote Mr. Greenspan, CRA has ``very significantly increased the amount 
of credit that's available in the communities, and if one looks at the 
detailed statistics, some of the changes have really been quite 
profound.''
    I would also be remiss if I did not say that I am appalled by 
Senator Gramm's attempt to scale back CRA, and limit its impact. The 
bill that Senator Gramm pushed through the Senate Banking Committee 
would exempt more than 60% of all banks nationwide, and almost 75% in 
Wisconsin. I strongly oppose this legislation, and will oppose any bill 
that weakens CRA.
    As this committee meets once again to consider a rewrite of our 
nation's financial services laws, we have an opportunity to preserve 
and expand CRA. Although I understand that it will be difficult to push 
through any changes that would expand CRA-like obligations to insurance 
companies, securities firms, mortgage firms and other financial 
companies allowed to affiliate with banks, I still plan to pursue these 
issues.
    These issues are very important to address because H.R. 10 would 
permit the unprecedented conglomeration of banks, securities firms, and 
insurance companies. These huge financial conglomerates would be 
allowed to shift their activities from banks to CRA-exempt affiliates 
and subsidiaries. Therefore, banks would have fewer resources to make 
home and small business loans to low- and moderate income communities.
    Mr. Chairman and Mr. Dingell, I sent over three proposals to the 
Democratic staff a few weeks ago that I hope you will consider 
including in the financial modernization markup vehicle you present to 
the members of this committee. They seek to ensure that community 
reinvestment keeps pace with the major structural changes that would 
occur in the banking and broader financial services industry as a 
result of H.R. 10.
    I would like to submit copies of each of these proposals for the 
record along with my written testimony. Two of the proposals were 
offered by Rep. Luis Guiterrez during the House Banking Committee 
markup of H.R. 10. One concerns a data disclosure requirement for 
insurance company affiliates of banks, and the other expands CRA to 
non-bank affiliates that make loans or engage in banking activities.
    The third proposal is one that I offered during a Banking Committee 
markup of H.R. 10 in the 105th Congress. It passed in committee as an 
amendment to H.R. 10, but was not in the version of H.R. 10 that came 
up for a floor vote. It would establish an Advisory Council on 
Community Revitalization that would make recommendations to Congress on 
how to meet the capital and credit needs of underserved communities in 
the wake of financial modernization.
    I would also like to submit for the record a copy of a proposal 
that I finished drafting yesterday. It simply calls on the federal 
financial regulatory agencies to conduct a study to examine the impact 
that H.R. 10 would have on the Community Reinvestment Act if enacted. 
If the regulators determine that the law has had an adversarial impact 
on CRA, they would have the authority to issue regulations addressing 
the problem. This proposal is not controversial, and makes common 
sense. As you may know, the Banking Committee approved version of H.R. 
10 already includes a provision requiring a study on the impact H.R. 10 
would have on small financial institutions.
    I hope that every member of this committee will support the 
preservation of CRA, and will strongly consider the proposals I have 
submitted for consideration today. They will help ensure that in our 
effort to update our antiquated banking laws and bring the U.S. 
financial services system into the 21st century that we do not leave 
our communities behind.

    Mr. Oxley. We now turn to our sole witness for today, the 
Honorable Alan Greenspan, the Chairman of the Fed.
    Mr. Greenspan, again, welcome back to the committee, and 
thank you for your good work in this and many other areas.

STATEMENT OF HON. ALAN GREENSPAN, CHAIRMAN, BOARD OF GOVERNORS 
                 OF THE FEDERAL RESERVE SYSTEM

    Mr. Greenspan. Thank you very much, Mr. Chairman. I would 
particularly like to thank the committee for the invitation 
that gives me the opportunity to present the views of the 
Federal Reserve on the current version of H.R. 10. Last year I 
testified at length before this committee on many of the issues 
related to your deliberations on this legislation. In the 
interest of time, I thought it might be best if I limit my 
formal comments to the critical issue of whether the important 
new powers being contemplated are exercised in a financial 
services holding company through a nonbank affiliate or in a 
bank through its subsidiary.
    Let me be clear. We at the Federal Reserve strongly support 
the new powers that would be authorized by H.R. 10. We believe 
that these powers, however, should be financed essentially in 
the competitive marketplace and not financed by the sovereign 
credit of the United States. This requires that the new 
activities be permitted through holding companies and 
prohibited through banks. To do otherwise is potentially a step 
backward to greater Federal subsidization and eventually to 
more regulation to contain the subsidies. I and my colleagues 
accordingly are firmly of the view that the long-term stability 
of U.S. financial markets and the interests of the American 
taxpayer would be better served by no financial modernization 
bill rather than one that allows the proposed new activities to 
be conducted by the bank as proposed by H.R. 10. In that 
regard, we join Congressman Dingell in his remarks with respect 
to that issue.
    Government guarantees of the banking system provide banks 
with a lower average cost of capital than would otherwise be 
the case. The subsidized cost of capital is achieved through 
lower market risk premiums on both insured and uninsured debt 
and through lower capital than would be required by the market 
if there were no government guarantees. The lower cost of 
funding gives banks a distinct competitive advantage over 
nonbank financial competitors.
    Under H.R. 10, the subsidy that the government provides to 
banks as a byproduct of the safety net would be directly 
transferable to their operating subsidiaries to finance powers 
not currently permissible to the bank or its subsidiaries. We 
should be clear how the subsidy would link directly to an 
operating subsidiary. Because of the subsidy, the funds a bank 
uses to invest the equity of its subs are available to the bank 
at a lower cost than that of any other potential investor, save 
the U.S. Government. Thus, operating subsidiaries under H.R. 10 
could conduct new securities, merchant banking and other 
activities with a government subsidized competitive advantage 
over independent firms that conduct the same activity.
    H.R. 10 does not contain provisions that effectively 
curtail the transfer of the subsidy to operating subsidiaries 
or address this competitive imbalance. The provisions of H.R. 
10 that would require the deduction of such investments from 
the regulatory capital of the bank, after which the bank must 
still meet the regulatory definition of ``well-capitalized,'' 
attempt but fail to limit the amount of subsidized funds that 
an individual bank can invest in its subsidiaries. What matters 
is not regulatory capital, but actual or economic capital. The 
vast majority of banks now hold significantly more capital than 
regulatory definitions of ``well-capitalized'' require. This 
capital is not ``excess'' in an economic sense that is somehow 
available for use outside the bank. It is the actual amount 
required by the market for the bank to conduct its own 
activities. Thus, deductions from regulatory capital would in 
no way inhibit the transfer of the subsidy from the bank to the 
subsidiary.
    Some have argued that the subsidy transference to the 
subsidiaries of banks is no different from the transfer of 
subsidized bank dividends through the holding company parent to 
holding company affiliates. The direct upstreaming of dividends 
by a bank to its holding company parent that in turn invests 
the proceeds in subsidiaries of the holding company, while 
legally permissible, in fact does not occur. The empirical 
evidence indicates that, on net, at the largest organizations--
that is, over $1 billion in assets--there has been no financing 
of a bank's holding company affiliates with subsidized equity 
of the associated bank.
    The dividend flows from banks to their parent holding 
companies have been less than the sum of holding company 
dividends, interest on holding company debt, and the cost of 
holding company stock buybacks, a substitute for dividends. All 
of that part of the subsidy reflected in earnings has flowed 
directly to investors.
    That bank dividends are not used to finance holding company 
subsidiaries should not be surprising. It simply is not in the 
interest of the consolidated banking organization to increase 
bank dividend flows beyond parent company capital-servicing 
needs because the resulting decline in bank capital would 
increase funding costs of the bank.
    Research at the Federal Reserve indicates that over the 
past quarter century, for the largest banks the cost of 
uninsured bank funds has tended to rise as a bank's capital 
ratio fell and vice-versa. This is just what one should expect. 
As the risk-absorbing equity cushion falls, the risk for 
uninsured creditors rises. The flow of dividends from the bank 
to the parent holding company reduces bank capital. That 
reduction in turn reduces the risk buffer for uninsured 
creditors, increasing the funding costs of the bank on all the 
uninsured liabilities by more, the data show, than the small 
subsidy transference of funding the additional equity 
investment in the affiliate.
    Thus, were a bank holding company to finance its nonbank 
affiliates from bank dividends, that is, to directly pass on 
the bank subsidy to the holding company affiliates, the 
profitability of the consolidated organization would decline. 
If there were no net costs to the bank from upstreaming 
dividends to its parent for affiliate funding, it would be the 
prevalent practice today. It is not. In short, the subsidy 
appears to have been effectively bottled up in the bank. The 
Federal Reserve Board believes that this genie would be 
irreversibly let out of the bottle, however, should the 
Congress authorize wider financial activities in operating 
subs. Subsidized equity investments by banks can be made in 
their own subsidiaries without increasing funding costs on all 
of the bank's uninsured liabilities because the consolidated 
capital of the bank would not change in the process. When a 
bank pays dividends to its parent, the bank shrinks, and its 
capital declines. When a bank invests in its subsidiary, its 
capital remains the same.
    None of this is relevant today since the activities 
authorized to bank subsidiaries cannot differ from those 
available to the bank itself under current law. Hence, there is 
no additional profit to the overall banking organization in 
shifting existing bank powers to a subsidiary--the activity 
would receive the same subsidy in the subsidiary as it now gets 
in the bank. But H.R. 10 would currently permit activities not 
now permitted in the bank. Those activities, when performed in 
bank subsidiaries and financed with subsidized bank equity 
capital, would increase the potential profit to the overall 
banking organization. It would also inevitably induce the 
gravitation to subsidiaries of banks, not only of the new 
powers authorized by H.R. 10, but all of those powers currently 
financed in holding company affiliates at higher costs of 
capital than those available to the banks.
    How important is this subsidy? Even today when losses in 
the financial system and hence the value of the subsidy are 
quite low, the cost of debt capital to banks still averages 10 
to 12 basis points below that of the parent holding companies. 
That difference in bond ratings today between banks and the 
holding companies, let alone the larger difference between 
banks and other financial institutions, is a significant part 
of the 20 to 30 basis point gross margin on an A-rated or 
better investment grade business loans, more than enough to 
significantly change lending behavior if it were not available.
    Business loan markets are particularly competitive, and 
hence there is little leeway for a competitor with higher 
funding costs to pass on such costs to the borrower. For 
example, the weakened credit standing of the Japanese banks has 
engendered a risk premium that these entities have paid and 
today would have to pay to fund their U.S. affiliates. This has 
required them to sharply reduce their business loan volume in 
the United States. Japanese bank branches and agencies in the 
United States have reduced their share of business loans from 
over 16 percent of the total U.S. market in 1995 to less than 
11 percent today.
    In short, the subsidy is a critical competitive issue in 
competitive markets. Allowing the bank to inject Federal 
subsidies into the proposed new activities could distort 
capital markets and the efficient allocation of both financial 
and real resources. New affiliations, if allowed through banks, 
would accord them an unfair competitive advantage over 
comparable nonbank firms. The holding company structure, on the 
other hand, fosters a level playing field within the financial 
services industry contributing to a more competitive 
environment.
    Mr. Chairman, in addition to our concern about the 
extension of the safety net that would accompany the widening 
of bank activities through operating subsidiaries, the Federal 
Reserve Board is also sensitive to the implications of 
operating subsidiaries for the safety and soundness of the 
parent bank. Most of the new activities contemplated by H.R. 10 
would not be accompanied by unusually high risk, but they could 
imply more risk. Although, to be sure, diversification can 
reduce that risk, the losses that would accompany riskier 
activities from time to time would fall on the insured bank's 
capital if the new activities were authorized in bank 
subsidiaries. Such losses at holding company affiliates would 
fall on the uninsured holding company. This is an important 
distinction for the deposit insurance funds and potentially the 
American taxpayer. This potential for loss and bank capital 
depletion is another reason for urging that the new activities 
be conducted in a holding company affiliate rather than in a 
banking subsidiary.
    H.R. 10 is supposed to virtually eliminate this concern. 
The Office of the Controller of the Currency has asserted that 
it would order an operating sub immediately to be sold or 
declared bankrupt and closed before its cumulative losses 
exceeded the bank's equity investment in the failing sub. 
Combined with the provision of H.R. 10 adjusting regulatory 
capital for investment in subs, this provision is intended to 
cap the effect on the bank of subsidiary loss to the amount of 
the bank's original investment. Since that amount would have 
already been deducted from the bank's regulatory capital, the 
failure of a subsidiary, it is maintained, could not affect the 
regulatory capital of the bank.
    We had extensive experience with attempts to redefine 
reality by redefining regulatory capital in the thrift industry 
in the 1980's. This approach was widely viewed as a major 
mistake whose echoes we are still dealing with today. Economic, 
as opposed to regulatory, capital of the bank would not, as I 
have already noted, be changed by this special regulatory 
capital accounting, and such deductions from equity capital 
would not be reflected under GAAP.
    Perhaps more to the point, it seems particularly relevant 
to underline the losses in financial markets--large losses--can 
occur so quickly that regulators would be unable to close the 
failing operating sub as contemplated by H.R. 10 before the 
subsidiary's capital ran out. Indeed, losses might even 
continue to build, producing negative net worth in the 
subsidiary. At the time of closure of a subsidiary, there is 
nothing to prevent the total charges for losses against the 
parent bank's regulatory capital from exceeding the prior 
deduction required by H.R. 10. And closure and bankruptcy can 
and will be tied up in courts during which time the bank's 
capital and name are at risk. Our experience following the 
stock market crash of 1987--when a subsidiary of a major bank 
not only lost more than the bank's investment in its sub, but 
the bank was unable to dispose of the subsidiary for several 
years--underscores the seriousness of such concerns.
    While contemplating movements in stock prices, let me note 
that merchant banking is potentially the most risky activity 
that would be authorized by H.R. 10, and would be especially 
risky for the insured bank if permitted to be conducted in bank 
subsidiaries.
    Let me close, Mr. Chairman, by noting again that the Board 
is a strong advocate of financial modernization in order both 
to eliminate the inefficiencies of the current Great Depression 
regulatory structure and to create a system more in keeping 
with the technology and markets of the 21st century. We 
strongly support the thrust of H.R. 10 to accomplish these 
objectives. Equally as strongly, however, we also believe that 
the new activities should be authorized for banks through the 
holding company structure. That structure, especially for the 
new activities, also has the significant benefit of promoting 
effective supervision and the functional regulation of 
different activities. The holding company structure, along with 
the so-called ``Fed-lite'' provisions in H.R. 10, focuses on 
and enhances the functional regulation of securities firms, 
insurance companies, insured depository institutions and their 
affiliates by relying on the expertise and supervisory 
strengths of different functional regulators.
    Thank you very much, Mr. Chairman. I request that my full 
remarks be included for the record.
    [The prepared statement of Hon. Alan Greenspan follows:]
     Prepared Statement of Hon. Alan Greenspan, Chairman, Board of 
                   Governors, Federal Reserve System
    I would like to thank the Committee for the opportunity to present 
the views of the Federal Reserve on the current version of H.R. 10, the 
approach to financial modernization most recently approved by the House 
Banking Committee. Last year, I testified at length before this 
Committee on many of the issues related to your deliberations on this 
legislation. Our views have not changed on the need to modernize our 
banking and financial system, on consolidated supervision, on the 
emphasis on reduced regulation, on the unitary thrift loophole, and 
especially on continuing to prohibit banks from conducting through 
their subsidiaries those activities that they are prohibited to do 
themselves. In the interest of time, however, I thought it might be 
best if I limit my formal comments only to the latter, that is, the 
setting of the underlying structure of American banking in the 21st 
century. The issue is whether the important new powers being 
contemplated are exercised in a financial services holding company 
through a non-bank affiliate or in a bank through its subsidiary. Such 
a decision would be of minor significance, and decidedly not a concern 
of legislators and regulators, if banks were not subsidized.
    We at the Federal Reserve strongly support the new powers that 
would be authorized by H.R. 10. We believe that these powers, however, 
should be financed essentially in the competitive market place, and not 
financed by the sovereign credit of the United States. This requires 
that the new activities be permitted through holding companies and 
prohibited through banks.
Operating Subsidiaries
    The Board believes that any version of financial modernization 
legislation that authorizes banks to conduct in their subsidiaries any 
activity as principal that is prohibited to the bank itself, is 
potentially a step backward to greater federal subsidization, and 
eventually to more regulation to contain the subsidies. I and my 
colleagues, accordingly, are firmly of the view that the long-term 
stability of U.S. financial markets and the interests of the American 
taxpayer would be better served by no financial modernization bill 
rather than one that allows the proposed new activities to be conducted 
by the bank, as proposed by H.R. 10. For reasons I shall discuss 
shortly, the Board is not dissuaded from this view by provisions that 
have been incorporated in H.R. 10 to address our concerns.
    Subsidies. Government guarantees of the banking system--deposit 
insurance and direct access to the Fed's discount window and payments 
system guarantees--provide banks with a lower average cost of capital 
than would otherwise be the case. This subsidized cost of capital is 
achieved through lower market risk premiums on both insured and 
uninsured debt, and through lower capital than would be required by the 
market if there were no government guarantees. The lower cost of 
funding gives banks a distinct competitive advantage over nonbank 
financial competitors, and permits them to take greater risks than they 
could otherwise.
    The safety net subsidy is reflected in lower equity capital ratios 
at banks, that are consistently below those of a variety of nonbank 
financial institutions. Importantly, this is true even when we compare 
bank and nonbank financial institutions with the same credit ratings: 
banks with the same credit ratings as their nonbank competitors are 
allowed by the market to have lower capital ratios. While the 
differences in capital ratios could reflect differences in overall 
asset quality, there is little to suggest that this factor accounts for 
more than a small part of the difference.
    Under H.R. 10, the subsidy that the government provides to banks as 
a byproduct of the safety net would be directly transferable to their 
operating subsidiaries to finance powers not currently permissible to 
the bank or its subsidiaries. The funds a bank uses to invest in the 
equity of its subs are available to the bank at a lower cost than that 
of any other potential investor, save the United States Government, 
because of the subsidy. Thus, operating subsidiaries under H.R. 10 
could conduct new securities, merchant banking, and other activities 
with a government subsidized competitive advantage over independent 
firms that conduct the same activity. That is to say, the use of the 
universal bank structure envisioned in H.R. 10 means the transference 
of the subsidy to a wider range of financial businesses, producing 
distortions in the competitive balance between those latter units that 
receive a subsidy and identical units that do not--whether those units 
are subs of holding companies or totally independent of banking.
    H.R. 10 does not contain provisions that effectively curtail the 
transfer of the subsidy to operating subsidiaries or address this 
competitive imbalance. The provisions of H.R. 10 that would require the 
deduction of such investments from the regulatory capital of the bank 
(after which the bank must still meet the regulatory definition of 
well-capitalized) attempt, but fail, to limit the amount of subsidized 
funds that an individual bank can invest in its subs. What matters is 
not regulatory capital, but actual or economic capital. The vast 
majority of banks now hold significantly more capital than regulatory 
definitions of ``well-capitalized'' require. This capital is not 
``excess'' in an economic sense that is somehow available for use 
outside the bank; it is the actual amount required by the market for 
the bank to conduct its own activities. The actual capital maintained 
by a bank is established in order to earn the perceived maximum risk-
adjusted rate of return on equity. Unless this optimum economic capital 
is equal to, or less than, regulatory capital, deductions from 
regulatory capital would in no way inhibit the transfer of the subsidy 
from the bank to the subsidiary.
    Some have argued that the subsidy transference to subsidiaries of 
banks is no different from the transfer of subsidized bank dividends 
through the holding company parent to holding company affiliates. The 
direct upstreaming of dividends by a bank to its holding company parent 
that in turn invests the proceeds in subsidiaries of the holding 
company, while legally permissible, in fact does not occur--and for 
good reasons, as I will explain below. In the 1990's, dividend flows 
from banks to their parent holding companies have been less than the 
sum of holding company dividends, interest on holding company debt, and 
the cost of holding company stock buy backs, a substitute for 
dividends. Thus, the empirical evidence indicates that, on net, at the 
largest organizations there has been no financing of a bank's holding 
company affiliates with subsidized equity of the associated banks. All 
of that part of the subsidy reflected in earnings has flowed to 
investors. (There are a few large individual institutions that have, in 
some years, upstreamed dividends in excess of investor payments, but 
the cumulative amounts are very small and the conclusions are 
unchanged.)
    That bank dividends are not used to finance holding company 
subsidiaries should not be surprising. It simply is not in the interest 
of the consolidated banking organization to increase bank dividend 
flows beyond parent company capital-servicing cash flow needs because 
the resultant decline in bank capital would increase funding costs of 
the bank. Research at the Federal Reserve indicates that, over the past 
quarter of a century, for the largest banks the cost of uninsured bank 
funds has tended to rise as a bank's capital ratio fell and vice-versa. 
This is just what one should expect: As the risk-absorbing equity 
cushion falls, the risk for uninsured creditors rises. The flow of 
dividends from the bank to the parent holding company reduces bank 
capital. That reduction, in turn, reduces the risk buffer for uninsured 
creditors, increasing the funding cost of the bank on all the uninsured 
liabilities by more--the data show--than the small subsidy transference 
of funding the additional equity investment in the affiliate.
    Thus, were a bank holding company to finance its nonbank affiliates 
from bank dividends--that is, to directly pass on the bank's subsidy to 
the holding company's affiliates--the profitability of the consolidated 
organization would decline. If there were no net costs to the bank from 
upstreaming dividends to its parent for affiliate funding, it would be 
the prevalent practice today. In short, the subsidy appears to have 
been effectively bottled up in the bank. The Federal Reserve Board 
believes that this genie would be irreversibly let out of the bottle, 
however, should the Congress authorize wider financial activities in 
operating subs. Subsidized equity investments by banks can be made in 
their own subsidiaries without increasing funding costs on all of the 
bank's uninsured liabilities because the consolidated capital of the 
bank would not change in the process. But since the activities 
authorized to banks' subsidiaries cannot differ from those available to 
the bank itself, there is no additional profit to the overall banking 
organization in shifting bank powers to a subsidiary.
    But H.R. 10 would permit activities not now permitted in a bank. 
Those activities, when performed in bank subsidiaries and financed with 
bank equity capital would increase the potential profit to the overall 
banking organization. It would also inevitably induce the gravitation 
to subsidiaries of banks, not only of the new powers authorized by H.R. 
10, but all of those powers currently financed in holding company 
affiliates at higher costs of capital than those available to the bank. 
H.R. 10 thus effectively authorizes all holding company powers to be 
funded in the bank at funding costs significantly lower than the 
funding costs of its holding company.
    For the 35 of the 50 largest bank holding companies for which 
comparisons are available, ratings on debentures are always somewhat 
higher at the bank than at the holding company parent and, of course, 
higher ratings translate into lower interest rates. As might be 
expected, the data show that the value of these differences in bond 
ratings is higher during periods of market stress, when subsidies are 
more valuable, because the market is more risk sensitive. But even 
today, when losses in the financial system are quite low, the cost of 
debt capital to banks still averages 10 to 12 basis points below that 
of the parent holding companies. That difference in bond ratings today 
between banks and bank holding companies, let alone the larger 
difference between banks and other financial institutions, is a 
significant part of the 20 to 30 basis point gross margin on A-rated or 
better investment grade business loans--more than enough significantly 
to change lending behavior if it were not available.
    Business loan markets are particularly competitive, and hence there 
is little leeway for a competitor with higher funding costs to pass on 
such costs to the borrower. For example, the weakened credit standing 
of the Japanese banks has engendered a risk premium that these entities 
have paid--and today would have to pay--to fund their U.S. affiliates; 
this has required them to sharply reduce their business loan volume in 
the United States. Japanese bank branches and agencies in the United 
States have reduced their share of business loans from over 16 percent 
of the market in 1995 to less than 11 percent today.
    In short, the subsidy is a critical competitive issue in 
competitive markets. Allowing the bank to inject federal subsidies into 
the proposed new activities could distort capital markets and the 
efficient allocation of both financial and real resources. New 
affiliations, if allowed through banks, would accord them an unfair 
competitive advantage over comparable nonbank firms. The holding 
company structure, on the other hand, fosters a level playing field 
within the financial services industry, contributing to a more 
competitive environment.
    Safety and Soundness. In addition to our concern about the 
extension of the safety net that would accompany the widening of bank 
activities through operating subsidiaries, the Federal Reserve Board is 
also sensitive to the implications of operating subsidiaries for the 
safety and soundness of the parent bank. Most of the new activities 
contemplated by H.R. 10 would not be accompanied by unusually high 
risk, but they could imply more risk. The Board believes these 
activities add the potential for new profitable opportunities for 
banking organizations, but it is almost always the case that the more 
potentially profitable the activity, the riskier it is. Although, to be 
sure, diversification can reduce that risk, the losses that would 
accompany riskier activities from time to time would fall on the 
insured bank's capital if the new activities were authorized in bank 
subsidiaries. Such losses at holding company affiliates would, of 
course, fall on the uninsured holding company. This is an important 
distinction for the deposit insurance funds and potentially the 
taxpayer. This potential for loss and bank capital depletion is another 
reason for urging that the new activities be conducted in a holding 
company affiliate rather than in a banking subsidiary.
    H.R. 10 is supposed to virtually eliminate this concern. As I 
earlier noted, the bank's equity investment in the bank subsidiary 
under H.R. 10 would be deducted from the bank's regulatory capital, 
with the requirement that the remaining regulatory capital still meet 
the well-capitalized standard. At the same time, the OCC has asserted 
that it would order an operating sub immediately to be sold or declared 
bankrupt and closed before its cumulative losses exceeded the bank's 
equity investment in the failing sub. Combined with the provision of 
H.R. 10 adjusting regulatory capital for investment in subs, this 
provision is intended to cap the effect on the bank of subsidiary 
losses to the amount of the bank's original investment. Since that 
amount would have already been deducted from the bank's regulatory 
capital, the failure of the subsidiary, it is maintained, could not 
affect the regulatory capital of the bank.
    The Board is concerned that this regulatory accounting approach, 
that does not address the actual capital of a bank, could provide a 
false sense of security. We had extensive experience with attempts to 
redefine reality by redefining regulatory capital in the thrift 
industry in the 1980's. This approach was widely viewed as a major 
mistake whose echoes we are still dealing with today. Regulatory 
capital at the time soon began to mean nothing to the market, and, as a 
consequence, Congress in FDICIA ordered the banking agencies to follow 
Generally Accepted Accounting Principles (GAAP) whenever possible. In 
the current context, there is--as in the 1980's--no reason to believe 
the new regulatory definitions will change the reality of the market 
place. Economic, as opposed to regulatory, capital of the bank would 
not, as I have noted, be changed by this special regulatory capital 
accounting and such deductions from equity capital would not be 
reflected under GAAP. It is the economically more relevant GAAP 
statements to which uninsured creditors of banks look when deciding to 
deal with a bank, and they will continue to do so after financial 
modernization. Bank creditors will, in any event, continue to view the 
investment in the bank subsidiary as part of the capital protecting 
their position--for the simple reason that it does. If they see the 
economic and GAAP capital at the bank declining as operating sub losses 
occur, they will react as any prudential creditor should--regardless of 
artificial regulatory accounting adjustments or regulatory measures of 
capital adequacy.
    Perhaps more to the point, it seems to me particularly relevant to 
underline that losses in financial markets--large losses--can occur so 
quickly that regulators would be unable to close the failing operating 
sub as contemplated by H.R. 10 before the subsidiaries capital ran out. 
Indeed, losses might even continue to build, producing negative net 
worth in the subsidiary. At the time of closure of a subsidiary, there 
is nothing to prevent the total charges for losses against the parent 
bank's regulatory capital from exceeding the prior deduction required 
by H.R. 10.1 Our experience following the stock market crash 
of 1987--when a subsidiary of a major bank not only lost more than the 
bank's investment in its sub, but the bank was unable to dispose of the 
subsidiary for several years--underscores the seriousness of such 
concerns.
---------------------------------------------------------------------------
    \1\ Moreover, should creditors of the subsidiary choose to attempt 
to recover their funds from the bank parent, the removal of the loss 
charged against the bank's capital could occur only when a court has 
affirmed both the bankruptcy and the rejection of the claims on the 
bank made by the subsidiary's creditors. This process could and would 
take some time, during which, even if the court eventually found for 
the bank and/or the regulator, further losses by the subsidiary could 
continue to impinge on the bank's capital. And, again, the point is 
that the bank would have been at risk during that interval.
---------------------------------------------------------------------------
    H.R. 10 would exclude from permissible bank subsidiaries only 
insurance underwriting and real estate development. One of the 
permissible activities is merchant banking, which does not have a long 
or significant 20th century history in this country. Merchant banking 
currently means the negotiated private purchase of equity investments 
by financial institutions, with the objective of selling these 
positions at the end of some interval, usually measured in years 
Merchant banking has become so important an element of full service 
investment banking in this country, so much so that to prohibit bank-
related investment banks from participating in these activities would 
put them at a competitive disadvantage. The Board has consequently 
supported merchant banking as an activity of a holding company 
subsidiary, but believes it is potentially the most risky activity that 
would be authorized by H.R. 10, and would be especially risky if 
permitted to be conducted in bank subsidiaries.
    Existing law permits some limited exceptions to the otherwise 
prohibited outright ownership of equity by banks and their 
subsidiaries, but these are quite limited both in the aggregate and in 
the kinds of businesses in which equity can be purchased, as well as in 
the scale of each investment. True merchant banking, as envisioned by 
H.R. 10, would place no such limits--either per firm or in total. The 
potential rewards for such equity investments are substantial, but such 
potential gains are the mirror image of the potential for substantial 
loss. In addition, poor equity performance generally occurs during 
periods of weak nationwide economic performance, the same intervals 
over which bank loan portfolios are usually under pressure, raising 
concerns about the compounding of bank problems during such periods.
Functional Regulation
    The holding company structure--especially for the new activities--
also has the significant benefit of promoting effective supervision and 
the functional regulation of different activities. The holding company 
structure, along with the so-called ``Fed-lite'' provisions in H.R. 10, 
focuses on and enhances the functional regulation of securities firms, 
insurance companies, insured depository institutions and their 
affiliates by relying on the expertise and supervisory strengths of 
different functional regulators, reducing the potential burdensome 
overlap of regulation, and providing for increased coordination and 
reduced potential for conflict among functional regulators.
Executive Branch Prerogatives
    There is a final point I want to make since it appears to have 
driven Treasury's recent opposition to financial modernization 
legislation that has not adopted the universal bank model. It is not 
necessary to adopt the universal bank model in order to preserve the 
executive branch's supervisory authority for national banks or federal 
savings associations; nor is it necessary in order to preserve the 
share of this nation's banking assets controlled by national banks and 
federal savings associations. In fact, the share of assets controlled 
by national banks is predominant and growing, in part the result of the 
enactment of interstate branching authorities, an initiative the 
Federal Reserve fully supported. As shown in the tables in the appendix 
to my statement, national bank assets have increased in each of the 
last three years while state bank assets have declined over the past 
two years. As of year-end 1998, 58.5 percent of all banking assets were 
under the supervision of the Comptroller of the Currency, up from a 
little over 55 percent at the end of 1996. As the second table clearly 
suggests, the largest banks, especially those with large branching 
systems, tend to be national banks, providing a distinct advantage to 
national banks in an environment of interstate branching.
    Furthermore, Congress for sound public policy reasons has 
purposefully apportioned responsibility for this nation's financial 
institutions among the elected executive branch and independent 
regulatory agencies. Action to alter these responsibilities would be 
contrary to the deliberate steps that Congress has taken to ensure a 
proper balance in the regulation of this nation's dual banking system.
Summing Up
    The Board is a strong advocate of financial modernization in order 
both to eliminate the inefficiencies of the current Great Depression 
regulatory structure and to create a system more in keeping with the 
technology and markets of the 21st century. We strongly support the 
thrust of H.R. 10 to accomplish these objectives. Equally as strongly, 
however, we also believe that the new activities should not be 
authorized for banks through operating subsidiaries. We believe that 
the holding company structure is the most appropriate and effective one 
for limiting transfer of the Federal subsidy to new activities and 
fostering a level playing field both for financial firms affiliated 
with banks and independent firms. It will also, in our judgement, 
foster the protection of the safety and soundness of our insured 
banking system and the taxpayers, enhance functional regulation, and 
achieve all of the benefits of financial modernization for the consumer 
and the financial services industry.

          Table 1--Net Change in Commercial Bank Assets from De Novos, Mergers, and Charter Conversions
                                               Assets ($ Billions)
                                                    1995-1998
----------------------------------------------------------------------------------------------------------------
                                                                                                       12/31/94-
                                                         1995        1996        1997        1998      12/31/98
----------------------------------------------------------------------------------------------------------------
National Banks
Additions From:
  De Novo Banks.....................................        4.5         6.8         7.6         5.3        24.2
  Mergers with Other Charter Types..................       22.0        86.4       119.6        41.3       269.3
  Charter Conversions...............................       20.6        52.5        60.4        15.8       149.3
    Total Additions.................................       47.1       145.7       187.6        62.4       442.8
Deletions From:
  Failures..........................................        0.0         0.1         0.0         0.0         0.1
  Mergers with Other Charter Types..................       16.2       136.5         8.2        20.6       181.5
  Charter Conversions...............................       49.7         6.0         9.2        17.3        82.2
    Total Deletions.................................       65.9       142.6        17.4        37.9       263.8
Net Increase in National Bank Assets from De Novos,       (18.8)        3.1       170.2        24.5       179.0
 Mergers, and Charter Conversions...................
State Banks
Additions From:
  De Novo Banks.....................................       11.1         3.5         2.4         2.9        19.9
  Mergers with National Banks.......................       16.2       136.5         8.2        20.6       181.5
  Charter Conversions...............................       47.9         8.2        14.7        22.0        92.8
    Total Additions.................................       75.2       148.2        25.3        45.5       294.2
Deletions From:
  Failures..........................................        0.7         0.0         0.0         0.0         0.7
  Mergers with National Banks.......................       22.0        86.4       119.6        41.3       269.3
  Charter Conversions...............................       18.9        52.4        47.0        13.6       131.9
    Total Deletions.................................       41.6       138.8       166.6        54.9       401.9
Net Increase in State Bank Assets from De Novos,           33.6         9.4      (141.3)       (9.4)     (107.7)
 Mergers, and Charter Conversions...................
----------------------------------------------------------------------------------------------------------------


                      Table 2--Percent Distribution
 Various Indicators of Relative Size By Charter Class of Commercial Bank
                        [As of December 31, 1998]
------------------------------------------------------------------------
                                                  Charter Class
                                        --------------------------------
               Indicator                              State      State
                                          National    Member   Nonmember
                                           (OCC)       (FR)      (FDIC)
------------------------------------------------------------------------
Top 25 By Size
Consolidated Assets....................       71.7       26.9        1.4
Domestic Deposits......................       80.5       17.1        2.4
Offices in U.S.........................       88.9        7.4        3.7
Top 50 By Size
Consolidated Assets....................       69.1       29.0        1.9
Domestic Deposits......................       75.2       21.9        2.9
Offices in U.S.........................       82.2       13.7        4.1
All
Consolidated Assets....................       58.5       24.1       17.4
Domestic Deposits......................       57.4       19.5       23.1
Offices in U.S.........................       57.3       16.6       26.1
Number of Banks Operating Full-service
 Facilities in:
2 states...............................       53         15         35
3 states...............................        8          8          6
4 states...............................        4          2          1
5 states...............................        3          0          0
More than 5 states.....................       11          1          1
------------------------------------------------------------------------


    Mr. Oxley. Without objection, so ordered. We thank you for 
your testimony, Mr. Chairman, and the Chair will begin the 
questioning, even though it appears that we have both the red 
and the green light on.
    As you know, the Banking Committee made some changes in the 
operating subsidiary language from the bill that passed the 
House last session. It is my understanding that the product 
that came out of the Banking Committee preserved in the 
operating subsidiary the securities underwriting and merchant 
banking segments and indeed eliminated insurance underwriting 
from within the op sub. Your view on their efforts is what? Is 
that a good start toward removing the operating subsidiary 
language totally? What is your opinion of what the Banking 
Committee did?
    Mr. Greenspan. Mr. Chairman, I think that having both 
securities and merchant banking in operating subsidiaries as 
the structure is envisaged in H.R. 10 creates a very serious 
problem for the structure of American banking as we enter the 
21st century. A number of people have looked at this question 
of the operating sub versus affiliate issue either as a matter 
of turf between the Treasury and ourselves or strictly as a 
marginal question of an option that a banking organization 
should be allowed to make judgments on for business reasons. It 
is not a turf issue, it is a fundamental issue with respect to 
how the United States wishes to restructure its regulatory 
apparatus, given the extraordinary changes that are now 
currently under way in the technology of finance which is going 
to have a very dominant effect on how financial services are 
created and delivered to consumers and to business.
    If there were no subsidy involved in this issue, Congress, 
indeed no one, should question the freedom of individual 
business organizations to make business judgments as to where 
they put particular organizations. This is not a choice. If 
given the opportunity, any sensible banker confronted with a 
lower cost of capital in an operating subsidiary than in a 
nonsubsidized organization would not consider that a choice. 
There is only one possibility. You put it in the sub of the 
bank. And that, in my judgment, will create significant 
corrosion to what has been a superb financial system that has 
developed in this country.
    Mr. Oxley. You stated in your testimony that you felt that 
the subsidy amounted to about a 10 to 12 basis points 
advantage. Was that based on a study that the Fed conducted? 
And if you could perhaps give us a little better detail as to 
how that study was conducted.
    Mr. Greenspan. Mr. Chairman, why don't I include for the 
record--what we did is we really tabulated for 35 bank holding 
companies the credit rating given to the debentures of the 
holding company and the credit rating given to the major bank 
of that holding company. What we found is that in no cases did 
the bank holding company have as good a rating as the bank, and 
in some cases the difference was more than just marginal. But I 
will include those data for the record.
    [The information referred to follows:]

    As part of our ongoing research into the size of the safety-net 
subsidy, the attached tables summarize work by Federal Reserve staff to 
measure the difference in borrowing costs between the lead bank in 
large banking organizations and the holding company parent. Since 1990, 
the interest rate on long-term debt issued by the lead bank has 
averaged about 10 basis points less than the interest rate on 
comparable debt issued by the bank holding company; on an annual basis, 
this funding cost advantage for the bank has ranged from about 8 to 9 
basis points in recent years up to 14 basis points in 1990 and 1991.
    The calculation of this difference in borrowing costs is done in 
two steps. The first step compares Moody's rating on long-term debt 
issued by the lead bank and by the parent holding company for all of 
the top 50 banking organizations that have ratings on comparable debt 
for both entities. This comparison can be done for 35 of the top 50 
organizations. As shown in table 1, the bank debt carries a higher 
rating than the holding company debt in every case. The difference 
averages about 1\1/4\ rating ``notches'', where one notch represents 
the difference between, for example, debt rated A1 and A2. The second 
step translates the 1\1/4\ notch difference into the implied borrowing 
cost advantage for the lead banks. We do this using annual Moody's 
indexes of interest rates on bonds at various ratings within the 
investment-grade range. Table 2 displays this borrowing cost advantage 
in each year since 1990.
    The notes to tables 1 and 2 provide further information about the 
calculations.

                                 Table 1
   Debt Ratings of Top 50 Bank Holding Companies and Their Lead Banks
                (Number of institutions in each category)
------------------------------------------------------------------------
                                                              Number of
      Rating of Lead Bank Relative to Holding Company       Institutions
------------------------------------------------------------------------
Higher....................................................           35
  One notch...............................................           27
  Two notches.............................................            8
Same......................................................            0
Lower.....................................................            0
Not available.............................................           15
------------------------------------------------------------------------
Notes: This table compares the debt rating of each of the top 50 U.S.
  bank holding companies with the debt rating of its lead bank, based on
  data from Moody's Investors Service, Banking Statistical Supplement,
  United States, August 1998. Whenever possible, we compare the ratings
  of long-term senior debt issued by the bank and the holding company;
  if such ratings are not available, we compare the ratings of long-term
  subordinated debt issued by both entities. This comparison could not
  be done for 15 of the top 50 banking organizations because the holding
  company and the lead bank did not have ratings on comparable debt. For
  all of the other 35 banking organizations, the bank's debt was rated
  more highly than the debt of its holding company parent. For 27 of
  these organizations, the bank's debt was rated one ``notch'' above the
  holding company's, while for eight organizations, it was rated two
  notches above the holding company's. One notch represents the finest
  gradation in Moody's rating scale; for example, one notch separate
  debt rated A1 and A2, while two notches separate debt rated A1 and A3.
  On average, the lead bank was rated 1\1/4\ notches above its holding
  company parent.


                                 Table 2
Funding Cost Advantage for Lead Banks Relative to Bank Holding Companies
------------------------------------------------------------------------
                                                            Funding Cost
                                                              Advantage
                           Year                               (in basis
                                                               points)
------------------------------------------------------------------------
1990......................................................         14.3
1991......................................................         13.9
1992......................................................         11.5
1993......................................................          9.8
1994......................................................          9.0
1995......................................................          8.2
1996......................................................          9.4
1997......................................................          8.2
1998......................................................          9.4
------------------------------------------------------------------------
Notes: This table values the average 1\1/4\ notch rating advantage for
  the lead bank relative to its holding company parent. The figures in
  this table result from multiplying 1\1/4\ notches by the average
  difference in interest rates per rating notch, evaluated annually.
  This difference was calculated from Moody's indexes of interest rates
  for bonds rated Baa, A, Aa, and Aaa. Each of these broad rating
  categories (except for Aaa) contains three notches. Thus, a mid-level
  Baa rating is three notches below a mid-level A rating, which is
  itself three notches below a mid-level Aa rating. We assume that a mid-
  level Aa rating is three notches below the Aaa rating, even though
  there are no explicit gradations within the Aaa category. Because the
  Moody's interest rates for adjacent rating categories reflect
  difference of three notches, we divided the interest-rate spread
  between Baa-rated and A-rated bonds by three to obtain the difference
  per notch, and did the same to calculate the per-notch interest rate
  spread between the A and Aa ratings and the Aa and Aaa ratings. We
  then averaged the resulting per-notch interest-rate spreads to
  generate the funding cost advantage shown in the table for each year.


    Mr. Oxley. Without objection, that will be made part of the 
record and we appreciate that. Let me just end with one 
question. As my memory serves me, throughout the 1980's, the 
Treasury consistently opposed expanded powers for operating 
subs. What, in your estimation, is the reason that Treasury may 
have changed or I should say has obviously changed their minds 
in that regard?
    Mr. Greenspan. Well, that is factually correct. Indeed, 
having been involved in many endeavors jointly with Treasury to 
create a financial modernization bill, we never differed on 
that question. So that Treasury in a certain sense had been 
even more strongly against operating subs than we.
    I don't wish to make judgments as to why this Treasury has 
come to the position that it has. That is a question, I think, 
most appropriately put to the Secretary of the Treasury when 
you have him up here. I don't want to try to characterize his 
answer because he can do it better than I.
    Mr. Oxley. Thank you, Mr. Chairman. The gentleman from New 
York, Mr. Towns.
    Mr. Towns. Thank you very much, Mr. Chairman. The Treasury 
has criticized Japan for having extensive subsidies and 
conflicts of interest in their financial system and has 
encouraged the Japanese to adopt a holding company structure 
for their banking system. Why isn't this good advice for the 
United States?
    Mr. Greenspan. Well, again, Congressman, I think that ought 
to be directed to the Secretary of the Treasury.
    Mr. Towns. But I just want to draw from all of this 
knowledge that you have and I don't want to pass up this 
opportunity.
    Mr. Greenspan. Well, having heard me for the last 20 
minutes or so, I don't want to bore you with repeating a lot of 
what I have said previously, sir.
    Mr. Towns. Moving on, then, let me ask you this. Is it 
really possible that an operating subsidiary could lose more 
than the capital of the parent bank before regulators could 
close the operating subsidiary?
    Mr. Greenspan. No, it wouldn't lose more capital than the 
parent bank. That would be a Herculean task. But it surely 
could lose more than the capital of the subsidiary itself, 
meaning more than the capital that the parent bank would invest 
in the sub. And I think that is the crucial issue. That is, 
there is a presumption that it is easy to insulate the parent 
bank from losses in the sub. Our experience specifically in the 
case which I indicated in 1987, and in a lot of other related 
issues, is that is wishful thinking. When we are in a financial 
crisis, depository institutions, whether they are subs or 
anything else, have relatively low capital. They are highly 
leveraged institutions. And you can run through that capital in 
a rapidly changing market faster than a hot knife goes through 
butter, and the notion that we regulators have the capacity to 
fend that off I think is misplaced.
    Mr. Towns. Could you explain the wholesale financial 
institution provision, how it works?
    Mr. Greenspan. There has been, as I am sure you are aware, 
Congressman, a fairly major expansion in wholesale banking and 
a demand for a lot of sophisticated services that occurs as a 
consequence of the really quite dramatic change in technology 
that has occurred over the years. So there is essentially some 
form of increased demand for an institution which would be a 
wholesale bank. It will be regulated and has the 
characteristics under H.R. 10 of a regular commercial bank with 
the sole exception that it is not insured by the FDIC and 
cannot accept deposits below $100,000. So it is essentially a 
wholesale institution which is essentially a bank.
    Mr. Towns. Thank you. In the last Congress, this committee 
reported legislation that included provisions allowing the SEC 
to be a holding company, regulatory, or a broker that owned a 
relatively small bank. Do you have any objection to this 
provision?
    Mr. Greenspan. None whatsoever. Indeed, as I recall, we 
testified I think exactly in that regard to this committee a 
year ago. In any event, should a large securities firm purchase 
a small bank, the presumption that somehow the Bank Holding 
Company Act should be applicable in the sense that it currently 
is envisaged sort of makes no sense. I mean, our view basically 
is that the oversight of the financial services holding company 
in that type of situation almost surely should be the 
securities firm, not the bank.
    Mr. Towns. Thank you very much Mr. Chairman.
    Mr. Oxley. The gentleman's time has expired. The gentleman 
from Ohio, Mr. Gillmor.
    Mr. Gillmor. Thank you very much, Mr. Chairman. I would 
like to pursue, Mr. Chairman, a couple of questions on the 
concept of ``too big to fail'' as it functions as a practical 
matter. The bigger the institution, it gets special treatment, 
and I think it basically amounts to a subsidy by smaller and 
medium institutions. To what extent in looking at mergers do 
you consider that, if at all?
    Mr. Greenspan. Congressman, you are raising one of the 
really more difficult supervisory problems that we at Federal 
Reserve have.
    We are acutely aware that almost by definition a merger 
creates larger institutions and should the larger institution 
fail at some point, it clearly could have significant contagion 
effects in the financial system and those systemic concerns 
obviously are crucial to us.
    The answer is yes, we do look at the issues and we try to 
envisage how, should that institution run into difficulty, we 
would create a responsible liquidation, one that would not 
undercut the safety and soundness of the overall system. It is 
a very difficult issue.
    The presumption, however, that we will just automatically 
bail out large institutions is false. Were we actually to make 
that an issue of policy, I think we would find that the 
efficiency of the American banking system, which is really 
quite impressive, would deteriorate. Our issues face not on the 
question of how to keep the organization in place, but how you 
create a degree of structured liquidation so that the pieces 
are taken apart in a manner which does not create difficulties 
for the rest of the system.
    In any event, we don't look at it as an issue of too big to 
fail. We look at it as an issue of very difficult to liquidate. 
If the markets presumed that we really did have a too big to 
fail policy in this country, the ratings on bank debentures, 
even though they are higher than bank holding company 
debentures, are nowhere near the rating you would give to a 
U.S. Treasury issue or an organization essentially guaranteed 
directly or indirectly by the U.S. Government. There is still a 
pretty big gap there which implies, fortunately, that the 
markets realize that an institution cannot be too big to fail.
    But the question you raise makes it more difficult for us 
and we have spent a considerable amount of additional time 
looking at those larger institutions in the context of the type 
of principle that I just enunciated.
    Mr. Gillmor. One of the things that I have been working on 
has been an amendment which would require that that be one of 
the factors that would be considered. And I am just wondering 
if you would have--I would like to get that language to you 
when we get it finalized but I am wondering if you would have 
any strenuous objection to that concept since, as you indicate, 
you are already looking at that to a degree.
    Mr. Greenspan. Congressman, I really don't think that it is 
legislatively necessary. We have all the legislative powers 
that are required to implement that particular issue. And as 
far as I can judge, not only the Federal Reserve but all of the 
other supervisory organizations, both banking and otherwise, 
are acutely aware of the issue that you raise, and it is hard 
for me to imagine that that is not an issue that is 
continuously on the table.
    Mr. Oxley. The gentleman's time has expired.
    Mr. Gillmor. Thank you, Mr. Chairman.
    Mr. Oxley. The gentleman from Michigan, Mr. Dingell.
    Mr. Dingell. Mr. Chairman. I thank you. I have here before 
me something that I am very interested in because it tells me 
that the Japanese have chosen the route of holding companies 
rather than operating subs. Is that because the banks in Japan 
are very weak and the Japanese found that not only the banking 
system but the financial system is weak and they are choosing 
the stronger of the two courses which would give them a better 
chance of a strong system and a better chance to an earlier 
recovery?
    Mr. Greenspan. I would say yes to both questions, yes.
    Mr. Dingell. Mr. Chairman, I ask unanimous consent that 
this be inserted in the record at the appropriate place.
    Mr. Oxley. Without objection.
    [The information referred to follows:]

           [Tuesday, April 27,1999--The Wall Street Journal]

                 Daiwa Securities Becomes Holding Firm
     By Jathon Sapsford, Staff Reporter of The Wall Street Journal
    TOKYO--Daiwa Securities Co. Monday became the first globally 
recognized Japanese corporation to restructure under a holding-company 
format, reviving a business custom once banned by U.S. occupiers after 
World War II.
    It is a strategy the world will be hearing more of from Japan. 
Businesses in nearly every industry--banking, telecommunications, 
technology and manufacturing--have said they are looking at remaking 
themselves as holding companies and then turning their divisions into 
subsidiaries as a way of cutting costs.
    Daiwa is the first big company to take the plunge. ``I believe that 
the conventional [Japanese] style . . . is not sufficient for meeting 
future challenges,'' said Daiwa President Yoshinari Hara, in a full-
page add in Japan's newspapers on Monday. ``This is why we have chosen 
the holding company structure.''
    Daiwa's move, on the surface at least, will turn it into the 
Japanese equivalent of a U.S. holding company. Daiwa said It will 
change its name to Daiwa Securities Group Inc. and that this will be 
the entity its current stakeholders own. It will split its divisions 
off into a series of 10 subsidiaries owned by the holding company. 
Those subsidiaries will pay dividends to the parent, which in turn will 
pay dividends to shareholders.
    The goal for Japanese companies considering holding-company 
transformations is to reduce bureaucracy and increase flexibility. 
Through the holding company, corporations could ``exit'' businesses 
that aren't making a profit by selling them off or folding them into a 
joint venture with another company that is stronger, in the given area. 
That is proving difficult for many big companies to do under the 
current structure, according to Japanese business officials.
    A holding-company structure would allow corporations to pay some 
staff more than others, thus rewarding initiative and performance--a 
practice that runs counter to Japan's egalitarian pay structure. The 
goal is to dismantle a system under which employees are paid on the 
basis of their seniority, regardless of how much they contribute to the 
company's bottom line. By splitting divisions into separate companies, 
Daiwa, for example, could pay retail-stock salesmen a salary 
commensurate with the limited skills required to sit at a branch 
counter and sell shares.
    Meantime, it could pay more to staff in its investment-banking 
division, which demands more experience and responsibility. ``The key 
difference is that you can pay people different amounts,'' said Garry 
Evans, a strategist at HSBC Securities Japan Ltd.
    Holding companies were at the center of this country's zaibatsu, 
the conglomerates of the pre-World War II era. The U.S. banned them 
during the Allied occupation of Japan for fueling the Japanese war 
effort. The individual units spun off at that time grew into huge 
empires with broad lines of businesses under the same roof.
    Now, companies ranging from big banks such as Sanwa Bank Ltd. and 
Fuji Bank Ltd. to manufacturer's like Nissan Motor Corp. and 
telecommunications company Nippon Telegraph & Telephone Co. have 
expressed interest in the holding-company format.
    Tax issues, however, remain a big hurdle. Transferring assets from 
a parent company to a subsidiary is a process subject to a ``gift tax'' 
under Japanese law. That can be expensive for banks, which would have 
to pay as much as half the value of the loan assets on their books. The 
government is studying a change in the tax code to make such transfers 
easier. Daiwa said part of its transfer taxes will be offset by its 
retained earnings.

    Mr. Dingell. Mr. Chairman, now I note here some years back 
NationsBank to its mostly elderly bank customers was selling 
risky funds with an understanding on the part of the buyers 
that their money was protected by the Federal Government. 
NationsBank peddled these securities in conjunction with an 
operating subsidiary, Nation's Securities. Now, question: By 
expanding the capabili-

ties of operating subs, does H.R. 10 open the door for future, 
more varied fraudulent practices by banks and their 
subsidiaries?
    Mr. Greenspan. Well, I certainly think that the issue is 
one that we have to be concerned about. It is very important 
that we put a Chinese wall or other safeguard, however we wish 
to describe it, between securities activities and banking 
activities and very especially not in any way indicate that the 
safety net which is under banking activities as authorized by 
the Congress not be somehow suggested as available to people 
buying securities. And I suspect that the greater the distance 
you have between the bank and the organization selling 
securities, the less that problem is likely to emerge. I should 
say that it is one of the more difficult issues that banking 
supervisors have confronted in recent years and I suspect that 
were we to authorize the structure of the operating sub, as 
indicated in H.R. 10, it would make our job more difficult.
    Mr. Dingell. Thank you. Now, Mr. Greenspan, you have 
referred to the possibility that H.R. 10 could galvanize a 
holding company to shift capital to a bank as opposed to a 
separate holding company affiliate in order to take advantage 
of the Federal subsidy. I note, however, the Department of 
Treasury reports empirical evidence which they indicate does 
not necessarily support this prediction. Parenthetically I will 
say I am on your side but I want to get your comments.
    Treasury cites mortgage banking. Of the top 20 holding 
companies, six currently conduct mortgage banking activities in 
an affiliate, nine conduct such activities in the bank or a 
subsidiary of the bank, and five use a combination of bank and 
affiliate. What does this tell you? How do you explain this if 
you please?
    Mr. Greenspan. We are aware of the criticism and we have 
looked at it in some detail and we don't agree with their 
factual analysis for a number of reasons. First, it is 
certainly true that there are a lot of activities that legally 
could be exercised within the bank and are actually exercised 
in an affiliate of the holding company. There are a number of 
reasons. In many cases in earlier years they were geographical, 
there were tax reasons. But the most interesting issue is that 
there has been a substantial move of powers currently 
authorized in the bank but having been exercised in holding 
company affiliates which have been moved to the bank. With 
respect to a number of these types of activities, if the 
capital required is very low, then the advantage of putting an 
activity in the bank where the cost of capital is less may not 
matter. And then if there is no capital, meaning there is no 
subsidy, then there is no reason why one would necessarily put 
it in either an affiliate of the holding company or in the bank 
itself.
    With respect to those mortgage companies that are in both 
areas, I think you will find that in innumerable cases, 
especially in the very large cases, that although the activity 
starts within the holding company, it is essentially funded 
with moneys from the bank at subsidized rates. I would conclude 
that looking at the whole set of powers and how they proceed, 
as we went to interstate branching and as we changed a number 
of the tax laws and as we changed regulation, many of the 
reasons which induced banking organizations to keep powers in 
affiliates of holding companies, even though they were legally 
available to the bank have changed, and there is a dramatic and 
unquestioned flow of those powers under current law from bank 
holding company affiliates into the bank. What is left out 
there are essentially those types of activities for which 
capital is not important, agency type of activities, for 
example, and therefore the lower cost of the capital of the 
bank doesn't help very much, or very idiosyncratic questions 
with respect to tax, with respect to special factors within the 
organization. Those are rare and diminishing.
    Mr. Oxley. The gentleman's time has expired.
    Mr. Dingell. Thank you, Mr. Chairman.
    Mr. Oxley. The gentleman from Oklahoma, Mr. Largent.
    Mr. Largent. Chairman Greenspan, I would like to ask you 
one question and that is to ask you to take us into the 
boardroom of a bank and explore the motive, rationale, 
incentive for a bank to choose an operating subsidy format or a 
holding company format beyond the points that you brought out 
in your testimony about having a competitive advantage through 
the taxpayer subsidy. What are the incentives for banks to 
choose operating subsidies versus a holding company format?
    Mr. Greenspan. The major advantage is basically the cost of 
capital. I have been associated with banking as a consultant 
and as a director for very many years and the conventional 
wisdom was always when you have a power, new or otherwise, try 
to exercise it in that part of the organization where the cost 
of capital is least. Since most banking products have very 
narrow profit margins, it really matters when you lower the 
cost of capital by a very few basis points. So while there may 
be, in particular cases again, idiosyncratic characteristics of 
a special type of organization or power that may suggest that 
other things equal, you may organize it as an affiliate or as a 
sub of the bank, the cost of capital overwhelms all of those 
other characteristics because you can organize a subsidiary of 
a bank almost identically in every respect the way you organize 
an affiliate of the holding company. The presumption that 
somehow the holding company affiliate is more costly to 
organize than the subsidiary of a bank I have seen no evidence 
for. It may be, but I have never seen something which is of 
significance in this regard.
    Mr. Largent. Thank you, Mr. Chairman.
    Mr. Oxley. The gentleman's time has expired. The gentleman 
from Florida, Mr. Deutsch.
    Mr. Deutsch. Thank you, Mr. Chairman. Mr. Greenspan, 
through the testimony, through the questions, you have given, I 
think, a pretty good overview. If you could take maybe a 
minute, especially as I assume we are either on C-SPAN or MS-
NBC, to discuss from a layman's perspective the difference 
between what the Banking Committee bill passed and what you are 
proposing? What do you see as the effect for the average 
consumer?
    Mr. Greenspan. Take the difference between, for example, 
H.R. 10 as passed by the Banking Committee and the bill that 
came through this House last year. Well, there are really two 
ways of looking at it, and it is difficult to put various 
probabilities on it, but most of the provisions in both bills 
improve the movement of services to the average consumer. Most 
of the differences occur in ways which are far more reaching to 
the economy as a whole and affect consumers because they affect 
the economy, affect their jobs, affect basically the standard 
of living of the whole economic system. To the extent that you 
have subsidized misdirected capital, you are creating a less 
efficient flow of capital and therefore a less efficient 
economic system, jobs which are more difficult to get and jobs 
which pay less. To the extent that you have an issue of safety 
and soundness which can create real serious problems in the 
financial system, such as what happened to the savings and 
loans during the 1980's, then again consumers are really quite 
potentially impacted.
    I would not endeavor to say that the individual provisions 
of either the current H.R. 10 or last year's House Commerce 
print differ significantly with respect to the direct 
transmission of services, delivery of services to consumers, 
but they have profoundly important differences for broader 
issues which affect consumers as workers and protect them with 
respect to their retirement funds and their future.
    Mr. Deutsch. If I can try to get through three other 
questions relatively quickly as well. One of the things which I 
have learned over the last couple of months talking to people 
who have an interest from an industry perspective on H.R. 10 is 
effectively under the present regulatory structure, my sense is 
that you, in fact banks, at a sophisticated level through large 
consumers in fact are already effectively engaged in equity 
trading through swaps of a variety of kinds. So effectively it 
is already going on at a relatively sophisticated level, but is 
that an accurate assessment of what is going on today?
    Mr. Greenspan. I think we have to distinguish between the 
so-called section 20 affiliates of the holding companies which 
actually, of course, do operate in the securities business in 
competition with nonbanking organizations. They do not have 
access to the subsidy of the bank and they operate on a 
competitive playing field. Some of them, I might add, argue 
that they are more regulated than securities firms and they 
feel in a sense that they are operating at a disadvantage. 
There is, to be sure, equity within the bank in many different 
areas but it is highly restricted by regulation. That is, we 
have regulations which very significantly delimit what equity 
holdings can occur as a consequence of, for example, a failure 
of a loan to repay and the collateral tends to be equity, for 
example. There is a lot of that which goes on. But it is very 
significantly contained in a manner which does not create the 
types of problems which I try to outline in some detail in my 
prepared remarks.
    Mr. Oxley. The gentleman's time has expired. The gentleman 
from Illinois, Mr. Shimkus.
    Mr. Shimkus. Thank you, Mr. Chairman. And, Mr. Chairman, it 
is good to have you here. I want to focus my question on the 
local community bankers who are state chartered, small in size, 
locally owned, may or may not be in competition with a credit 
union. I am describing the ones in my district. Community 
oriented, fulfilling a niche of local services and in today's 
environment providing needed capital for farmers in this 
agricultural crisis.
    They have all--I voted for the bill. I support especially 
our version that came out in the last Congress. But they have 
all been pretty adamantly opposed to it. One question is should 
they have been, based on your perspective? Should they have 
been opposed to the bill that passed the House? And second, 
what can we do with a similar bill that passed the House, what 
can we do to make the bill better for local community bankers?
    Mr. Greenspan. Well, it is certainly the case that there is 
much in H.R. 10 and, indeed, in last year's House Commerce 
print, which effectively is directed at the organization of the 
larger institutions. And in the case of the House Commerce 
Committee's print, an endeavor to try to create a regulatory 
structure which will contain the types of instabilities which I 
think are currently involved and implicit in H.R. 10. 
Essentially, the smaller banks have a very significant interest 
in the safety and soundness of the Federal deposit insurance 
fund. And from the issue of the extent to which operating subs 
can create difficulties for deposit insurance and the taxpayers 
clearly, the smaller banks which have a very substantial 
interest in the deposit insurance fund are directly affected.
    Second, there is also a very important interest of smaller 
banks in the overall safety and soundness of the banking system 
because they are major players in the whole structure. There 
are not as many provisions which directly affect them as for 
the larger institutions, but they are not bystanders with 
marginal interest. The safety and soundness of the overall 
system cannot but be a very critical issue to smaller banks 
whether we are talking about agricultural banks or talking 
about other community banks. Everybody is very crucially tied 
to the total financial system and that that functions 
effectively has got to be in their interest.
    Mr. Shimkus. And, Mr. Chairman, what can we do to the bill 
if it was similar to the print of last year, to make it better 
for the community bankers? Do you see anything that can be 
changed?
    Mr. Greenspan. I would say that the bill that came out of 
this committee last year was fairly good. There is the obvious 
question here of the unitary thrift, which as far as I am 
concerned and as far as we have testified previously, both 
before the House and before this committee previously, the 
unitary thrift issue, which is an opening up, in my judgment, 
of banking and commerce, which could be a serious issue and 
which creates a good deal of concern for community bankers was 
closed in the House Commerce print. It is not fully closed 
potentially here.
    Mr. Oxley. The gentleman's time has expired.
    Mr. Shimkus. Thank you, Mr. Chairman.
    Mr. Oxley. The gentleman from Michigan, Mr. Stupak.
    Mr. Stupak. Thank you, Mr. Chairman. And welcome, Mr. 
Greenspan. I would like to ask you about the operating 
subsidies. If the U.S. adopts the operating subsidy model for 
banks, is it likely then that other countries would follow this 
subsidy model?
    Mr. Greenspan. I am afraid they already do. One of the 
things which distinguishes the American banking system from 
much of the rest of the world is that there is far greater 
direct and indirect subsidization of banks abroad than here. 
And I think as a consequence of that, the quality of banking 
abroad has been demonstrably inferior, less competitive, less 
effective in delivering services to consumers than the American 
banking system. I think they are becoming aware of that fact. I 
trust that they recognize that less direct government implied 
subsidization or indirect, as is more often the case, would be 
helpful to the effective competitive capability of their 
banking systems.
    Mr. Stupak. If we got involved and if the United States 
started to do subsidies, do you believe that other countries 
would increase their subsidies to their banks to try to stay 
competitive with the U.S. banks?
    Mr. Greenspan. That is a good question. I doubt it, but I 
wouldn't be able to rule it out. They do an awful lot now. They 
do it more indirectly in the sense that a lot of them have 
universal banks and, in fact all of the powers are in the bank, 
you don't even need an operating sub. And the general notion of 
too big to fail, which does create problems in the United 
States, is a far more relevant issue in other countries. And 
indeed, undoubtedly a goodly part of the reason why we have had 
a lot of problems with the banks in the Asian crisis is because 
there was an implicit government guarantee and as a consequence 
of that, there was an awful lot of lending into those 
institutions on the expectation that the central bank of the 
smaller countries would bail them out. At the end of the day, 
even though the central banks tried, they didn't have the 
resources to do it.
    Mr. Stupak. And of course we all know the impact on the 
global financial markets when that occurred.
    Mr. Greenspan. Exactly.
    Mr. Stupak. In small communities which a subsidy of the op 
sub received from the banking magnify their competitive 
advantage over other entities like brokers, and is it possible 
that independent brokers in small markets such as in my area 
would be disadvantaged by the bank subsidy?
    Mr. Greenspan. They are and it depends on how much capital 
they require. In other words, if you have a very small 
brokerage firm which does not require a great deal of capital, 
meaning you essentially are giving more advice and not involved 
in securities trading in any particular way, it is conceivable 
to me that the amount of capital required would not be large 
and that an exactly comparable activity within a small bank 
might not be all that more competitive than the small brokerage 
because the amount of capital is less. But the principle is the 
same, and to the extent that you get into larger and larger 
securities operations, then the question of subsidized capital 
really makes a difference.
    Mr. Stupak. Okay. How would you respond to the comments 
that you support the holding company structure because the 
Federal Reserve is its regulator?
    Mr. Greenspan. I am aware of that and the basic issue is 
that clearly we are the regulator of holding companies. That if 
the op sub becomes active as premised in H.R. 10, and as all of 
the activities move to the sub--I might just say 
parenthetically, if that weren't the case that the argument 
that they are making that it doesn't happen makes no sense to 
me--the argument is that the powers will move to the sub, that 
the holding company will become a shell, that the Federal 
Reserve will lose all of its power, and that therefore that is 
the reason why we are concerned. Truly we are concerned about 
the breakdown of the holding company. It would make it more 
difficult for us to supervise. But that is not the reason why 
we are arguing for this particular issue. Because if we were 
truly concerned about Federal Reserve turf, we would have never 
been before the Congress very strongly advocating the bill 
which created significant interstate branch banking in this 
country, which we were strongly supportive of before the 
Congress, even though we knew it would significantly enhance 
the quality of the national bank franchise charter compared 
with the state charter, which is what we obviously are dealing 
with and supervise. It was good for the country, it was good 
for the financial system. It was good for banking. We strongly 
supported it, even though it essentially reduced the turf of 
the Federal Reserve.
    We don't think that that particular view of why we are very 
much concerned about the operating subs' impact on the 
financial system and the country squares with our actions in 
recent years.
    Mr. Oxley. The gentleman's time has expired. The 
gentlewoman from New Mexico.
    Mrs. Wilson. Thank you, Mr. Chairman. Chairman Greenspan, 
my district also has some of these large national banks and 
huge chains now, but we also have the smaller community banks 
and as I understand it, under the proposal that came out--not 
the proposal that came out of the Banking Committee but the 
separate subsidiary kind of approach, that a community bank in 
order to sell title insurance would require the formation of a 
holding company and another subsidiary. And I wonder whether 
you think that that is favorable to large institutions. Is this 
a barrier? Is this a kind of barrier to competition for those 
smaller banks. And if you were on the board of one of those 
small banks how would you recommend that they address this 
challenge of not being part of a holding company?
    Mr. Greenspan. Legally, they can be done in either--I mean, 
let me just say up front, the crucial issue of title insurance 
is that it requires very little capital to operate. Whether you 
do it in the bank or in an affiliate of the holding company 
frankly doesn't really much matter. And I am not sure that 
there is any competitive advantage one way or the other. 
Indeed, any type of agency activity in which there is very 
little capital involved probably can be effectively initiated 
in the sub of the bank or an affiliate of the holding company 
and frankly it would have very little economic significance.
    I mean, our concern is relevant to the types of activities 
for which there is a large amount of capital required. Then it 
matters. Most of the activities which smaller banks are 
involved in usually don't fall into that category and as far as 
I am concerned, this question of the operating sub versus the 
affiliate is really a larger bank question.
    Mrs. Wilson. So it is your understanding that under either 
of the draft bills that those small community banks could write 
title insurance and would not have to----
    Mr. Greenspan. That is my understanding, but let me just 
check with my counsel before they tell me I have created a 
major legal mistake. Well, I just learned for the first time 
ever I have been told that my general counsel is not quite sure 
about title insurance. But let me say, I am sure about the 
economics of it.
    Mrs. Wilson. I know it is of concern to some of my 
community bankers and perhaps we might connect and sort that 
out on their behalf. I appreciate that.
    Mr. Greenspan. Why don't we get back to you and give you in 
writing what we know about this issue. But just let me say in 
summary, none of the issues that I raised about subsidies apply 
to any type of activity in which the capital requirement is de 
minimis or not a crucial competitive question.
    Mrs. Wilson. Thank you.
    Mr. Oxley. The gentlewoman's time has expired. The counsel 
informs me that the next hearing will include several issues on 
insurance and I would invite the gentlewoman's participation at 
that point.
    We now recognize the gentleman from Massachusetts.
    Mr. Markey. Thank you. Welcome, Mr. Chairman. I would like 
to focus on the issue of what happens to consumers' most 
personal information, their financial records or their health 
and insurance information, when banks and brokerage firms and 
insurance companies all merge with one another under H.R. 10. I 
am greatly concerned, as you know, about this issue.
    I have been reviewing the financial privacy provisions of 
H.R. 10, which appear in the bill, the medical and health 
privacy provisions and the preexisting language. In my view 
these provisions provide consumers with little or no real 
privacy protection. For example, Mr. Chairman, the financial 
privacy language covers only banks and thrifts, not broker-
dealers, not investment companies, not investment advisors, and 
not insurance companies. Wouldn't you agree that financial 
privacy legislation should also cover Wall Street investment 
firms, mutual funds, financial planners and other investment 
advisors as well?
    Mr. Greenspan. Congressman, I think you are raising one of 
the questions that is going to become increasingly difficult 
for the whole regulatory structure because I think there are 
two basic conflicting issues here which are implicit in the 
issue that you are concerned about.
    I am conflicted on this question, and I guess that I 
represent probably what most people in the business world have 
problems with as a libertarian, as I am very sensitive to the 
issue of privacy, and I think that one of the things that is so 
important about this government, about this country is that we 
try to protect the individual, his rights, and the privacy 
question in ways that are not in any way handled in most other 
countries. There are very few countries in this world who 
handle this issue in a way which I personally feel comfortable 
with.
    Mr. Markey. Well, I support wholeheartedly the libertarian 
side of your personality, and I could just end the answer right 
there.
    Mr. Greenspan. But there is another side where the conflict 
occurs, and that is the general awareness of how important in 
the future the question of information is going to be with 
respect to the production of goods and services.
    Mr. Markey. And I appreciate that, Mr. Chairman, very much. 
But the point that I am trying to make here is that the bill 
itself only covers a very small part of the universe. It only 
covers banks and thrifts. It doesn't cover anything else. So if 
you merely--and even in that language, it merely requires that 
the bank tell the customer what its privacy policy is with 
respect to the disclosure of customer information to third 
parties other than agents of the depository institution, and it 
only applies to transfers for marketing purposes as opposed to 
any other business purpose. So as I read the language, so long 
as the banker tells its customers that its privacy policy is 
that the customers essentially have no privacy, then they would 
be in compliance with the narrowly drawn provision. Is that 
your understanding as well?
    Mr. Greenspan. Well, I haven't read the bill in detail and 
don't feel competent to really come to grips with this issue. I 
do agree with you in your concerns. It may well be that if I 
ever got into the language and got into a big debate, I 
probably would be maybe more on your side than I am now 
stating. But I am aware of the fact that there is another side 
to this issue.
    Mr. Markey. And I appreciate that other side. The other 
side is so well represented here that your articulate 
representation of it is superfluous. Our views on the other 
side I think will help to balance out the debate.
    Mr. Greenspan. Let me just say, Congressman, that this is 
not a small issue. It is an issue which is very important: It 
brings to bear really two fundamental aspects of this country. 
One, our very strong striving to bring information technology 
to the forefront, to allow information to be critical in the 
production of goods and services, which is one of the reasons 
why we are doing so well, but on the other hand there is this 
issue, and it did not exist before.
    Mr. Oxley. The gentleman's time has expired. The gentleman 
from Illinois.
    Mr. Markey. Congratulations, Mr. Chairman. Can we have a 
second round, Mr. Chairman?
    Mr. Oxley. No.
    Mr. Greenspan. I will be glad to answer you in private.
    Mr. Markey. I have a whole series of questions. I would 
appreciate it.
    Mr. Rush. Chairman Greenspan, you have stated pretty 
clearly your opposition to the op sub model. This is in 
contrast with the administration's adamant support of this. I 
mean, and I know that reasonable people can disagree, do you 
have any idea about why the administration is as adamant in 
their support of the op sub model as you are in opposition to 
it?
    Mr. Greenspan. I think I do, but since you are going to 
have the Secretary of the Treasury up here, he is very capable 
of expressing in considerable detail his reasons, and I don't 
think I should endeavor to characterize them.
    Mr. Rush. In that case, do you think that there is any 
possibility of the op sub model existing with the necessary 
safeguards to protect safety and soundness?
    Mr. Greenspan. I have stated that if you have an 
institution which by its nature is something which creates 
serious difficulties for the financial system and whose 
benefits are very difficult to find, meaning the benefits that 
are alleged for op subs can very readily be put into holding 
company affiliates, as best I can judge, I find it very 
difficult to find reasons to go forward. So the presumption of 
doing it and then trying to find a mechanism which prevents it 
from happening strikes me as sort of the direction we ought to 
try not to go.
    Mr. Rush. Now, Chairman Greenspan, H.R. 10 provides for a 
GAO study within 6 months upon passage of the bill. Do you 
think that 6 months is an adequate enough time to really 
ascertain the financial impact of the bill, of the op sub 
model? Do you think that that is sufficient or should it be a 
longer period of study?
    Mr. Greenspan. I think there is, as I understand it, and I 
think I remember now there is a 6-month requirement to examine 
the regulatory burden, but I think that is a broader issue 
involved.
    The answer to your question is we should be able to do it 
in 6 months.
    Mr. Rush. Should be able to do it in 6 months?
    Mr. Greenspan. Well, to examine the burden that as I 
remember, I may be mistaken on this, Congressman, but my 
recollection is that what is required in H.R. 10 probably can 
be fulfilled in the timeframe. But as I say, I may be mistaken.
    Mr. Rush. It seems to me that the economic impact of H.R. 
10, there is a 6-month period that the GAO is supposed to 
report the economic impact.
    Ms. Washington. It is section 110 of the bill, Congressman.
    Mr. Greenspan. The economic impact on very small banks.
    Mr. Rush. On small and community banks. Right.
    Mr. Greenspan. Six months should be an adequate amount of 
time.
    Mr. Rush. Should be an adequate amount of time?
    Mr. Greenspan. If may be that when we get into it and 
somebody says that is a mistake, but you put a deadline on, 
something happens, things get done. Maybe that is not a bad 
idea.
    Mr. Rush. Okay. Thank you.
    Mr. Oxley. The gentleman's time has expired.
    Chairman Greenspan as always, we appreciate your patience 
and your excellent testimony, and the subcommittee now stands 
adjourned.
    [Whereupon, at 11:51 a.m., the subcommittee was adjourned.]



                   THE FINANCIAL SERVICES ACT OF 1999

                              ----------                              


                         WEDNESDAY, MAY 5, 1999

                  House of Representatives,
                             Committee on Commerce,
           Subcommittee on Finance and Hazardous Materials,
                                                    Washington, DC.
    The subcommittee met, pursuant to notice, at 10:07 a.m., in 
room 2123, Rayburn House Office Building, Hon. Michael G. Oxley 
(chairman) presiding.
    Members present: Representatives Oxley, Tauzin, Gillmor, 
Bilbray, Ganske, Shimkus, Wilson, Fossella, Ehrlich, Bliley (ex 
officio), Towns, Deutsch, Stupak, Engel, DeGette, Barrett, 
Luther, Capps, Markey, Hall, Rush, and Dingell (ex officio).
    Also present: Representative Whitfield.
    Staff present: David Cavicke, majority counsel; Robert 
Gordon, majority counsel; Linda Dallas Rich, majority counsel; 
Brian McCullough, professional staff; Robert Simison, 
legislative clerk; Consuela Washington, minority counsel; and 
Bruce Gwinn, minority professional staff.
    Mr. Oxley. The subcommittee will come to order. I am 
pleased to convene the second hearing on H.R. 10, the Financial 
Services Act of 1999.
    At our last hearing, we enjoyed the considerable expertise 
of Federal Reserve Board Chairman Alan Greenspan who educated 
us about the potential hazards of legislation that would expand 
bank powers to operating subsidiaries rather than affiliates.
    Chairman Greenspan is always compelling, but at that 
hearing he made several observations that bear repeating. He 
noted that he, as well as his colleagues on the Board of 
Governors of the Federal Reserve, believe that the long-term 
stability of U.S. Financial markets and the interests of the 
American taxpayer would be better served by no financial 
modernization bill rather than one that allows the proposed new 
activities to be conducted by the bank in an operating 
subsidiary as would be the case under H.R. 10 as reported by 
the House Banking Committee.
    Chairman Greenspan pointed out that the operating 
subsidiary structure poses a risk to the safety and soundness 
of our Nation's banking system. It also creates a competitive 
imbalance that would subvert the free-market principles that 
are the foundation for the success of our capital markets.
    I share the Chairman's concerns about these potential 
hazards. I am also troubled by the lack of functional or 
consistent regulation that would be created by H.R. 10.
    It is imperative that this legislation ensure that no 
matter where an investor buys his stock, he can be assured of 
the protection of the Federal securities laws. Just as 
important is the need to treat businesses that are engaged in 
the same activity in the same way. It makes no sense to exempt 
banks from the regulatory requirements to which securities and 
insurance firms are subject if they are going to be engaging in 
the very same business as those securities and insurance firms.
    Today we are fortunate to have before us the Secretary of 
the Treasury, the Honorable Robert Rubin. I look forward to 
learning more about his views on the issues today, and I 
understand they differ somewhat from our previous witness, 
Chairman Greenspan.
    We also will be hearing testimony today from the Chairman 
of the Securities and Exchange Commission, the Honorable Arthur 
Levitt. Chairman Levitt has been an outspoken defender of 
investors and a champion of functional regulation. Chairman 
Levitt has also supported the committee's position in the last 
Congress to avoid the dangers to both safety and soundness and 
efficient functional regulation that would be posed by the 
expansion of bank powers through an operating subsidiary.
    Joining Chairman Levitt will be the distinguished 
Commissioner of Insurance for the State of Kentucky, George 
Nichols, who has testified before this committee in the past. I 
look forward to Commissioner Nichols' views on the importance 
of functional regulation of insurance activities as well as the 
numerous other significant issues raised by this bill for both 
consumers and providers of insurance.
    Our third panel today will provide us with the perspective 
of industry participants--securities firms, banks, insurance 
underwriters, and insurance agents. It will help us better 
understand the implications of the legislation before us to 
folks who actually compete in the marketplace.
    We will open our hearing today with testimony from two of 
our distinguished colleagues from the Banking Committee: The 
Honorable Richard Baker from Louisiana, the chairman of the 
Subcommittee on Capital Markets, Securities and Government 
Sponsored Enterprises and the Honorable Marge Roukema, chairman 
of the Subcommittee on Finance Institutions and Consumer 
Credit.
    I thank each of our witnesses for joining us today, and I 
look forward to learning from each you as my colleagues, both 
Republican and Democrat, work to forge a compromise that will 
be necessary to create a strong bill to promote fair 
competition, protect investors and consumers, protect our 
nation's taxpayers and the safety and soundness of our 
financial marketplace, preserve our Nation's position as the 
leader in the rapidly developing global financial market.
    That ends the Chair's opening statement.
    I now turn to the ranking member, the gentleman from New 
York, Mr. Towns.
    Mr. Towns. Thank you very much, Mr. Chairman.
    Let me begin first by welcoming my colleagues, Congressman 
Baker and, of course, Congresswoman Marge Roukema.
    The subcommittee holds the second hearing on H.R. 10, the 
Financial Services Act of 1999. As I indicated last week, 
Congress has been working on this legislation for a long, long 
time. I think it is time that we get this bill done. We have a 
number of distinguished witnesses today.
    I would like to first welcome Treasury Secretary Robert 
Rubin. I appreciate Secretary Rubin's commitment to the 
Community Reinvestment Act, and I look forward to hearing his 
views today. Like Secretary Rubin, we should oppose efforts to 
roll back protection of CRA.
    I would also like to welcome Insurance Commissioner 
Nicholas and SEC Chairman Levitt. Protecting consumers is an 
important part of any financial service bill. We will consider 
your views very, very carefully.
    This committee has historically supported functional 
regulation, which is the idea that the same product is 
regulated by the same rules regardless of who is selling the 
product. This seems to me to be common sense. We cannot want a 
system in which industries shop around for the friendliest 
regulator.
    I would also like to welcome the representatives from the 
industry, which are on the financial panel. Glass-Steagell has 
been a barrier to competition for much too long. The benefits 
of increased competition will accrue, and then it will make our 
financial firms stronger internationally. We recognize that you 
need the legislation and look forward to hearing your views.
    In the last Congress, this committee took the lead on 
financial service legislation. We took legislation that had 
little support; and working together, we made changes that 
enabled the legislation to pass the House for the first time in 
65 years.
    In the coming weeks, we will craft a substitute to H.R. 10. 
I look forward to working with Chairman Bliley, and I look 
forward to working with the chairman of the subcommittee, 
Congressman Oxley, and, of course, Mr. Dingell, who is the 
ranking member of the full committee to make certain that we 
have legislation that, when we finish at the end of the day, we 
will all be proud of.
    Thank you very much, Mr. Chairman, I yield back.
    Mr. Oxley. The gentleman yields back.
    The Chair now recognizes the gentleman from Richmond, the 
chairman of the full Commerce Committee, Mr. Bliley.
    Chairman Bliley. Thank you, Mr. Chairman.
    I too want to welcome our two colleagues, the gentleman 
from Louisiana and the lady from New Jersey. And I know it will 
disappoint you, but I put my statement in the record.
    [The prepared statement of Hon. Tom Bliley follows:]
 Prepared Statement of Hon. Tom Bliley, Chairman, Committee on Commerce
    Today the Subcommittee on Finance and Hazardous Materials holds its 
second hearing on H.R. 10, the Financial Services Act of 1999. This 
legislation is important to the future of the securities, insurance, 
and banking industries. Removing statutory and regulatory barriers to 
competition will improve the efficiency for financial service 
providers. The efficiency will translate to greater services and lower 
costs for consumers and providers. But only if it is done right.
    I have been committed to deregulatory legislation for other 
industries provided that the legislation does not bestow competitive 
advantages to one market segment over another. It is not the 
government's role to choose winners and losers through the legislative 
process, nor is it the role of regulators. Unfortunately, this has been 
the case in the financial services industry.
    In large part this has been the case to date. Banks enjoy a lower 
cost of capital than non-banks through deposit insurance, access to the 
discount window, and access to the Federal Reserve payment system. This 
would not be a competitive advantage if banks were confined to 
competing with one another and not with securities and insurance firms, 
as stipulated in the Glass Steagall Act. However, in the past two 
decades, banking regulators have interpreted the statutes in a manner 
to allow banks to begin competing with securities and insurance firms.
    The very activities that banks were originally supposed to be 
prohibited from conducting are now offered through affiliates, and in 
some cases directly through the banks. This erodes the salutary effect 
of fair competition. Securities and insurance inns are still unable to 
own a bank, and do not share the funding advantages of banks. As a 
result, banks are acquiring securities firms at an alarming rate and 
reducing the competition that we seek to increase.
    While I am in favor of providing the corporate community 
flexibility to choose the structure that optimizes their strategic 
plans, I do not favor legislating a structure, such as the operating 
subsidiary, that provides competitive advantages for banks over their 
independent competitors. Additionally, there remain serious policy 
concerns about the consequences to the taxpayers of permitting new, 
risky activities in the subsidiary of a bank. I remain unconvinced of 
the need to gamble with an untested model that has proved disastrous in 
other economies. I have received additional analysis on the question of 
operating subsidiaries from Federal Reserve Chairman Greenspan, and I 
ask unanimous consent to include this analysis in the record.
    In this regard, I share the concerns expressed by Chairman 
Greenspan at our hearing last week. I look forward to the testimony of 
our witnesses today, including Secretary Rubin, and learning more about 
this most important issue.
    Another issue of concern to this Committee is the provision of 
consistent regulation for financial products, regardless of where the 
financial activity is conducted. In this regard, I look forward to the 
comments of Chairman Levitt and Commissioner Nichols. I am also 
grateful to the witnesses on the fourth panel who will present industry 
views to financial services modernization.
    I would also like to welcome our guests on the first panel today, 
our colleagues from the Banking Committee: the Gentleman from Louisiana 
and Chairman of the Subcommittee on Capital Markets, Securities and 
Government Sponsored Enterprises, Richard Baker, and the Gentlelady 
from New Jersey and Chairwoman of the Subcommittee on Financial 
Institutions and Consumer Credit, Marge Roukema.
    Mr. Chairman, I commend you, for holding this hearing and I look 
forward to working with you to improve this legislation.

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    Mr. Oxley. Without objection, and all of the members' 
statements will be made part of the record should they choose 
to do that.
    The gentleman from Massachusetts, Mr. Markey.
    Mr. Markey. Thank you, Mr. Chairman.
    It has now become increasingly clear that consumers are 
today at great risk on having their privacy totally compromised 
as the affiliations occurring in the marketplace and sanctified 
under this bill allows banks, brokers, and insurance companies 
to compile a detailed digital dossier of a consumer's most 
sensitive health and medical records, their credit cards, 
checking account transactions, their bank balances and loans, 
and their life and medical insurance information.
    If we fail to act now, we will soon be facing big brother 
banking, financial institutions that can snoop into our 
lifestyles, our finances, other health records, our most 
personal family secrets. Now the financial services industry 
likes to tell us all about the wonderful synergies that will 
result when our personal secrets are sold and transferred to 
affiliates.
    Let us just take a look into the future at what some of 
those synergies actually mean for our consumers. The next time 
you get cold called by a stockbroker, will he tell you, hey, I 
see that you have been buying Ritalin for your daughter. You 
know, there are a lot of kids on Ritalin these days for 
attention deficit disorder and the company that makes this 
stuff is about to have its stock go right through the roof; but 
right now, it is undervalued. So we are recommending to our 
customers that they buy now.
    And oh, I see that you have been buying Depends for your 
85-year-old mother-in-law who lives at home with you. Well, our 
health sector analysts have projected continued growth in the 
incontinence market as the baby boomers reach their golden 
years. So now is really the time to get in on the stock of the 
companies that make those products.
    Speaking of companies whose products are selling like hot 
cakes, I guess that I don't need to tell you how much that 
Viagra drug has taken off if you know what I mean.
    Next day when you and your wife drop by to visit your 
friendly banker seeking a mortgage for the dream home that you 
just made an offer on, does he sympathetically shake his head 
as he reviews his computer data base saying he is so sorry to 
see that your wife has recently been under treatment for breast 
cancer. But the bank is just going to have to require a larger 
down payment and higher interest rates to reflect the increased 
risk they would dare if they were to grant this mortgage 
application given the fact that you will be relying on both of 
your incomes to make the mortgage payments.
    And oh, by the way, we see that you have been charging 
quite a tab down at Joe's tavern over the last 2 months which I 
guess is understandable in light of your daughter's ADD, your 
mother-in-law's incontinence problem, and your wife's breast 
cancer treatments. But we are just somewhat concerned about the 
impact of your recently increased drinking habits on your 
continued ability to pay back this mortgage that you are asking 
us to grant you.
    And when you drop by your insurance agent a few days later 
to take out a new life insurance policy, will he, after a few 
clicks of the mouse on his computer, look over to you and ask, 
so, can you tell me what all those recent charges are for sky-
diving lessons?
    Well, if we allow all of this to be mixed into one company, 
each one of these people will have access to your file whether 
or not they have any basis to have access to it.
    Now, your friendly banker or broker or insurer in that one 
company wouldn't be foolish enough to actually reveal to you 
that they have gathered all of this sensitive information about 
you because they know that if they ever did, you would reach 
right across the desk and throttle them for their insolence in 
prying into your personal affairs and talking about your 
daughter, your wife, your mother in those terms. But they do 
have the file right in front of them even though you didn't go 
to them, that broker or that insurance agent or any other part 
of that affiliate for those services.
    Under current law, there is nothing, absolutely nothing to 
prevent them from taking your family secrets and selling or 
transferring them to their affiliates all in the name of 
synergies. H.R. 10 does very little to stop the principal harm 
done by those much touted synergies, the taking of an 
individual's most precious private property right, their right 
to privacy.
    We are going to form a Congressional privacy caucus. We 
need one. As all of these technologies converge, as all of 
these financial institutions converge, we need a Congressional 
privacy caucus to ensure that we have an ongoing monitoring of 
these issues. Every citizen has a right to knowledge of the 
information that is being gathered about them, notice that the 
information is going to be reused for purposes other than that 
which they originally intended, and the right to say no, they 
don't want this information used for any other purpose.
    I hope that as we move forward on the markup of this 
legislation that we can ensure that these privacy rights of 
every American are indeed protected.
    I thank you, Mr. Chairman, and I yield back the balance.
    [The prepared statement of Hon. Edward J. Markey follows:]
   Prepared Statement of Hon. Edward J. Markey, a Representative in 
                Congress from the State of Massachusetts
    Thank you, Mr. Chairman. One of the most critically important 
domestic policy issues coming before the Congress this session is what 
is going to happen to the consumer's most personal information, 
including their financial records, or their health and insurance 
information when banks, brokerage firms, and insurance companies all 
merge with one another under the financial services modernization 
legislation, H.R. 10.
    It has now become increasingly clear that consumers are today at 
great risk of having their privacy totally compromised as the 
affiliations occurring in the marketplace and sanctified under this 
bill allow banks, brokers, and insurance companies to compile a 
detailed digital dossier of a consumer's most sensitive health and 
medical records, their credit card and checking account transactions, 
their bank balances and loans, and their life and medical insurance 
information. If we fail to act now, we will soon be facing Big Brother 
Banking--financial institutions that can snoop into our lifestyles, our 
finances, our health records, our most personal family secrets. Now, 
the financial services industry likes to tell us all about the 
wonderful ``synergies'' that will result when our personal secrets are 
sold or transferred to affiliates.
    But let's just take a look into the future at what some of these 
``synergies'' actually could mean for consumers. The next time you get 
cold-called by a stock broker, will he tell you, ``Hey, I see here that 
you've been buying Ritalin for your daughter. Well, you know, there are 
a lot of kids on Ritalin these days for Attention Deficit Disorder, and 
the company that makes this stuff is about to have its stock go right 
through the roof. But right now, it's undervalued and so we're 
recommending to our customers that they buy now.
    ``Oh, and I see that you've been buying Depends for your 85-year 
old mother-in-law, who lives at home with you. Well, our health sector 
analysts are projecting continued growth in the incontinence market as 
the Baby Boomers reach their Golden Years, so now is really the time to 
get in on the stock of the companies that make these products. And 
speaking of companies whose products are selling like hotcakes, I guess 
I don't need to tell YOU how much that Viagra drug is taking off--if 
you know what I mean?''
    And, the next day, when you and your wife drop by to visit your 
friendly banker seeking a mortgage for the dream home you've just made 
an offer on, does he sympathetically shake his head as he reviews his 
computer database, saying that he's so sorry to see that your wife has 
recently been under treatment for breast cancer, but ``the bank is just 
going to have to require a larger downpayment and higher interest rate 
to reflect the increased risk it would bear if it were to grant this 
mortgage application, given the fact that you will be relying on both 
of your incomes to make the mortgage payments.''
    ``Oh, and by the way, we see that you've been charging quite a tab 
down at Joe's Tavern over the last two months, which I guess is 
understandable in light of your daughter's ADD, your mother-in-law's 
incontinence problem, and your wife's cancer treatments. But we're just 
somewhat concerned about the impact of your recently increased drinking 
habits on your continued ability to pay back this mortgage you're 
asking us to grant you.''
    And when you drop by you insurance agent a few days later to take 
out a new life insurance policy, will he, after a few clicks of the 
mouse on his computer, look over to you and ask, ``So, can you tell me 
what all these recent charges are for Skydiving Lessons?'' ``And I also 
see that you've recently written several checks for psychiatric 
counseling and you've also submitted claims for a Prozac prescription--
what's that all about?'' ``Now, I am sorry to have to ask this, but you 
know--it's company policy. I mean, between your kid's ADD, your mother-
in-law's incontinence, your wife's breast cancer, your recently 
increased drinking, your impotence, and, well, this new skydiving 
thing--well, our management might say that we shouldn't really insure 
you at all. I mean, let's face it, given all you've been going through, 
you are definitely one big suicide risk.''
    Now, of course, your friendly banker, broker, or insurer won't be 
foolish enough to actually reveal to you that they've gathered all this 
sensitive information about you, because they know that if they ever 
did you'd probably reach right across the desk and throttle them for 
their insolence in prying into your personal affairs. But, under 
current law, there is nothing to prevent them from taking your family 
secrets and selling or transferring them to their affiliates--all in 
the name of ``synergies.'' And H.R. 10 does very little to stop the 
principal harm done by these much touted ``synergies''--the taking of 
an individual's most precious private property right, their right to 
privacy.
    In order to provide meaningful privacy protections, H.R. 10 needs 
to provide consumers with three things: Knowledge of what information 
is being collected about them; Notice before information is transferred 
to affiliates for purposes other than the original purpose for which it 
was provided, and a right to say No. I intend to offer amendments to 
this legislation which would provide consumers with Knowledge, Notice 
and Know, and I urge my colleagues to support this effort. In addition, 
I would like to notify the Members that I am today establishing a 
Congressional Privacy Caucus to serve as a clearinghouse for 
information on privacy matters and educate and organize Members with an 
interest in these critical issues, so that we can prevent the digital 
disutopia that I have just described from coming into being. I urge my 
colleagues to join me in this endeavor.

    Mr. Oxley. The gentleman yields back. The Chair now 
recognizes the vice president of the subcommittee, the 
gentleman from Louisiana, Mr. Tauzin.
    Mr. Tauzin. Thank you, Mr. Chairman.
    I commend you for moving H.R. 10 again this year in an 
attempt to settle this incredibly complex and contentious set 
of issues. Just last week, Alan Greenspan, chairman of the 
Federal Reserve Board, shared with us his concerns regarding 
H.R. 10 as it was reported out of the banking committee.
    I am pleased to see my colleague from Louisiana who serves 
on that committee here. I wanted to say up front that I think 
Mr. Greenspan's concerns about the op-sub model proposed by the 
banking committee are shared by this member. As reported out of 
H.R. 10 as it came out of banking it would enable banks to 
transfer safety net subsidies to their operating subsidiaries 
engaged in financial activities not conducted directly in the 
banks.
    Mr. Greenspan indicated his concern, I share it, that this 
would place traditional securities and insurance firms at a 
competitive disadvantage as it clearly would not have the 
access to the payment system that would be affordable indeed to 
banks engaging in these activities. Ultimately, I disagree with 
the notion that the securities or insurance firm should have 
access to a payment system just because it is an operating 
subsidiary of a bank. In fact, I can't see a good reason why 
any securities, insurance, and nonbanking entity should be 
afforded access to the payment system.
    To try to put it in perspective here, banks have always 
been allowed to receive Federal safety net subsidies for one 
reason, because we believe that it is important to preserve the 
safety and soundness of the banking system in which Americans 
deposit their money for safekeeping. It makes sense. Depositing 
money in a bank should be, as much as possible, a riskless 
activity. And the payment system exists to ensure against or 
eliminate as many of those risks as possible when that money is 
deposited.
    By contrast, it is counterintuitive, in fact it is 
ridiculous to say that an investor is going to expect any loss 
she might incur as a result of investing in an inherently risky 
capital market should be insured by the taxpayers through the 
Federal Government that insures these safety net deposits. 
Fundamentally then, it doesn't make sense for the Federal 
Government to insure against capital losses, and I can see no 
justification whatsoever for enabling sub-op investments and 
securities firms to access Federal safety nets subsidies.
    That access would indeed result in competitive 
disadvantages, and I think would subsidize the capital 
investment activities on behalf of the investing customers. I 
understand that Secretary Rubin will favor the sub-op model, 
and I am anxious to hear if he can address those concerns. 
Ultimately, there is an additional concern that I have with 
H.R. 10 that I want to hear briefly.
    I am concerned about the way that the insurance provisions 
are drafted. In my view, the bill in its current state seems to 
strip the States of their much needed authority to regulate the 
sale of insurance and protect insurance customers. In lieu of 
affording the States the requisite authority to properly 
regulate insurance, the bill appears to give the comptroller 
and the office of thrifts division a great deal of regulatory 
discretion to control these activities.
    I just had some recent experience with the FCC that I think 
we all should remember. The FCC recently, through court action, 
deprived our States of their authority to local telephone rates 
based on economies of scale and local costs. Just as local 
special considerations and insurance has generally been 
regulated on a State and local basis, because of that, I have 
grave concerns about a policy that would move more and more 
authority to a Federal system of regulation and the 
uncertainties of changes in that Federal regulatory scheme from 
time to time.
    That provision of H.R. 10 deeply concerns me. After all, 
the terms of the insurance policies are usually based on many 
local considerations to which Federal regulators are not at all 
sensitive. Again, Mr. Chairman, I am anxious to hear my good 
friend, especially my friend from Louisiana, but I also look 
forward to hearing Secretary Rubin's defense of what I consider 
to be some very bad policy when it comes to sharing the Federal 
safety net to risky capital investments. I yield back the 
balance of my time.
    Mr. Oxley. The gentleman yields back.
    The gentleman now recognizes the gentleman from Michigan, 
the ranking member of the full committee, Mr. Dingell.
    Mr. Dingell. Mr. Chairman, I thank you for your courtesy 
and I thank you for the hearing.
    Mr. Chairman, I will not belabor the points I made in my 
opening statement at last week's hearing. That record is, I 
think, a good one; and I am pleased to have made the opening 
statement and received the courtesy of the Chair on that 
matter.
    I will reiterate one thing. I am strongly opposed to H.R. 
10 in its current form. I am willing to work with my colleagues 
to improve it. However, unless it is significantly changed, I 
will regretfully be opposed to it at every stage of the 
legislative process with great vigor.
    On behalf of the minority, I will need to note a serious 
procedural and substantive issue for the record. Last week we 
were informed by the majority staff that we could not hear from 
consumer group witnesses at today's hearing because there would 
be three panels of administration and industry witnesses and 
thus no time or room to accommodate the minority's request.
    While I understand that time is dear, I would note that 
having a full and complete record is extremely important and 
having the views of consumers on this matter is something which 
is very important both to a proper hearing of the matter and 
also to a proper hearing record, as well as to give the 
committee the information on all viewpoints with regard to the 
legislation. I feel very strongly that we do need in this 
committee a strong record on key consumer issues, including 
privacy and the community reinvestment act. Therefore, it would 
be my hope that we could hear these witnesses at a time soon 
and that we could do a good job of achieving a proper and a 
full record.
    I would note that two of my colleagues from the banking 
committee, Republican members, are being heard this morning. 
They were added at the last minute. That is fine. I have no 
objection to that and certainly there is no ill will either 
toward these members or toward having them heard. But we do 
believe that there should be an opportunity for the committee 
to hear from consumer witnesses and that we should make the 
necessary room and opportunity for them to be heard.
    I would also note that the Treasury Department testimony 
arrived last evening after most members of the staff had left 
for the day. I respectfully request then that the record be 
kept open for the submission of written questions for the 
Secretary after we have had adequate opportunity to review his 
written statement and the issues that that statement raises.
    I would note that the Chair has been providing good 
leadership in our consideration of this matter, and I thank you 
for recognizing me for my comments.
    Thank you, Mr. Chairman.
    Mr. Oxley. The gentleman yields back. Without objection, 
any questions to the Secretary in writing would be in order. 
Without objection it is so ordered.
    Mr. Oxley. The gentleman from Kentucky, Mr. Whitfield.
    Mr. Whitfield. Thank you very much, Mr. Chairman. Thank 
you, Mr. Chairman, for recognizing me.
    I wanted to welcome today to this hearing George Nichols 
who is the Commissioner of Insurance from the State of 
Kentucky. I know he has testified before this committee before. 
He is a real expert in this area. He is considered one of the 
most effective insurance commissioners we have had in Kentucky 
for some time and his peers at the National Association of 
Insurance Commissioners respect him so much that they named him 
the chairman of their special committee on financial services 
modernization.
    So, Mr. Commissioner, we look forward to your testimony as 
well as that of the other distinguished witnesses this morning.
    I yield back the balance of my time.
    Mr. Oxley. The gentleman yields back.
    The gentleman from Minnesota, Mr. Luther. No opening 
statement?
    The gentleman from Iowa, Dr. Ganske.
    Mr. Ganske. Thank you, Mr. Chairman.
    I think it would not have been unreasonable for a lobbyist 
when I started in 1995 to have said I expect that you will see 
a vote on war and a vote on an impeachment of the President 
before you will ever see Glass-Steagell changed.
    Well, it is possible that we are seeing light at the end of 
the tunnel, and the reason for that is that I think there is a 
consensus that the form of Glass-Steagell would provide for 
better services for consumers and would also help our financial 
services industry in the United States compete better globally. 
Des Moines has a very strong financial services and insurance 
industry, and so I have been very interested in this issue.
    Why am I optimistic? Well, there was a big bipartisan vote 
that came out of banking, and I appreciate Mr. Baker and Mrs. 
Roukema for being here today. I am hearing that leadership on 
both sides of the aisle in both the House and the Senate would 
like to see something happen this year as well as the 
administration. That doesn't mean that there aren't some 
problems and some bumps along the way that we will have to look 
at. It has already been mentioned that the operating subsidiary 
issue, the financial medical privacy issue, CRA--but I feel 
that there is a coalition that is there that has come together 
based on work that we did in the last Congress that is delicate 
but is in agreement on most of the major things as it relates 
to insurance, securities, banking, and consumer protections.
    And I am very hopeful, Mr. Chairman, that maybe this year 
we will actually get the job done. Maybe the stars will come 
into alignment. It takes an awful lot of work by a lot of 
people, and I commend you for your effort on this.
    I also want to note that Mr. Arnold Schultz is here today 
from Grundy Center which is very close to Des Moines. We will 
appreciate his testimony.
    Thank you, Mr. Chairman.
    Mr. Oxley. The gentleman yields back.
    The gentleman from Illinois, Mr. Shimkus? Do you have an 
opening statement? None.
    The gentleman from New York, Mr. Fossella. Mr. Bilbray, the 
gentleman from California.
    Mr. Gillmor, the gentleman from Ohio.
    Mr. Gillmor. Mr. Chairman, I don't have an opening 
statement. I just want to welcome a fellow ``buckeye'' who is 
going to be on our last panel, W. Craig Zimpher, with 
Nationwide Insurance who I first knew when he worked in then 
Governor Rhodes' office and has had a distinguished career both 
in government and the private sector, and we look forward to 
hearing his testimony.
    Mr. Oxley. I thank the gentleman. And finally the gentleman 
from Maryland, Mr. Ehrlich.
    No further opening statements, we will now turn to our 
distinguished Members panel. Let me introduce the first 
witness, the gentleman from Louisiana, Mr. Baker.

    STATEMENT OF HON. RICHARD H. BAKER, A REPRESENTATIVE IN 
              CONGRESS FROM THE STATE OF LOUISIANA

    Mr. Baker. Thank you, Mr. Chairman. I certainly appreciate 
the courtesy that you have extended and that of the committee 
to allow me to appear here this morning with Ms. Roukema and to 
present a perspective from the House Banking Committee on this 
controversial subject.
    The world is changing irrevocably in manners that few 
understand and even less can accurately predict. No doubt there 
are many companies that can lend you a mortgage, but there is 
one out there that can also do that and sell you a casket as 
well under current law.
    The pressure is on, whether from uniquely chartered special 
purpose institutions, such as unitary thrift, a section 20 
affiliate, or a foreign bank. The traditional institution has 
competitors with market advantages governmentally created.
    Just one example. Since 1990, the Fed has issued approval 
for 18 foreign banks to own subsidiaries that engage in the 
underwriting of securities in the United States. This is not 
insignificant as the aggregate asset size of these foreign 
institutions exceeds $450 billion. The Fed has acknowledged 
that a foreign bank may establish a subsidiary while a U.S. 
bank may not.
    On another point somewhat unrelated but of equal curiosity, 
under the Bank Holding Company Act, a bank may own up to 24.9 
percent of nonvoting stock in a United States corporation, but 
at the same time that same bank may own up to 40 percent of 
nonvoting stock of a foreign corporation. I never have 
understood nor had it explained to me why a larger share of 
ownership in a foreign corporation is safer than a smaller 
share of ownership in a domestic corporation.
    Clearly there is a patchwork of regulatory standards and 
statutes that create current market inequities. I note, Mr. 
Towns, in your opening statement your concern for having a 
uniform playing field in which all participants are treated 
equally. The regrettable observation is, today, we have 
irregularities that create market inequities already. But to 
add another level of complexity to that decisionmaking process, 
I would note that there are nonregulated financial service 
organizations that do provide a full range of financial 
services without similar regulatory responsibilities.
    This means that competitors of regulated financial 
institutions have a real cost advantage in the delivery of the 
same financial products. For instance, Ford Motor Company can 
offer a money market account which is, in all respects, a 
checking account as well as investment counseling, insurance 
products, radios, and bumpers.
    Is this bad? Consumers don't think so. Profits are at 
record levels, stock valuations are at record levels. But they 
don't pay deposit insurance premiums. Consumers don't care. The 
Federal Reserve monitoring is not there. Consumers don't care. 
They don't comply with CRA. Consumers don't care. Neither the 
OTS, the FDIC, the OCC, or the Treasury inspect the books. 
Customers just don't care.
    There is good reason why the customers don't worry about 
the lack of government intrusion. As Fed Governor Ferguson best 
stated on February 25 of this year, and I note after the Long-
Term Capital failure, ``perhaps the most fundamental principle 
that must guide us is that private market participants are the 
first line of defense against excessive private and public risk 
in the financial system.''
    I would note that it was the market that first advised the 
regulators of Long-Term's significant problems, not the 
regulatory system. Despite the regulatory failure in the LTCM 
problems, the system almost always works in the best interest 
of the taxpayer and the consumer.
    Can we assure there will never be failures? Certainly not. 
The markets do treat failure very harshly, but can we assure 
that there will never be any loss to the deposit insurance fund 
no matter whether we have the affiliate or the subsidiary 
structure? Absolutely not.
    But the Secretary of the Treasury and all four past and 
present FDIC chairpersons, the current and three preceding, two 
Republicans and two Democrats, agree that the op-sub provisions 
make market sense and consumer sense. In fact, the preceding 
FDIC chairmen argue that forcing activities into an affiliate 
actually exposes insured banks to greater risks than that of 
the operating subsidiary.
    So what are we to do? Ultimately, the consumer and taxpayer 
should be our focus. Government policy should not determine 
profitability. Government regulations should not determine 
winners and losers. In America, management should discuss in 
their boardroom how to best use their shareholders' investment 
to efficiently serve customers.
    The best service at the lowest price serves investors and 
consumers well. But leaving business managers to structure 
their business as they see fit should not only be permissible 
but encouraged. The Fed would acknowledge that for the complex 
international financial corporation that is permissible under 
current law, the best risk analysis comes from the 
corporations' own internal risk-management analysis.
    Can we appropriately conclude that we can best determine 
business structure when we can't fully understand even the 
business activities that we are attempting to regulate? 
Governor Meyer, in a speech of March 2 of this year said, ``if 
we excluded banks from financial modernization in order to 
avoid safety net and subsidy transference over a wider area, 
banks would simply take smaller shares of the total financial 
markets' pie as their less-protected and subsidized competitors 
expanded.''
    I doubt that banks would wither away, but they would surely 
become less important. Let me say it in my own way. Imagine for 
a moment your last name is Kennedy, not the Massachusetts kind 
but the Clinton, Louisiana, kind, and you are sitting behind 
the desk as the CEO of Feliciana Bank and Trust in Louisiana, a 
$44.2 million institution. While you look down the street, and 
it is a short street, you look to the automobile dealership 
where you used to finance six, maybe eight automobiles a month. 
Now G.E. Capital finances those. You look up the street to the 
sheriff's department and you see G.E. Capital financing the 
fleet-leasing program for that sheriff's department. As a 
matter of fact, everywhere you look in that town you find 
evidence of G.E. Capital, home mortgages, insurance, retail, 
finance, credit cards, computer services, appliance 
manufacturing, plastics, lighting and aircraft engines. By the 
way, they can advertise it all on their own network, NBC.
    Now, do you think that Mr. Kennedy is really worried about 
affiliate versus subsidiary structure? You see, G.E. Capital is 
not subject to Federal regulation. Neither the FDIC, the OTC, 
the OCC, or CRA or any other financially regulatory constraint 
which Mr. Kennedy is subject to. This is just one example among 
many. So while we fervently debate the advisability of 
affiliate versus subsidiary, Mr. Kennedy wonders why A.G. 
Edwards, credit unions, and G. E. Capital and the like are able 
to do what he can't, make a profit without strangling 
government regulation.
    Does the Federal Reserve really need to sit on Mr. 
Kennedy's board to protect America's economic interests? Would 
a subsidiary in Clinton, Louisiana, threaten national safety 
and soundness? I do not think so. Let the free enterprise 
system work. Let services and products meet consumers needs. 
Let regulators monitor professional conduct, and let Mr. 
Kennedy make his own business decisions whether those include a 
subsidiary or not. In this matter, financial markets will 
continue to innovate products and services whereby consumers 
will be protected and served in the best manner possible.
    Thank you, Mr. Chairman.
    [The prepared statement of Hon. Richard H. Baker follows:]
   Prepared Statement of Hon. Richard H. Baker, a Representative in 
                  Congress from the State of Louisiana
    The world is changing, irrevocably, in manners that few understand, 
and even less can accurately, predict. Governor Meyer of the Federal 
Reserve captures this change well.
        High-speed computers and constant pressure to press the 
        envelope of regulatory limits made possible everything from 
        money market mutual funds to derivatives; from loans once held 
        permanently by a bank to securitization into a capital market 
        instruments; from computer shopping for a mortgage to a higher 
        yielding deposit at a virtual bank; from equity mutual funds 
        from a bank or a broker to a checking account at your credit 
        union; from a company that will lend you a mortgage to one that 
        will do that and sell you a casket (yes a casket manufacturer 
        owns an S&L); and I could go on.--Gov. Laurence Meyer (March 
        12, 1999)
    The pressure is on, whether from uniquely charted, special purpose 
financial institutions, such as a unitary thrift, a Section 20 
affiliate, or a foreign bank, the traditional institution has 
competitors with market advantages governmentally created. Just one 
example, since 1990, the Fed has issued approval for 18 foreign banks 
to own subsidiaries that engage in the underwriting of securities in 
the U.S. This is not insignificant as the aggregate asset size of these 
foreign institutions exceeds $450 billion. The Fed has acknowledged 
that a foreign bank may establish and fund a subsidiary, while a U.S. 
bank may not.Another anachronism of financial regulation includes 
current Fed practices. Under the Bank Holding Company Act, a bank may 
own up to 24.9% of non-voting stock in a U.S. corporation, but at the 
same time it may own up to 40% of a foreign corporation. I have never 
understood how a larger share of a foreign corporation is less risky 
than a smaller share of a U.S. corporation. And don't get me started on 
the subject of unitary thrifts except for one observation. The unitary 
thrift charter was created by Congress in 1967. Not only do these 
institutions engage in diversified financial activities, they engage in 
commercial activities as well. Although existing charter operations 
number in the hundreds, many more applicants are pending approval. More 
importantly, of all thrifts operating today, unitary thrifts control 
70% of all thrift assets.
    Despite this predominant market share, are regulators in pursuit of 
abusive market participants? No. Are consumer organizations demanding 
their closure? No. Are securities and insurance companies fighting to 
eliminate them? Not hardly. In fact, the only group outspoken in their 
demand for limits on the unitary thrifts are the banks. Why, because of 
the competitive advantage of their charter.
    Clearly, there is a patchwork of regulatory standards and statutes 
that create current market inequities. But to add another level of 
complexity to our decision marking process non-regulated financial 
service organizations provide a full range of financial services 
without a similar regulatory responsibility. This means that non-
regulated competitors of regulated financial institutions have a real 
cost advantage in the delivery of financial services.
    For instance, many non-banks such as GMAC and Ford Motor Company 
offer a money market account, which is, in all respects a checking 
account, as well as investment counseling, insurance products, radios, 
and windshield wipers. Is this bad? Customers don't think so. Profits 
are at record levels, stock valuation is at record levels. But they 
don't pay deposit insurance premiums. Customers don't care. The Federal 
Reserve doesn't claim to monitor their conduct. Customers don't care. 
They don't comply with CRA. Customers don't care. Neither the OTS, the 
FDIC, the OCC, or the Treasury inspect the books. Customers don't care. 
And there is good reason why customers don't care about intrusive 
government regulation.
    As Fed Governor Ferguson best stated on February 25 of this year, 
note after Long Term Capital's demise:
        Perhaps the most fundamental principal that must guide us is 
        that private market participants are the first line of defense 
        against excessive private and public risk in the financial 
        system. Private borrowers, lenders, investors, institutions, 
        traders, brokers, exchanges, and clearing systems all have huge 
        stakes in containing their risks as individual agents and risk 
        to the system as a whole. Private market participants can 
        discourage excessive risk taking by choosing to do business 
        with those firms that demonstrate sound risk management 
        systems, and portfolios that balance appropriately risk and 
        expected return.--(Gov. Ferguson, Feb. 25, 1999)
    Despite the regulatory failure in the LTCM incident, the system 
almost always works in the interest of the taxpayer.
    Can we assure there will never be failures? Certainly not. The 
markets do treat failure harshly! Can we assure there will never be any 
loss to the deposit insurance funds, no matter what structure we 
dictate? Absolutely not.
    But I am assured by the Secretary of the Treasury, and all four 
FDIC chairpersons, (the current and three preceding--2 Republicans and 
2 Democrats), agree that the op-sub provisions make market sense and 
consumer sense. In fact, the preceding FDIC chairmen argue that forcing 
activities into an affiliate actually exposes insured banks to greater 
risks than that of an operating subsidiary.
    So what are we to do? Ultimately the consumer and the taxpayer 
should be our focus. Government policy should not determine 
profitability. Government regulation should not determine winners and 
losers. In America, management should hold discussions in the boardroom 
how to best use their shareholders investment to efficiently serve 
their customers. The best and most convenient service at the lowest 
price serves investor and consumer well. Permitting business managers 
to structure their business as they see fit should not only be 
permissible, it should be encouraged.
    The Fed acknowledges, that for complex international financial 
institutions--all operating under existing law--the best risk analysis 
comes from the institutions own internal managerial risk assessment. 
Can we appropriately conclude that we can best determine business 
structure, when we don't fully understand the nature of the business 
activities we are attempting to regulate?
    Let me say it another way. Imagine for a moment your last name is 
Kennedy--not the Massachusetts kind, but the Feliciana Louisiana kind, 
and you're sitting behind the desk of Clinton Bank and Trust, which is 
a $44.2 million community bank. While we debate subsidiary versus 
affiliate, he looks down the street and sees, say for example, the 
local credit union or GE Capital which is financing the 6 or 8 cars a 
month he used to finance. He sees GE Capital down the street leasing an 
auto fleet to the Sheriff's department. GE Capital in fact can do home 
mortgages, insurance, retail finance, credit cards, computer service, 
appliance sales, plastics, lighting, and aircraft engines, and 
advertise it all on their network-NBC. All without bank holding company 
regulation. Do you think Mr. Kennedy is really worried about affiliates 
versus subsidiaries? You see GE Capital is not subject to Federal 
regulations, FDIC, OTC, OCC--and particularly CRA--or any other 
financial regulatory constraint, but Mr. Kennedy is subject.
    Now this is just one example among many. So while we fervently 
debate the advisability of affiliate versus subsidiary, Mr. Kennedy 
wonders why credit unions, unitary thrifts like AG Edwards, GE Capital, 
and the like are able to do what he can't--make a profit without the 
strangling government regulation. Does the Federal Reserve really need 
to sit on Mr. Kennedy's board to protect America's economic interests? 
Would a subsidiary in Clinton, Louisiana threaten national safety and 
soundness? I do not think so.
    Let's let free enterprise work. Let services and products meet 
consumer needs. Let regulators monitor professional conduct. And let 
Mr. Kennedy make his own business decision--whether a subsidiary or 
not.

    Mr. Oxley. Thank you, Mr. Baker.
    We now turn to our distinguished lady from New Jersey. What 
are your druthers, Marge?

 STATEMENT OF HON. MARGE ROUKEMA, A REPRESENTATIVE IN CONGRESS 
                  FROM THE STATE OF NEW JERSEY

    Mrs. Roukema. Well, my druthers would be, I think in the 
interest of your time and everyone's patience here, to just 
submit my testimony and give maybe a 2 minute summary so that 
it can be submitted. Because I, as chairwoman of the Financial 
Institution Subcommittee, have very strong feelings here on the 
subject of the holding company affiliate structure that are 
consistent with Chairman Greenspan's position. I know you, Mr. 
Chairman, have referenced the Greenspan position.
    This is not about winners and losers, it is about fire 
walls and safety and soundness and the American taxpayers. In 
my full testimony, I reference the fact that if we don't learn 
from history, we are doomed to repeat the same mistakes and 
item by item referenced the savings and loan debacle as being a 
parallel that we would be inviting if we did not follow Mr. 
Greenspan's position.
    This is not a turf battle. It is about having more than 
rhetoric relating to safety and soundness and those fire walls. 
I believe firmly, as my testimony will reflect in specific 
detail, that the holding company structure is absolutely 
essential to prevent conflicts of interest and the safety and 
soundness questions.
    In addition, I must say that if you look at the Asian 
crisis, you will see that government interference in the 
financial institutions there brought about the Asian crisis. I 
am not talking as a Republican or as a Democrat. But if you 
have elected officials through the Treasury Department setting 
up arbitrary and discretionary requirements for financial 
institutions in the future, you are inviting political 
manipulation rather than objective standards for those 
purposes.
    Finally, I would like to say that by all means I believe we 
need a bill this year. If we in the Congress do not get a bill 
this year, we are essentially saying that the regulators and 
the Court--we can't do our business and the regulators and the 
courts will fill in and redesign financial institutions and 
modernization without statutory authority because we would have 
abrogated our responsibility.
    Again, Mr. Chairman, I believe that you will see that the 
testimony reflects completely from my own experience and my 
position as the chairwoman of what Chairman Greenspan has laid 
out to you and what you, Mr. Chairman, and Mr. Tauzin, vice 
chairman, have enunciateed in your opening statements.
    [The prepared statement of Hon. Marge Roukema follows:]
Prepared Statement of Hon. Marge Roukema, a Representative in Congress 
                      from the State of New Jersey
    ``We cannot escape history. We of this Congress and this 
administration will be remembered in spite of ourselves.'' Those words 
remain as true today as they were the day Abraham Lincoln uttered them 
in 1862 and they have special significance for Congress as we consider 
legislation that would comprehensively modernize our financial laws.
    Financial modernization may not have the headline-grabbing power of 
air strikes in Serbia or school violence, or the potential to affect 
our daily lives like a proposed tax increase. But this legislation is 
critically important. If not ``done right'' it has the potential to 
drain hundreds of billions from America's financial system and from 
federal budget priorities such as preserving Social Security and 
improving education. This is not about winners and losers. By all 
means, we need a bill this year.
    The pending financial modernization legislation is designed to 
replace outmoded laws--many of which were drafted during the Great 
Depression. The bill would tear down the out-of-date barriers that 
prohibit banks, securities firms, insurance companies and other 
financial service providers from affiliating with each other and 
entering each other's businesses. It would foster competition for 
financial services, permit financial organizations to offer consumers a 
wider array of products and services, and enhance the ability of U.S. 
banking and financial companies to compete more efficiently in the 
global market.
    Congress has a special responsibility, however, to ensure that the 
newly authorized affiliations and activities occur within a framework 
that protects the safety and soundness of this nation's insured banks, 
the Federal deposit insurance funds and the American taxpayer. In fact, 
this decision regarding the how we construct an appropriate framework 
for authorizing new financial activities is likely the most important 
decision associated with financial modernization, and a misstep will 
have profound consequences for our financial system and the taxpayer.
    We have been down this road before. The savings and loan debacle of 
the 1980s cost the Federal deposit insurance funds and, ultimately, the 
American taxpayer hundreds of billions of dollars. Indeed, the price 
tag grows every day as lingering lawsuits are settled.
    These losses were caused in part because S&Ls were permitted to 
engage in risky activities directly or through subsidiaries -- 
incurring substantial losses. In some cases, these losses had a direct 
impact on the financial solvency of the parent thrift. Hundreds of 
federally insured thrifts had to be bailed out by the federal 
government, and ultimately, by us, the taxpayers.
    Following the thrift taxpayer-financed bailout, Congress restricted 
the ability of insured state banks to engage through subsidiaries in 
such risky activities, such as underwriting property and casualty 
insurance or making equity investments in non-banking entities. We also 
required the accounting practices of Federal banking agencies to ``be 
uniform and consistent with generally accepted accounting principles.''
    Now we have to apply the standards of safety and soundness to 
financial modernization. Unfortunately, the painful lessons of the 
thrift debacle have faded with time and our enduring economic boom has 
tempered memories of what can happen, particularly to insured 
depository institutions, when the economy turns sour.
    I believe the Treasury Department's own modernization proposal has 
the potential to repeat the costly mistakes of the thrift crisis. In 
particular, the Treasury Department has championed a proposal that 
would allow so-called ``operating subsidiaries'' of national banks to 
engage in some of the potentially risky activities that Congress has 
not allowed national banks to conduct directly. These activities 
include merchant banking activities, which would allow subsidiaries of 
national banks to acquire up to 100 percent of the equity of companies 
engaged in any type of financial or commercial activity,
    Here we go again. Treasury's proposal would place the American 
taxpayer at risk. Losses at an operating subsidiary can occur quickly 
and can significantly exceed the bank's total capital and investment in 
the subsidiary. These losses must be fully and immediately reflected in 
the financial statements of the parent insured bank under generally 
accepted accounting principles and, thus, can have an immediate impact 
on the bank's solvency. The direct ownership and management link 
between an operating subsidiary and its parent bank also gives the bank 
a strong incentive to support a financially distressed operating 
subsidiary. These economic realities have not changed since the thrift 
crisis of the 1980s.
    Treasury would address the risks inherent in the operating 
subsidiary structure through the creation of so-called regulatory 
``firewalls.'' But these firewalls would not fully protect an insured 
national bank, the Federal deposit insurance funds or the American 
taxpayer from losses incurred by an operating subsidiary. Experience 
with the thrift crisis proves that such artificial regulatory 
accounting devices are not effective because they cannot alter economic 
realities--losses at a subsidiary reduce the economic resources of the 
parent.
    This is precisely why Congress must support the ``holding company'' 
framework. The holding company framework has an established track 
record of better insulating insured banks from the risks associated 
with new activities. An insured bank does not control a holding company 
affiliate. Instead, the bank is owned by the uninsured holding company. 
Losses incurred by a holding company affiliate are not directly 
reflected in the financial statements of an affiliated bank and are 
borne by the uninsured holding company--not the insured bank.
    It is for these reasons that the financial modernization bills 
passed last year by the House and by the Senate Banking Committee 
rejected the operating subsidiary framework and required a holding 
company framework. Many who discount last year's action claim it is 
nothing but a turf battle. It is not. There are sound policy reasons to 
institute a prudent system of checks and balances.
    There is one final risk that the operating subsidiary structure 
would present. It would invite the further politicization of banking 
and financial policy by greatly expanding the authority of the Treasury 
Department and, thus, the ability of any Administration--Democrat or 
Republican--to exert influence over banking organizations. For sound 
reasons, Congress has carefully divided responsibility for financial 
institution regulation and policy among the politically elected 
executive branch and independent regulatory agencies, such as the 
Federal Reserve Board.
    We have the right regulatory structure now. Here I would point to 
Asia where the ongoing financial crisis was exacerbated by the outright 
corrupt relationship between the Asian governments and their respective 
financial industries.
    The operating subsidiary structure would dangerously upset this 
careful balance and lead to the further politicization of financial 
policy. Banks play too important a role in our economy to allow banking 
policy to become further politicized.
    The lessons of the financial collapse that led to Depression and 
the more recent Asian economic crisis should be ``red flags'' reminding 
Congress to do it job to protect the safety and soundness of the 
financial services sector. It does that by following the lead of 
Federal Chairman Alan Greenspan and by rejecting Treasury's dangerous 
``opsub'' scheme.

    Mr. Oxley. Without objection, the full statement will be 
made part of the record as well as Mr. Baker's. We thank both 
of you for your testimony. The Chair would note that we do have 
a vote on the floor, and the committee will stand in recess for 
15 minutes.
    [Brief recess.]
    Mr. Oxley. The subcommittee will reconvene.
    We are honored to have as our lead witness this morning the 
Honorable Robert Rubin, Secretary of the Treasury. Secretary 
Rubin, thank you for appearing before the committee today. We 
appreciate you taking the time to be with us, and we apologize 
for the usual floor votes and other distractions, but we are 
eagerly anticipating your participation and your testimony. 
With that, let me recognize you for whatever time you wish to 
spend with us.

 STATEMENT OF HON. ROBERT E. RUBIN, SECRETARY OF THE TREASURY, 
 ACCOMPANIED BY RICHARD S. CARNELL, ASSISTANT SECRETARY OF THE 
              TREASURY, DEPARTMENT OF THE TREASURY

    Mr. Rubin. Thank you, Mr. Chairman. Let me start by 
thanking you for the opportunity to be here with you.
    Mr. Oxley. Is that microphone on?
    Mr. Rubin. I do not know the answer to that, sir. Is it 
better now? Would you rather I have it on or off?
    Mr. Oxley. We will take a vote on that.
    Mr. Rubin. I think I will put it on. Let me start again, if 
I may.
    Mr. Chairman, we are delighted to be here. I appreciate the 
opportunity to present our views on H.R. 10, and financial 
modernization more generally. Let me begin, if I can, with a 
general comment that the United States financial services 
industry is stronger and more competitive in the global economy 
than at any time in many, many decades, including dominance in 
investment banking and a stronger position abroad in commercial 
banking than certainly at any time in my memory.
    Moreover, financial modernizations are occurring through 
the marketplace, products are being developed in one sector 
that serve another sector and mergers are taking place. This is 
because of the lowering of regulatory barriers.
    Financial modernization, I have no doubt, will continue in 
the absence of legislation. But, in our view, it is important 
to get legislation--if we can get good legislation--because 
with good legislation it can be done in a more orderly fashion. 
However, if it is going to be done through legislation, it 
needs to be done right.
    Let me now turn to H.R. 10. The administration strongly 
supports H.R. 10, which, as you know, is supported by the 
Banking Committee with a vote of 51 to 8 on bipartisan basis. 
H.R. 10 takes the necessary actions to modernize our financial 
system with respect to Glass-Steagell and the Bank Holding 
Company Act and it takes two other steps that are of critical 
importance to the administration. It preserves the relevance of 
the Community Reinvestment Act and it permits financial service 
organizations to organize themselves in whatever way they feel 
best serves their business purposes and their customers.
    What I would like to do is focus primarily on how H.R. 10 
deals with these two issues in what we view to be the right 
fashion. Then I will briefly mention four other ways that we 
think H.R. 10 could be improved.
    The first is preserving the relevance of the Community 
Reinvestment Act, which is a key tool in providing capital to 
distressed areas. We strongly support H.R. 10's requirement 
that any bank seeking to conduct new financial activities be 
required to achieve and maintain a satisfactory CRA rating.
    In our view, to preserve the relevance of CRA at a time 
when the relative importance of bank mergers may decline and 
banks will focus to a greater degree on establishing new 
nonbank financial activities, the authority to engage in these 
new activities must be connected to satisfactory CRA 
performance.
    The second administration priority is to allow banking 
organizations to choose a structure that best serves their 
customers.
    Before getting into specifics on this point, let me make 
two general observations. The first is that the subsidiary 
option is a proven success, not a risky experiment, and one 
that every current and recent financial modernization bill, 
including the bill reported by this committee last year, would 
continue to allow in some form. For example, subsidiaries--U.S. 
banks currently engaged overseas in securities underwriting, 
merchant banking, and other nonbanking activities--these 
subsidiaries have over $250 billion in assets, and they would 
be allowed to continue under all recent versions of H.R. 10 
including last year's bill. These subsidiaries, as you know, 
have been approved by the Federal Reserve Board and are 
supervised by the Federal Reserve Board.
    Second, foreign banks are permitted to engage in securities 
through subsidiaries in the United States. These subsidiaries, 
which currently have roughly $450 billion in assets, would be 
allowed to continue under all recent versions of H.R. 10. And 
here, too, the subsidiaries have been approved by the Federal 
Reserve Board and are supervised by the Federal Reserve Board.
    The second point is that allowing the choice of subsidiary 
or affiliate has received broad support. The choice of a 
subsidiary option. This is supported by the current chairman of 
the FDIC, which, as you know is the agency responsible for 
securing bank deposits, and her four predecessors, in total 
three Republicans and two Democrats, and by independent 
economists and other academics.
    The FDIC chair has testified that subsidiaries are actually 
preferable to affiliates for purposes of safety and soundness. 
Of the 18 other countries composing the European Union and the 
G-10, none requires the use of separate bank holding company 
affiliates for underwriting and dealing in securities.
    Now for specifics. Under H.R. 10, subsidiaries and 
affiliates are subject to safety and soundness safeguards that 
are absolutely identical. The bill contains the following 
rigorous safeguards. Subsidiaries of banks would be 
functionally regulated in exactly the same manner as affiliates 
of banks. The authority of the SEC, for example, over 
subsidiaries engaged in securities activities would be exactly 
the same as over affiliates engaged in those same activities.
    Second, every dollar a bank invested in a subsidiary would 
be 100 percent deducted from the bank's regulatory capital, 
just as is the case for every dollar a bank pays as a dividend 
to its parent holding company for investment in an affiliate. 
The bank would have to be well-managed and well-capitalized 
before such an investment and on an ongoing basis with either a 
subsidiary or an affiliate. A bank could not invest any more in 
a subsidiary than it could pay as a dividend to its parent 
holding company for investment in an affiliate.
    The rules governing loans from a bank to a subsidiary would 
be exactly the same as they are for loans from a bank to an 
affiliate. These safeguards are primarily addressed to safety 
and soundness; but they also resolve another potential concern, 
the possibility of a subsidiary gaining a competitive advantage 
by receiving subsidized funding from the parent bank.
    While the idea of a bank having a net subsidy is debatable, 
these funding restrictions ensure that banks are no more able 
to transfer any subsidy to a subsidiary than to an affiliate. 
Now, it has been argued that even with these restrictions in 
place, the bank would still have an incentive to operate 
through a subsidiary because the bank's funding cost would be 
lower.
    A bank may have such incentive, but that has nothing--
zero--to do with the transfer of any subsidy that may exist. 
Rather, it is based on the interests of creditors, the same 
interests that have caused the current Chairman of the FDIC and 
the four former FDIC chairs, three Republicans and two 
Democrats, to state that the subsidiary is preferable to the 
affiliate with respect to safety and soundness. In other words, 
it is a better credit risk. It may be, I should say, it may be 
a better credit risk.
    If a company has a valuable subsidiary, then the capital 
markets will reward that company with lower funding costs 
because, as I said a moment ago, the company is a better credit 
risk. Creditors prefer to see valuable assets lodged in a place 
where creditors can reach them if the company gets into 
financial trouble. The FDIC shares this preference, as it 
seizes the assets of a bank in the event it fails. A subsidiary 
meets this test; an affiliate does not. Thus market incentives 
in this area are rational and have nothing--zero--to do with 
any subsidy received by the bank.
    One last point on subsidy. As I have said, if there is a 
subsidy, it could be equally transferred to an affiliate and a 
subsidiary. And if there is one, the evidence is that it is not 
significant enough to make a truly significant difference. If 
banks received a net subsidy significant enough to make a 
competitive difference, then presumably they would dominate the 
low margin--the very low margin--government securities market. 
They do not. The same is true with respect to mortgage banking 
subsidiaries of banks, which do not dominate that area either.
    Thus we see no public policy reasons to deny the choice of 
a subsidiary. However, there are four important policy reasons 
to allow that choice.
    First, financial services firms should, like other 
companies, have a choice of structuring themselves in the way 
that makes the most business sense--and that, in turn, should 
lead to the lowest costs and best service to their customers.
    Second, the relationship between a subsidiary and its 
parent bank provides a safety and soundness advantage as 
compared to an affiliate, the subject that I have just 
discussed. And to repeat this once again, it is for that reason 
that the Chairman of the FDIC and the four preceding 
chairpersons have said that an op-sub is preferable to an 
affiliate with respect to safety and soundness.
    Third, one of the elected administration's, any 
administration's, critical responsibilities is the formation of 
economic policy, for which it is held accountable. An important 
component of that economic policy for which it is held 
accountable is banking policy. For an administration to have an 
effective role in banking policy, it must have a strong nexus 
with the banking system. That in turn requires the maintenance 
of the effectiveness of a national bank charter. In this 
instance, I am talking about bank policy, not regulation. By 
law, the Secretary of the Treasury cannot get involved in case-
specific regulatory matters.
    We also believe that it is very important that the Federal 
Reserve Board maintain its strong connection with the banking 
system. Therefore, we have taken steps to help ensure that the 
Federal Reserve's jurisdiction is not weakened. Under H.R. 10, 
the Federal Reserve would continue to be the sole regulator of 
bank holding companies and their affiliates, and the largest 
banks would be required to operate through a bank holding 
company.
    We strongly support H.R. 10, though in certain respects we 
believe it could be improved. Let me briefly touch on four of 
those.
    We are concerned about the Federal Home Loan Bank System 
provisions of H.R. 10. A great deal of the subsidized debt 
raised by the system is used not to expand home ownership, but 
rather to fund arbitrage activities and short-term lending to 
benefit the system and its bank and thrift members.
    As currently drafted, H.R. 10 takes no steps to ensure that 
the funds that the system raises will be used for the public 
purpose for which the system was established. Rather H.R. 10 
would allow the system's regulator to cut the capital 
requirements of the system in half. We believe such a step to 
be very unwise.
    We are also concerned about a provision of H.R. 10 that 
would allow greater affiliations between commercial firms and 
savings associations. We have serious concerns about mixing 
banking and commercial activities. Thus we are concerned that 
H.R. 10 would allow commercial firms to acquire any of the 600 
thrifts currently owned by unitary thrift holding companies.
    Finally, we continue to believe that any financial 
modernization bill must have adequate protection for consumers, 
and that there are improvements that could be made by this 
committee and approved by the full House, including provisions 
addressing securities sales regulation issues.
    Let me conclude, Mr. Chairman, by saying that the financial 
modernization legislation can produce significant benefits, but 
the job must be done right. H.R. 10 has received broad industry 
and bipartisan Congressional support, and we believe its 
critical provisions should be preserved. We look forward to 
working with this committee and with Congress to move a bill 
forward that best serves the interests of the American people.
    Thank you, Mr. Chairman.
    [The prepared statement of Hon. Robert E. Rubin follows:]
   Prepared Statement of Hon. Robert E. Rubin, Secretary of Treasury
    Mr. Chairman, Members of the Subcommittee, I appreciate this 
opportunity to discuss the Administration's views on financial 
modernization, including H.R. 10, the Financial Services Act of 1999.
    Mr. Chairman, as we approach financial modernization legislation, 
the Administration's overall objective has been to do what best serves 
the interests of consumers, businesses and communities, while 
protecting the safety and soundness of our financial system. We will 
support legislation that achieves those aims.
    Let me begin by noting that the U.S. financial services industry is 
stronger and more competitive in the global market than at any time in 
many decades. The United States is dominant in global investment 
banking and highly competitive in other segments of financial services. 
U.S. commercial banks are today more competitive abroad than at any 
time I can remember. The problem our financial services firms face 
abroad is lack of access rather than lack of competitiveness.
    Financial modernization is occurring already in the marketplace 
through innovation, technological advances, and the lowering of 
regulatory barriers. Banks and securities firms have been merging; 
banks are selling insurance products; and insurance companies are 
offering products that serve many of the same purposes as banking 
products--all of which increases competition and thus benefits 
consumers.
    Financial modernization will continue in the absence of 
legislation, but it can, with good legislation, occur in a more orderly 
fashion. Treasury has long believed in the benefits of such 
legislation, but we have also been clear that if this is going to be 
done, it needs to be done right.
    Let me turn now to H.R. 10. The Administration strongly supports 
H.R. 10, which was reported by the Banking Committee by a bipartisan 
51-8 vote. H.R. 10 takes the fundamental actions necessary to modernize 
our financial system by repealing the Glass-Steagall Act's prohibitions 
on banks affiliating with securities firms and repealing the Bank 
Holding Company Act prohibitions on insurance underwriting. And it 
takes two other steps that are of critical importance to the 
Administration: it preserves the relevance of the Community 
Reinvestment Act, and it permits financial services firms to organize 
themselves in whatever way best serves their customers and their 
businesses.
    Today, I would like to focus primarily on how H.R. 10 gets these 
two issues right. I will then discuss four ways that we believe that 
H.R. 10 could be improved.
    The first issue is preserving the relevance of the Community 
Reinvestment Act (CRA). CRA encourages a bank to serve creditworthy 
borrowers throughout communities in which it operates. Since 1993, a 
greatly invigorated CRA has been a key tool in the effort to expand 
access to capital in economically distressed areas and to make loans to 
rebuild low and moderate-income communities.
    We strongly support H.R. 10's requirement that any bank seeking to 
conduct new financial activities be required to achieve and maintain a 
satisfactory CRA record. If we wish to preserve the relevance of CRA at 
a time when the relative importance of bank mergers may decline and the 
establishment of non-bank financial activities will become increasingly 
important, the authority to engage in newly authorized activities must 
be connected to a satisfactory CRA performance. We strongly urge the 
Committee to retain this important provision and otherwise leave CRA 
intact.
    The second Administration priority is to allow banking 
organizations to choose the structure that best serves their customers. 
Before getting into specifics, I would like to make two general points.
    The first is that the subsidiary option is a proven success, not a 
risky experiment, and one that every current and recent financial 
modernization bill--including the bill reported by this Committee last 
year--would continue to allow in some form. For example:

 Subsidiaries of U.S. banks currently engage overseas in 
        securities underwriting, merchant banking and other non-banking 
        activities. These subsidiaries--which currently constitute $250 
        billion of assets--would be allowed to continue under all 
        recent versions of H.R. 10, including last year's bill. These 
        subsidiaries, I might add, have been approved by the Federal 
        Reserve and are supervised by the Federal Reserve.
 Foreign banks are currently permitted to engage in securities 
        underwriting through subsidiaries in the United States. These 
        subsidiaries--which currently constitute $450 billion of 
        assets--would be allowed to continue under all recent versions 
        of H.R. 10. These subsidiaries, too, have been approved by the 
        Federal Reserve and supervised by the Federal Reserve.
 Subsidiaries of state banks are currently authorized to engage 
        in a broad range of non-bank activities permitted by their 
        state charter, provided that the FDIC does not find these 
        activities to pose a risk to the deposit insurance funds. Such 
        non-bank activities would continue in some form under all 
        recent bills.
     The second point is that the idea of allowing the choice of 
subsidiary or affiliate has received broad support. The subsidiary 
option is supported not just by Treasury but also by the current 
Chairman of the FDIC, the agency responsible for insuring bank 
deposits, and her four predecessors--two Republicans and two 
Democrats--and by independent economists and other academics. The FDIC 
chair has testified that the subsidiary is actually preferable to an 
affiliate for purposes of safety and soundness. Of the 18 other 
countries composing the European Union and the G-10, none requires the 
use of separate bank holding company affiliates for underwriting and 
dealing in securities. Of those authorizing links between banking and 
insurance underwriting, all but one allow the choice of a subsidiary or 
an affiliate. By allowing a choice of structure, H.R. 10 is clearly in 
the mainstream of economic and legal thinking in this area.
    Now, for the specifics. In H.R. 10, subsidiaries and affiliates are 
subject to safety and soundness safeguards that are absolutely 
identical. The bill contains the following rigorous safeguards:

 Subsidiaries of banks would be functionally regulated in 
        exactly the same manner as affiliates of banks. The authority 
        of the SEC, for example, over a subsidiary engaging in 
        securities activities would be exactly the same as over an 
        affiliate engaging in those same activities, and customers of 
        that subsidiary would benefit from the same customer investor 
        protections as customers of an affiliate.
 Every dollar a bank invests in a subsidiary would be deducted 
        from the bank's regulatory capital, just as is the case with 
        every dollar a bank pays as a dividend to its parent holding 
        company for investment in an affiliate. A bank would have to be 
        well-managed and well-capitalized before and after such 
        investment is deducted from its capital and on an ongoing 
        basis.
    The capital investment would remain on the bank's books for 
        purposes of Generally Accepted Accounting Principles (GAAP), 
        since all of the assets and liabilities of the subsidiary are 
        consolidated with the bank for GAAP purposes. But that 
        accounting consolidation does not affect safety and soundness 
        in any way: as I noted, the bank must maintain capital at the 
        highest level set by the banking regulators--the well 
        capitalized level--even assuming the investment is a total 
        loss, and the bank cannot lose more than its investments in and 
        loans to the subsidiary, which are expressly limited by 
        statute.
 A bank could not invest any more in a subsidiary than it could 
        pay as a dividend to its parent holding company for investment 
        in an affiliate.
 The rules governing loans from a bank to a subsidiary would be 
        exactly the same as they are for a loan from a bank to an 
        affiliate.
    These safeguards are primarily addressed to safety and soundness, 
but they also resolve another potential concern: the possibility of a 
subsidiary gaining a competitive advantage by receiving subsidized 
funding from its parent bank. While the idea that a bank receives a net 
subsidy is debatable, these funding restrictions ensure that banks are 
no more able to transfer any such subsidy to a subsidiary than to an 
affiliate.
    Now it has been argued that, even with these restrictions in place, 
the bank would still have an incentive to operate through a subsidiary 
because its funding costs would be lower. A bank may have such an 
incentive, but that incentive has nothing to do with the transfer of 
any subsidy that may exist. Rather, it is based on the interests of 
creditors--the same interests that have caused the current and three 
former FDIC Chairs to conclude that the subsidiary is preferable to the 
affiliate with respect to safety and soundness.
    If a company has a valuable subsidiary, then the capital markets 
will reward that company with lower funding costs because it is a 
better credit risk. Creditors prefer to see valuable assets lodged in a 
place where creditors can reach them if the company defaults. The FDIC 
shares this preference, as it seizes the assets of a bank in the event 
it fails. A subsidiary meets this test, but an affiliate does not. 
Thus, market incentives in this area are rational--and have nothing to 
do with any subsidy received by the bank. It is difficult to understand 
why Congress would wish to disrupt these sound market incentives--
incentives that also promote safety and soundness.
    One last point on subsidy. As I have said, if there is a subsidy it 
could be equally transferred to an affiliate and a subsidiary. And if 
there is one, it is not significant enough to make a practical 
difference. If banks received a net subsidy significant enough to make 
a competitive difference, then presumably they would dominate the low-
margin government securities market. They do not. Presumably, mortgage 
banking subsidiaries of banks, which currently operate without any of 
the funding restrictions imposed by H.R. 10, would dominate their non-
bank competitors. They do not. I cannot help but conclude from our real 
world experience that the net subsidy is not that significant and, more 
importantly, that under the funding limitations of H.R. 10, any subsidy 
that a subsidiary would manage to extract from its parent bank would be 
inconsequential.
    Thus, we see no public policy reasons to deny the choice of a 
subsidiary; however, there are four important policy reasons to allow 
that choice.
    First, financial services firms should, like other companies, have 
the choice of structuring themselves in the way that makes the most 
business sense and this, in turn, should lead to better service and 
lower costs for their customers.
    Second, the relationship between a subsidiary and its parent bank 
provides a safety and soundness advantage. As I have noted, firms that 
choose to operate new financial activities through subsidiaries are, in 
effect, keeping those assets available to the bank rather than 
transferring them outside the bank's reach. The bank's interest in the 
subsidiary could be sold if it ever needed to replenish its capital. If 
the bank were ever to fail, the FDIC could sell the bank's interest in 
the subsidiary in order to protect the bank's depositors and the 
deposit insurance fund.
    Third, one of an elected Administration's critical responsibilities 
is the formation of economic policy, and an important component of that 
policy is banking policy. In order for the elected Administration to 
have an effective role in banking policy, it must have a strong 
connection with the banking system. That connection would be weakened 
if new financial activities were off limits to OCC supervision.
    We also believe it is very important that the Federal Reserve Board 
maintain its strong connection with the banking system, and therefore 
we have taken steps to help ensure that the Federal Reserve's 
jurisdiction is not weakened. Under H.R. 10, the Federal Reserve would 
continue to be the sole regulator of bank holding companies and their 
affiliates, and the largest banks would be required to operate through 
a bank holding company. The Federal Reserve would also supervise 
subsidiaries of State member banks, and would continue to supervise 
overseas subsidiaries of national banks and U.S. subsidiaries of 
foreign banks. Insurance underwriting would be conducted solely in 
Federal Reserve-supervised bank holding company affiliates. And the 
Federal Reserve would have the authority to veto any new activity for a 
subsidiary--Fed-supervised or not--just as the Treasury would have the 
authority to veto any new activity for an affiliate.
    While we strongly support the House Banking Committee bill, there 
remain certain aspects of the bill that concern us.
    We are concerned about the Federal Home Loan Bank System provisions 
of H.R. 10. The FHLBank System is currently the largest issuer of debt 
in the world. Last year, it issued approximately $2.2 trillion in debt, 
and it currently has $350 billion in debt outstanding. As a government 
sponsored enterprise directed to foster home ownership, the System 
receives tax benefits, an exemption from SEC registration for its 
securities, and benefits from a market perception that the government 
stands behind the System, even though there is no legal obligation to 
do so. Yet a great deal of the government subsidized debt raised by the 
System is used, not to advance its home ownership purpose, but rather 
to fund arbitrage activities and short-term lending that benefit the 
System and its bank and thrift members. For those who care about the 
market-distorting effects of government subsidies on U.S. markets, the 
Federal Home Loan Bank System should be a substantial concern.
    The System's arbitrage is not only an abuse of its government 
subsidy but also injects risk into a System that was designed--by 
requiring all loans to be collateralized by stable, low-risk 
mortgages--to have very little.
    As currently drafted, H.R. 10 effects no reform of the System's 
arbitrage and takes no steps to ensure that the funds it raises will be 
used for a public purpose. Rather, H.R. 10 would allow the System's 
regulator to cut the capital requirements of the System in half. We 
believe such a step is very unwise.
    We are also concerned about a provision of H.R. 10 that would allow 
greater affiliations between commercial firms and savings associations. 
We have serious concerns about mixing banking and commercial activities 
under any circumstances, and these concerns are heightened as we 
reflect on the financial crisis that has affected so many countries 
around the world over the past two years. Thus, we are concerned that 
H.R. 10 would allow commercial firms to acquire any of the over 600 
thrifts currently owned by unitary thrift holding companies. Currently, 
only a few unitary thrifts are owned by non-financial firms--many are 
owned by insurance companies and securities companies, for example--but 
if H.R. 10 were to break down the barriers to affiliation among 
financial firms, then their need for owning thrifts would be 
substantially reduced. The logical buyers at that point would be non-
financial firms.
    We continue to believe that any financial modernization bill must 
have adequate protections for consumers. We believe that improvements 
should be made by this Committee and approved by the full House. Thus, 
we look forward to working with the Committee on provisions addressing 
sales of securities regulation issues.
    Mr. Chairman, let me conclude by reiterating that financial 
modernization legislation can produce significant benefits, but the job 
must be done right. H.R. 10 has received broad industry and bipartisan 
Congressional support, and we believe its critical provisions should be 
preserved.
    We in the Administration look forward to working with you and 
others in Congress to move the bill forward and improve it where 
necessary in order to produce legislation that truly benefits 
consumers, businesses and communities, while protecting the safety and 
soundness of our financial system. Thank you very much.

    Mr. Oxley. Thank you, Mr. Secretary. We again appreciate 
your willingness to come here to testify and to answer some 
questions. Let the Chair begin with some questions.
    This is perhaps inevitable because there was so much 
discussion about operating subsidiaries both by Chairman 
Greenspan last week and then you in your testimony today.
    So let me begin with the obvious. You have indicated you 
believe that the provisions in the bill H.R. 10, as passed by 
the Banking Committee, effectively curtail the transfer of the 
subsidy that exists for banks to their operating subsidiaries. 
Would the provisions of H.R. 10 requiring deduction of 
investments and operating subsidiaries apply only to regulatory 
capital of the bank and not necessarily the operating capital?
    Mr. Rubin. Well, what the legislation would do is require a 
deduction from the regulatory capital. In terms of GAAP 
accounting, they would still be consolidated. But as you know, 
Mr. Chairman, if it turns out there were losses in the 
subsidiary, then the bank, when it sells the subsidiary or 
liquidates the subsidiary, whatever the case may be, for GAAP 
purposes it would recapture those losses. They would be in 
effect recaptured at the bank level. But for regulatory capital 
purposes, the deduction would be 100 percent.
    Mr. Oxley. Chairman Greenspan testified to this committee 
on two different occasions that the Fed had done an extensive 
study and indicated that banks using the operating subsidiaries 
concept would enjoy a 10 to 12 basis point advantage over other 
financial institutions.
    You obviously disagree, but I am curious as to why such a 
wide disparity of opinion between two well-respected 
individuals such as yourself and Chairman Greenspan.
    Mr. Rubin. Could I correct one oversight. I apologize, Mr. 
Chairman, I have forgotten to introduce our Assistant 
Secretary, Rick Carnell, who is absolutely delighted to respond 
to questions as well.
    Mr. Oxley. Welcome, Mr. Carnell.
    Mr. Rubin. I apologize to Rick for that.
    I lived in capital markets, as you know, Mr. Chairman, for 
26 years before I entered the world of--I don't know how to 
describe the world that I am in now. I was going to say 
something, but I decided not to.
    If there is a funding advantage, and I think, by the way, 
this may cut both ways. Let me give you a full answer, if I 
may, because it is a somewhat complicated question. It is one 
that I actually know something about.
    If there is a funding advantage to a bank in setting up a 
subsidiary, it has nothing to do with transfer of subsidy. That 
is identical. But if you are a creditor of a bank and the bank 
takes a certain portion of its capital and puts it into the 
subsidiary to conduct securities business or whatever it may 
be, securities underwriting, those assets then remain subject 
to the creditors of the bank if the bank gets in trouble 
without having to get bank board approval or any such thing.
    If the bank gets in trouble, the creditors can simply seize 
all of the assets. So the bank is actually a better credit 
risk. The same reason the FDIC says the subsidiary is 
preferable for safety and soundness, it is also better for 
credit risk. There are many instances if they put the--or at 
least in some instances, if they put the assets in the 
subsidiary rather than putting them in the affiliate, because 
if so, then the creditors can't grab them.
    Now, on the other hand--how much of a funding advantage 
that would be I don't know, Mr. Chairman.
    On the other hand, there may be other banks that would have 
just the opposite incentive, because they may have a holding 
company, which is where a lot of the financing gets done, that 
is doing financing at unattractive rates because the creditors 
are concerned that the flow of funds from a subsidiary could be 
interrupted by a bank regulator. So what they might like to do, 
what the creditors of the holding company would like to see, is 
a larger portion of the assets be in the affiliate. So in that 
case, that might actually be an incentive for the bank to take 
its capital and put it in the affiliate to engage in the new 
activities. So it is a very complicated subject cut either way.
    But in the cases in which there is a funding advantage by 
putting assets into the subsidiary, conducting activities in 
the subsidiary, this has zero--nothing--to do with passing 
along a subsidy; it has everything to do with simply being a 
better credit risk.
    Mr. Oxley. The Chairman said that he, along with the other 
members of the Board of Governors, had made an extensive study 
and indicated some numbers that you could actually get ahold 
of. That is, he indicated that it was a 10 to 12 basis point 
advantage.
    Mr. Rubin. Mr. Chairman, if there is, it is simply because 
it is a better credit risk because that is how they operate. 
But let me ask Mr. Carnell to respond.
    Mr. Carnell. If I could just put it in context and then 
respond to the specific point about the differences.
    The typical bank holding company has a tremendous reliance 
on its subsidiary banks for its assets and its earnings. The 
banks are most of the holding company's assets. And the holding 
company is typically completely dependent on those banks for 
money with which to pay its own debt. The reason that holding 
companies pay more than their banks to borrow money is that 
creditors price in the risk that--if the bank gets into 
trouble--the bank regulators or even the prompt corrective 
action statute will cutoff the flow of dividends from the bank 
to the holding company. That is the key to the pricing 
difference.
    Chairman Helfer in her 1997 testimony before the Banking 
Committee spoke specifically about this point. The FDIC staff 
did a study where they talked to the rating agencies about why 
the banks and the holding companies had different credit 
ratings which reflects this different cost of capital, the 
different costs of funds here. And the answer that the rating 
agencies gave was that there was a greater risk of this 
interruption of dividends.
    Let me point to another risk, in addition to the risk of 
interruption of dividends, and that is that if there were to be 
any failure of the bank, the creditors of the holding companies 
are going to wait in line last, they are going to wait in line 
after the FDIC and the depositors of the bank, they are going 
to wait in line, so they are really in the same position as 
stockholders of the bank, because they don't get anything 
unless the holding company, as a stockholder of the bank, gets 
something. So it reflects the structural weakness of the 
holding company rather than any transmission of subsidy.
    Mr. Rubin. Very good.
    Mr. Oxley. The Chair's time has expired.
    The gentleman from New York, Mr. Towns.
    Mr. Towns. Thank you very much, Mr. Chairman.
    Let me begin by saying, can we be guaranteed--well, I won't 
use the word guaranteed, but ``assured'' of competitive 
equality if we adopt an operating subsidiary provision?
    Mr. Rubin. I think, Mr. Towns, that you can be assured of 
absolute competitive equality, except to the extent that--which 
is the issue we were just discussing--except to the extent that 
the bank is actually a better credit risk and safer and 
sounder, which obviously is to the benefit of the taxpayers, 
because the assets have been put in a place where they can be 
reached by the FDIC and the creditors. So I think there is zero 
difference with respect to transfer of a subsidy. Zero. But to 
the extent that creating the subsidiary structure actually 
makes the bank a better credit risk, then that is in the 
interests of the taxpayers and might create some funding 
advantage for the bank.
    Mr. Towns. Can we maintain functional regulations of 
securities and insurance activities under an operating 
subsidiary structure?
    Mr. Rubin. We have provided--or I shouldn't say we have 
provided, I apologize. H.R. 10 provides that functional 
regulation of the op-sub is to be identical to functional 
regulation of the affiliate. Now, we did not actually put--as 
you know, H.R. 10 does not put insurance underwriting in the 
op-sub, but with respect to securities underwriting and 
merchant banking--which would be done there--functional 
regulation would be absolutely identical, and this is 
specifically so provided in H.R. 10.
    Mr. Towns. What else other than the comments that you have 
made, do we need to do, do you feel, to really fix this bill?
    Mr. Rubin. I think----
    Mr. Towns. You know we have been trying to do this for 65 
years.
    Mr. Rubin. The Congress has been trying to do it for a 
while, but not everything happens immediately.
    Mr. Towns. You were not here all 65 years.
    Mr. Rubin. That is a long time, I agree. I think you are on 
the verge of a good bill, Mr. Towns, I really do. I think the 
confluence of forces that have come together have come very 
close to producing a good bill. I would urge, this is my view, 
at least, that we take a look at the Federal Home Loan Bank 
provisions in the sense that I mentioned. FHLOB serves a very 
important purpose, but I think that the fact that there is so 
much focus on arbitrage and overnight loans is an issue that 
ought to be dealt with. There are some consumer protection 
issues that I think should be taken care of. We very much share 
the SEC's concerns about certain issues with respect to 
functional regulation that we would like to work with the SEC 
and the committee on to improve, but I think you are close to a 
very good bill.
    Mr. Towns. Thank you very much, Mr. Chairman. I yield back.
    Mr. Oxley. The gentleman yields back.
    The gentleman from Illinois, Mr. Shimkus. I am sorry, the 
Vice Chairman from the State of Louisiana, Mr. Tauzin.
    Mr. Tauzin. Mr. Secretary, how can you say that there is no 
competitive disadvantage, that the competition is equal, 
except? ``Except'' means it is not equal.
    I mean, if Mr. Greenspan is correct, weighing in all of 
these factors of greater creditor position and cheaper capital 
as against the possibility of a bank regulator stepping in 
because of some problems at the bank, weighing in all of those 
features, you have a 10 to 12 basis point advantage, and if you 
are giving the banks op-sub access to the payment system that 
other securities and insurance firms don't have, how can you 
say that the competition is equal?
    Mr. Rubin. Well, the op-sub would not have access to the 
payment system, and any benefit that the bank gets by access to 
the payment system can be transferred equally to the op-sub or 
to the affiliate.
    I don't know what advantage any particular institution 
would have with respect to its overall funding by using an op-
sub, but one thing I am sure of is that each of these cases is 
going to be different. I have no doubt, since most of the 
funding for these institutions is done at the holding company 
level, that there will be many instances that the institution 
will actually think its economic advantage lies in putting its 
assets into the affiliate.
    But unfortunately--I shouldn't say unfortunately--the 
holding company is in a weaker position for funding, and if 
assets can be put outside of the reach of the bank regulators, 
that is better from the point of view of the holding company 
and the holding company's funding rates.
    In the instances where the subsidiary does create an 
advantage, it is simply a better credit risk. It is safer and 
sounder for the taxpayers.
    Mr. Tauzin. You said in some instances the bank is a better 
creditor. You obviously would make room for the fact that in 
some instances it is not.
    Mr. Rubin. No. Oh, no, no. All I was saying is that if 
there is a funding advantage, it is solely--100 percent--solely 
because the bank is a better credit risk due to the fact that 
the assets are someplace that can be reached by the bank's 
creditors.
    Mr. Tauzin. Isn't that going to be different from bank to 
bank? I assume if you have a bank that is in an excellent 
position, it may indeed enjoy a heck of an advantage with a op-
sub provision in this bill. If a bank is in a more tenuous 
position where in fact there may be fear of Federal banking 
regulators disrupting the flow of dividends, then that may be--
that may not be such a good idea to go with the----
    Mr. Rubin. No, I think it actually cuts the other way, Mr. 
Tauzin. If you have a very, very strong bank, then the 
creditors aren't going to be concerned about the possibility of 
the failure of the bank. Therefore, keeping the assets within 
reach of the creditors isn't going to matter. But it may be, in 
fact it could well be, that the creditors----
    Mr. Tauzin. It may well be that----
    Mr. Rubin. Wait a minute. The creditors of that institution 
could be concerned about the holding company and might like to 
see the holding company strengthened, in which case the cost of 
money actually is benefited by taking the assets and putting 
them into the affiliate.
    Mr. Tauzin. I grant you that. I grant you it may be--I see 
that. But the point is it is going to be different, depending 
upon the position of the bank, and in some cases the bank, I 
think, is going to have a very clear advantage over a nonbank 
insurance or securities firm. And the question we are going to 
have to face in this committee is whether or not, as Mr. Towns 
alluded to, whether or not that is really fair competition or 
we are creating an old, traditional, unlevel playing field 
again.
    Mr. Rubin. Oh, I don't agree with that. I think what you 
have got is that where a bank is a better credit risk--and it 
can be a better credit risk for an enormous number of reasons--
then it should be able to borrow more cheaply. That is how the 
credit markets work. There are all kinds of reasons why it 
might be a better credit risk, and one of them might be that it 
has taken a bunch of its assets and decided to do securities 
underwriting or dealing or whatever through a subsidiary and 
kept those assets subject to the claims of its creditors.
    Mr. Tauzin. I know my time has certainly about expired, but 
I would like very much, Mr. Secretary, if you would 
specifically address the 10 to 12 point basis points study and 
indicate for us, perhaps in writing, why you think it is flawed 
in any respect. Because if that is a real number that we have 
our hands on what Mr. Greenspan has supplied to us that is 
still sitting out there unchallenged, except in theory, without 
a specific refutation, the concerns are real.
    Mr. Rubin. I would be delighted to respond, we would be 
happy to respond. But one thing I can assure you of, Mr. 
Tauzin, is that if there is an advantage--and I suspect every 
institution will be different. I know, I used to do this for a 
living. If there is a difference, it is solely for the same 
reason that all other companies have different rates as amongst 
themselves: because of credit differences.
    Mr. Tauzin. That is the way it should be. It should not be 
because of language in this bill. That is what concerns me.
    Mr. Rubin. That is the point, I agree. This bill should not 
restrict a banking institution from finding the way that makes 
it the most creditworthy borrower and therefore having the best 
rate, and that is in the taxpayers' interest, and that is why 
the Chairman of the FDIC says there should be choice, to enable 
banks to do that which will--that structurally, make them 
safest and soundest. That is exactly the point.
    Mr. Oxley. The gentleman's time has expired.
    The gentleman from Michigan, Mr. Dingell.
    Mr. Dingell. Mr. Chairman, I certainly want to welcome my 
old friend Mr. Rubin back to the committee. We always enjoy his 
visits here and find them enormously valuable and informative. 
I would like to welcome my good friend back.
    Mr. Rubin. Thank you, Mr. Dingell.
    Mr. Dingell. I have been very much impressed, Mr. Rubin----
    Mr. Rubin. I can't quite hear you.
    Mr. Dingell. I have been very much impressed with the 
comments you made about how allowing a bank to have an 
operating sub which would do all of these things would be a 
benefit to the bank, would be of benefit to the bank in terms 
of its liquidity, in terms of its earnings, in terms of its 
credit risk, and a number of other things.
    I am curious, I am curious--the bill also gives, however, 
to the bank the ability to do these things in a wholly owned 
affiliate, but none of the advances and advantages appear to 
apply to the affiliate, and I am just curious; why would a bank 
choose to utilize the affiliates if there are such huge 
advantages to the bank by going through the operating 
subsidiary?
    Mr. Rubin. I didn't mean to imply, Mr. Dingell, that in all 
or even in most instances a subsidiary would be preferable. I 
think there would be many instances in which a bank holding 
company, which is where most of the financing is done for these 
institutions, will determine that it is preferable to take the 
assets and put them into the affiliate, because the problem 
that the bank holding companies have is that, in effect, the 
creditors of the bank holding companies come behind the 
creditors of the bank. I am just telling you things you know. 
So what the creditors of the bank holding company like to see 
are assets that lie outside of the reach of the bank 
regulators. So I actually think that in many instances, the 
affiliate would have the advantage, not the op-sub, in terms--
--
    Mr. Dingell. That would be particularly true where you had 
a weak bank, and it would be particularly true where you had a 
holding company that was apprehensive about the weakness of the 
bank, its credit ratings, and also about the fact that that 
bank might go under.
    Mr. Rubin. Well, you know, it is funny. I think it could 
actually cut both ways, because if you have a weak bank and the 
holding company is worried about the weak bank, they have 
competing considerations. But it seems to me by giving them 
their choice and allowing them to do what is best for them, I 
think they will probably do what is best for the taxpayers and 
the FDIC. But if they have a weak bank, Mr. Dingell, it may 
well be that they will decide the thing they have to do is to 
take those assets and keep them where it most reassures the 
creditors of the bank, and that would be to put them in the op-
sub.
    On the other hand, they might say, no, we want to make sure 
that our holding company is in the best position possible, and 
therefore put them in the affiliate. I think every business 
situation is going to be different.
    Mr. Dingell. Well, now, here we have----
    Mr. Rubin. I might say that if the bank is actually weak, 
then you can't have a sub in the first place. There is a 
capital requirement to have these new activities, as you know.
    Mr. Dingell. Here you note that, in the case of operating 
subsidiaries, that to keep these banks--or rather to keep the 
assets of these kinds of facilities available at the bank 
rather than transferring them out of the bank's reach, the 
bank's interest in the subsidiary could be sold if it needed to 
replenish its capital. If the bank were to fail, the FDIC could 
sell the bank's interest in the op-sub in order to protect the 
bank's depositors and the deposit insurance fund; isn't that 
so?
    Mr. Rubin. Correct.
    Mr. Dingell. So now this gets down to raising several 
questions. This is a great deal for banks, but how is it fair 
to the competition with nonbank competitors?
    Mr. Rubin. Well, I think that in terms of the nonbank 
competitors in the securities businesses, Mr. Dingell, they 
will themselves have all sorts of ways that they raise money. 
The way the system basically works is that each competitor 
organizes--I used to do this when I ran these places--organizes 
itself in the way to most effectively raise money. We had all 
sorts of subsidiaries in order to raise money most effectively, 
and I assume that is what a bank would do.
    Mr. Dingell. How does it create a level playing field, and 
how will your firewalls be real if your statements about 
keeping these assets in the hands of banks are also true?
    Mr. Rubin. Well, you have a level playing field with 
respect to transfer of subsidy. There is no difference-- zero 
difference--with respect to transferring the subsidy. With 
respect to allowing institutions to organize themselves in a 
way that makes them most attractive to creditors, your level 
playing field is that every institution that is involved in the 
competitive arena will presumably organize itself so as to 
effectively raise money.
    Mr. Dingell. How about an entity that chooses to remain 
simply a financial institution which is not a bank, a Wall 
Street broker? This puts enormous pressure, for example, on a 
national or regional broker to simply either sell out to or be 
bought by or to buy a bank, so that it would derive these 
benefits. So you are essentially driving the systems toward a 
peculiar kind of homogeneity.
    Mr. Rubin. I don't think so, Mr. Dingell, for two reasons. 
No. 1, I don't think the evidence suggests that the funding 
advantage is substantial enough to have an effect, or to have a 
meaningful effect on the business results of these 
organizations. But much more importantly, I think that what you 
have right now is different organizations that compete with 
each other, each trying to raise money in whatever way is most 
effective for them. And all you are saying here is that we are 
not going to allow the banks to take advantage of the subsidy, 
zero. We are not going to allow them to take advantage of their 
subsidy, but we are going to have full competition. That is the 
idea of financial modernization.
    And for full competition that has no advantage to the 
subsidy, these institutions can find some way of raising money 
more cheaply and offering their customers a lower-cost service. 
That is what competition is all about.
    Mr. Dingell. Isn't it also true, however, that there are 
huge advantages----
    Mr. Rubin. That there are what?
    Mr. Dingell. Isn't it also true that there are huge 
advantages, both to the bank and to the operating subsidiary in 
terms of lower capital costs, lower cost of money, greater 
efficiencies by keeping the brokerage business or the insurance 
business in the operating sub?
    Mr. Rubin. Well, the insurance business can't be in the 
operating sub, because H.R. 10 wouldn't allow that. If there 
are advantages in financing, Mr. Dingell, then those 
advantages, as I said a moment ago, have nothing to do with 
subsidy, and it really is the American economic system at work, 
which is institutions finding ways to more effectively raise 
money. It is for the same reason when I was part of an 
investment banking firm----
    Mr. Dingell. So there is an advantage there. By the way, I 
would note that the insurance underwriting is in the operating 
sub.
    Mr. Rubin. No. That would be the affiliate.
    Mr. Dingell. But the sales are.
    Mr. Rubin. The sales can be.
    Mr. Dingell. The sales can be, and that is, of course, to 
me the most troublesome part of the business.
    Mr. Rubin. There may be an advantage in funding, Mr. 
Dingell. If there is, that, in effect, is why we are doing 
financial modernization all together, which is to absolutely 
preclude any unfair use of the subsidy, and beyond that, to 
encourage greater competition. If we weren't going to do that, 
then it seems to me we shouldn't be in financial modernization 
all together.
    Mr. Oxley. The gentleman's time has expired.
    Mr. Dingell. I thank you, Mr. Chairman.
    Mr. Oxley. The gentleman from Iowa, Mr. Ganske.
    Mr. Ganske. Thank you, Mr. Chairman. Thank you, Mr. 
Secretary, for coming. I have four questions on operating subs, 
so I guess about a minute, 15 seconds for each one of those. We 
will see if we can get through these.
    Mr. Secretary, the Treasury Department in the 1980's 
opposed expanded powers for operating subs. Why has the 
Treasury changed its view?
    Mr. Rubin. That was a totally different set of proposals 
with respect to operating subs. They did not have the 
safeguards that we have in this proposal. Just a different 
proposal.
    Mr. Ganske. All right. The Treasury has criticized Japan 
for having extensive subsidies and conflicts of interests in 
their financial system and has encouraged the Japanese to adopt 
a holding company structure for their banking system, I 
believe. If that is true, why?
    Mr. Rubin. No, we didn't actually recommend a holding 
company. We have been critical of certain practices in the 
Japanese banking system--and I think there are very serious 
issues that need to be addressed--but they have nothing to do 
with the op-sub versus affiliate question. In fact, in Japan, 
as you probably know, banks have the choice now of an op-sub or 
an affiliate, except in certain respects with respect to 
insurance, but we never had anything to do with that issue. 
They have a combination of banking and commerce, and I think 
there have been a lot of issues there that at least should be 
focused on, in our judgment.
    Mr. Ganske. I think it is fair to say that the Treasury 
Department has been concerned about the interconnectedness in 
the Japanese economy; is that not true?
    Mr. Rubin. Yes, but that had nothing to do with the 
question of whether a financial institution conducted its 
nonbanking financial activities in the op-sub or the affiliate. 
It had to do with the keiretsu, the interlinking, if you will, 
of banking and commerce.
    Mr. Ganske. So what you are saying is that under--if you 
have certain safeguards, your position is that op-subs are 
okay?
    Mr. Rubin. Our position is that with the safeguards in H.R. 
10, op-subs are absolutely identical to affiliates.
    Mr. Ganske. Okay. Well, you indicate that there haven't 
been any problems with op-subs. I understand that NationsBank 
settled claims of $50 million for defrauded investors with 
securities sold by an op-sub. Do you have the facts of that 
case, and what are the banking regulators doing about that?
    Mr. Rubin. Let me make a general comment and ask Mr. 
Carnell to respond, if I may. I have no doubt that from time to 
time, in any sort of organization, there are going to be 
issues. The organization that I ran had issues from time to 
time, and we had to deal with them. I don't think that in 
itself speaks to the question of op-sub versus affiliate. In 
fact, I apologize for not remembering the name of it, but there 
was a bank with an affiliate that through mortgage banking 
activities failed in 1976 because of the activities between the 
affiliate and the bank. So this can happen under any structure.
    Mr. Carnell. The NationsBank securities firm was an SEC-
registered broker-dealer. The OCC and the SEC worked together 
in dealing with the abuses there, and all of this was done 
completely within the jurisdiction of the SEC.
    Mr. Ganske. All right. Well, here is my crucial question, 
because I don't want to see this financial services bill 
flounder on this op-subs thing. I hope that we can find some 
compromise between the administration and the different parties 
on this. You point out that the Commerce Committee print from 
last Congress provided for limited operating subsidiaries. 
These op-subs were limited to agency activity to address 
Chairman Greenspan's concern about giving away taxpayer money.
    My question is, would you be willing to support agency-only 
op-subs as the compromise to try to keep this moving along?
    Mr. Rubin. The answer to that is no, but that was not my 
point about the H.R. 10 of last year. I apologize. My point was 
that the foreign subsidiaries of U.S. banks, and the U.S. 
subsidiaries of foreign banks, can do the kinds of activities 
that we are talking about, and they are both subject to Fed 
approval and Fed regulation. That was my point, not the 
provision you were talking about.
    Mr. Ganske. And so--if you would clarify for me again what 
is your position at this time on what we had in our print last 
year, limiting op-subs to agency activity.
    Mr. Rubin. That in our judgment is not responsive to our 
belief that banks should have choice for the reasons that I 
have said. That would not be a satisfactory provision. My point 
about last year's bill was that you all did actually approve a 
bill that involves very substantial securities dealing and 
underwriting activities by subsidiaries of banks. That was my 
only point.
    Mr. Ganske. Mr. Chairman, let me just ask one follow-up 
question, with your permission.
    Mr. Secretary, how do we get this agreement on this? How 
are you and Mr. Greenspan and Mr. Levitt going to come together 
on this?
    Mr. Rubin. Well, let me say that the Fed and the Treasury 
have an extraordinarily good working relationship, and I think 
it has been of tremendous benefit to this country. I think the 
probability of this country being able to provide the 
leadership it did in connection with the financial crises of 
the last 2 years would have been substantially reduced if we 
did not have the excellent working relationship we have. This 
is a matter where we simply disagree.
    But you have a bill that has passed, 51-8, so there was 
obviously strong bipartisan support in the House Banking 
Committee. And that is a bill that, in our judgment at least, 
should be the basis, with some minor matters that need to be 
dealt with, should be the way in which financial modernization 
is dealt with.
    Mr. Ganske. Thank you.
    Mr. Oxley. The gentleman's time has expired.
    The gentleman from Michigan, Mr. Stupak.
    Mr. Stupak. Thank you, Mr. Chairman.
    Mr. Secretary, in just listening to testimony, when we talk 
about operating subsidy, I believe we are talking about access 
to the discount window and the Federal guarantee to insure the 
bank assets. Do you disagree with that?
    Mr. Rubin. I do. We are not talking about the operating sub 
having any access to the window, or any guarantee of assets. 
The operating sub would have none of that.
    Mr. Stupak. But the bank has the access which makes the 
capital then cheaper, does it not, if the bank has access to 
the discount window and the guarantee?
    Mr. Rubin. The bank has the access. That may make their 
capital somewhat cheaper, although that, as you know, is a 
matter that is somewhat disputed. But the subsidy that is 
thereby created can then only be transferred to the subsidiary 
in accordance with the provisions of H.R. 10. And under those 
provisions, the affiliate and the subsidiary are exactly 
identical--100 percent identical--with respect to the ability 
to benefit from the subsidy. A zero difference.
    Mr. Stupak. All right. Let me ask you this. In your 
statement, you maintain that a bank would not transfer the 
subsidy it receives through the access to the payment window 
and deposit insurance to a subsidiary anymore than an 
affiliate, because it would have to provide loans on the same 
terms.
    Mr. Rubin. Correct.
    Mr. Stupak. It is my understanding that Chairman Greenspan 
was not primarily concerned about the loans, but the fact that 
the capital banks invest in subs would be subsidized, and in 
case of the affiliate, the bank would not invest in the 
affiliate, only the parent who does not derive a subsidy.
    Now, so you don't dispute the notion that the access to the 
discount window and the Federal guarantee to insure bank assets 
decreases the cost of their capital, do you?
    Mr. Rubin. No. What I disagree with is the other parts of 
the statement that you made. There is a very lively debate 
amongst people who are expert in this area as to whether or not 
there is an actual subsidy in the bank, because as you know, 
the bank----
    Mr. Stupak. But it is not an actual subsidy, right? I mean, 
it is the access to the discount window and the Federal 
guarantee.
    Mr. Rubin. You have Federal guarantee, you have access to 
the discount window, both of which are benefits to the bank, 
but the bank also takes on other responsibilities. For example, 
CRA. I can just tell you if you read the literature and you 
talk to people in this world, they will tell you that there is 
a very lively dispute as to whether there is a subsidy, whether 
or not that subsidy exists. But I am not engaging in that 
debate at the moment. I am saying whether or not that subsidy 
exists is irrelevant with respect to this op-sub affiliate 
debate because the ability to take that subsidy and put it in 
one or the other is exactly the same.
    Now, for the reasons that we discussed with others--
including, I think, Mr. Dingell--a bank for all kinds of 
economic reasons may choose either the op-sub or the affiliate 
as the place to put its capital. I think there are some 
instances where I think they feel the affiliate gives them the 
greatest overall competitive advantage, and there are some that 
are going to consider that the op-sub gives them the greatest 
competitive advantage, but that has zero to do with the 
subsidy.
    Mr. Stupak. If it is exactly the same, as you said, then 
are you saying, then, that Goldman Sachs and Citicorp can 
obtain loans or issue debt at the same terms?
    Mr. Rubin. Citicorp, the holding company, or Citicorp, the 
bank?
    Mr. Stupak. The bank.
    Mr. Rubin. No, the bank may have a subsidy. That isn't the 
issue, Mr. Stupak. The question is, if they have a subsidy, and 
it is not so clear they have a subsidy--let me say, we competed 
with Citibank, wonderful institution, great institution, but we 
competed with them very effectively when I was in the 
securities business. But in any event, it suggests to me that 
if there is a subsidy, it isn't very large, where a large 
subsidy would be a determinative factor. In fact, the 
investment banks were extremely competitive.
    But leaving that aside, if there is a subsidy, it is 
equally transferable to the affiliate and to the subsidy. The 
subsidiary has no more advantage than the affiliate; it can be 
equally transferred to both. There are certain instances in 
which an institution will feel that its overall funding is 
advantaged by putting it in the affiliate, and there are other 
instances where they feel it would be an advantage by putting 
it in the subsidiary. That has nothing to go with the question 
of whether there is a subsidy.
    Mr. Stupak. But the answer then to my question based on 
your answer is, no, that they can't do it on the same terms; 
correct?
    Mr. Rubin. Can't do what?
    Mr. Stupak. Issue debt on the same terms, Citicorp or 
Goldman Sachs. They can't issue on the same terms.
    Mr. Rubin. Actually, we can respond to you in writing, Mr. 
Stupak, but I am not so sure you are right about that. What 
kind of debt are you talking about? Is it overnight debt or 1 
week debt or 1 month debt?
    Mr. Stupak. Well, as you formulate your answer, take the 
transcript and read it back and I think you will find your 
answer was no. So therefore,----
    Mr. Rubin. Well----
    Mr. Stupak. Well, just humor me and read it back before you 
answer my question if you are going to put it in writing, okay?
    Mr. Rubin. Mr. Stupak, even if you are right--and I think 
it is a much more complicated question than lends itself to a 
simple answer--it doesn't matter. Because if Citibank can get 
an advantage in borrowing, if there is a subsidy, then the 
question is, can Citibank transfer that subsidy any more 
readily to an op-sub than to an affiliate? And the answer to 
that is 100 percent no.
    Mr. Stupak. But they invest in their op-sub, right?
    Mr. Rubin. But they invest in the affiliate. What they do 
is, as you know, they move it up to the parent and then the 
parent takes that--if it is subsidized--subsidized capital and 
invests it in the affiliate. The same thing. Exact same thing.
    Mr. Stupak. All right. You mentioned that the foreign banks 
can engage in securities activities. Was Divo Securities an 
operating sub?
    Mr. Rubin. Was Daiwa securities? I actually don't know. You 
mean their operations here? They were subject to Fed 
supervision. I don't know whether it was a sub or not. Do you 
know? I don't know. We can get back to you.
    I don't think it would make any difference, really. I think 
that is irrelevant to this argument, but I don't know whether 
it was a subsidiary or some other form, I don't know. My guess 
is since that was a banking activity, my guess is it was not a 
subsidiary, but I don't know.
    Mr. Stupak. I don't know either. I thought I would ask.
    Chairman Greenspan stated in his testimony that Treasury 
had consistently opposed the operating subsidy in previous 
administrations. Why has this Treasury changed that prior 
policy.
    Mr. Rubin. Because what we did was to change the proposal. 
The op-sub that H.R. 10 contains is very substantially 
different than the proposal that the Treasury used to oppose.
    Mr. Stupak. Okay. You indicated that State banks are 
allowed to engage in a broad range of activities subject to 
their State charters and agreed to by the FDIC. How many States 
have allowed securities underwriting by State banks, and how 
many banks has the FDIC allowed to underwrite securities?
    Mr. Rubin. I do not know the answer to that. Do you?
    Mr. Carnell. Many States allow securities underwriting.
    Mr. Stupak. How many is many?
    Mr. Carnell. I don't know the number. We can get back to 
you for the record, but a substantial number of States allow 
underwriting in securities of State banks. The actual number of 
banks that have come to the FDIC over the 13 years in which the 
FDIC has allowed this is not large. It is a handful right now. 
There have been no problems at those banks, by the way.
    Mr. Oxley. The gentleman's time has expired.
    The gentleman from Illinois, Mr. Shimkus.
    Mr. Shimkus. Thank you, Mr. Chairman.
    It is good to have you, Mr. Secretary. I have great respect 
for your knowledge and experience, along with the Fed Chairman. 
So if we have two credible proponents of two opposing views on 
financial modernization, other factors may--you know, the 
public may be addressing other concerns.
    So let me ask a question that hasn't been asked yet, and I 
don't mean it to be disparaging of the administration, but if 
the public wants to ensure that our financial institutions are 
devoid of political influence regardless of who is in power in 
the executive branch, why would they, the public as a whole, 
safety and soundness, why would they side with your position 
versus the Fed Chairman's?
    Mr. Rubin. I think that is a good question. What the public 
does when they elect an administration is they basically give 
to that administration the responsibility and the 
accountability, for that matter, for economic policy; and 
economic policy very much includes banking policy.
    I think the critical distinction--and I think you are 
getting to a good point, Mr. Shimkus--the critical distinction, 
it seems to me, is between economic policy, banking policy--
where the Secretary is and, I think, should be deeply 
involved--and regulatory matters where it seems to me the 
Secretary should not be involved. And it is a violation of 
Federal law for the Secretary to be involved in case-specific 
regulatory matters. And by that I presume----
    Mr. Shimkus. I thought you were going to give me something 
else.
    Mr. Rubin. I don't know this, but I presume that it was 
made a violation of law precisely to protect the public against 
the concerns that you just mentioned.
    Mr. Shimkus. During my short time as a member of the 
subcommittee, the big battles between the bank holding company 
and the operating sub, that is how I like to--my terminology 
that I am comfortable with saying--under the operating sub 
which you support, the FDIC insurance--you are saying that 
there will be firewalls so that the FDIC insurance will not be 
at risk based upon the activities of the other elements in the 
operating sub, the insurance or the securities instances. But 
can you put a price on the full faith and credit of the Federal 
Government? You can't quantify that financially.
    Mr. Rubin. Well, what I am saying, Mr. Shimkus, and what 
the Chairman of the FDIC is saying, is that the taxpayers' 
funds are better protected by having the nonbank financial 
activities in the subsidiary than in the affiliate. The problem 
for the taxpayers--the FDIC, as you say--lies if the bank gets 
in trouble. And if the bank gets in trouble, the FDIC can 
liquidate the subsidiary and take the proceeds and use them to 
deal with the problems of the bank. If the activities are in 
the affiliate, then the FDIC cannot automatically reach those 
assets--in fact they can't--and liquidate them.
    Mr. Shimkus. But many of us are saying there is more risk 
taking the other view. If in essence the FDIC is--which you 
can't quantify the benefits to the operating sub of the other 
elements in the insurance and also----
    Mr. Rubin. No, but there is no way that the problems in the 
op-sub--I see your point--can adversely affect the bank, 
because as you know, under American corporate law----
    Mr. Shimkus. I am not a lawyer, so I don't know.
    Mr. Rubin. The parent is not responsible for the 
liabilities of the subsidiary, so the problems of the sub won't 
affect the bank. But conversely, if the bank gets in trouble, 
then the FDIC can reach the subsidiary. This is the reason that 
the current FDIC Chairman and four predecessors--three 
Republicans and two Democrats--have said they prefer for safety 
and soundness purposes the op-sub. They are actually looking at 
exactly what you are looking at, safety and soundness, and they 
are saying the op-sub is preferable for precisely these 
reasons.
    Mr. Shimkus. That is all I have, Mr. Chairman. Thank you.
    Thank you, Mr. Secretary.
    Mr. Oxley. The Chair now recognizes the gentleman from 
Massachusetts, Mr. Markey.
    Mr. Markey. Thank you, Mr. Chairman, very much. Welcome, 
Mr. Secretary.
    The subject I want to address if I could is the issue of 
privacy. I believe that every American has a right to knowledge 
that information is being gathered about them, notice that the 
information is going to be reused for purposes other than that 
which they had originally intended, and the legal right to say 
no with penalties against any entity which reuses that 
information: financial services, health care, any information 
technology. Fundamental right.
    Do you believe that a person's privacy is a property right? 
Does someone have the right to their own person, their own 
information, their own history? Is that a property right?
    Mr. Rubin. Could I give a two-part answer, Mr. Markey? When 
you stated the general principle, I was thinking to myself, I 
agree with you. When you stated it as a property right--I 
certainly agree with the general principle. You know, a 
property right is a very specific legal term with a lot of 
ramifications--and I would have to think about that. But I 
certainly agree with the principle.
    Mr. Markey. We spend a lot of time in Congress trying to 
give individuals rights to physical property.
    Mr. Rubin. I am not disagreeing with you. It is just 
something I need to think about. It is an interesting way to 
put it. It would not have occurred to me to think about it 
quite that way.
    Mr. Markey. In the bill H.R. 10, as it emerged from the 
Banking Committee, the financial privacy language covers only 
banks and thrifts, but not broker dealers, not investment 
companies, not investment advisors or insurance companies. None 
of them are covered in the H.R. 10 privacy language.
    Do you think all of those institutions should be covered by 
any privacy language which we pass, or should it only be the 
banks and thrifts?
    Mr. Rubin. Well, as you know, Mr. Markey, the President 
announced yesterday an initiative to try to substantially 
improve privacy, and I think that if you have--and I hope this 
is responsive to your question--that if you have a number of 
these different activities in the same institution, then the 
sharing of that information amongst the--I think this actually 
is responsive--amongst the components of that conglomerate, if 
you will--or for that matter the selling of the information--is 
something that the individuals should receive notice of and 
then should have the opportunity to prevent.
    Mr. Markey. Across all of the institutions?
    Mr. Rubin. Yes, I think that is right.
    Mr. Markey. Okay, good. Linda is nodding yes.
    Mr. Rubin. Well, Linda may agree. But I think she is right 
in this instance, which is not always the case.
    Mr. Markey. The issue is--in my experience it has been that 
is that Linda is always right.
    So here is the issue. The broker, having access to checks, 
would know that your daughter was being treated with Ritalin 
for ADD, that your wife was being treated for breast cancer--
the banker, the mortgage banker--that your wife had breast 
cancer, so he wouldn't have any other way of knowing, except 
for these--for access to your checks.
    The insurance agent in the same firm would know of the 
stress of your daughter and the stress of your wife, and that 
your mother is on Depends, and you have her at home. So he 
would know the extra stress that you were under that otherwise 
he wouldn't have any access to because he has your checks. So 
at the end of the day, shouldn't you have a right to say no?
    Mr. Rubin. The answer to that question is yes, in my 
judgment.
    Mr. Markey. That is great.
    Mr. Rubin. By the way, I think that was really the core of 
the President's announcement yesterday.
    Mr. Markey. I know that, and I am just trying to get it 
out.
    Mr. Rubin. So Linda agrees with the President as well.
    Mr. Markey. I have been looking to Linda for 20 years.
    Now, the legislation that passed the Banking Committee also 
limited this small segment of the financial services universe 
of banks and thrifts to merely requiring that a banker tell the 
customer what the institution's privacy policy is with respect 
to disclosure to other third parties, other than agents of the 
depository institution.
    The amendment that I will make in the committee is to make 
sure it is not just other depository institutions, but to every 
other affiliate of that institution that has that 
responsibility, and the administration agrees with that 
position.
    Mr. Rubin. I think that sounds right, yes.
    Mr. Ganske. Would the gentleman yield?
    Mr. Markey. I will be glad to yield.
    Mr. Ganske. And with the chairman's discretion, would--I 
ask unanimous consent for 1 additional minute.
    Mr. Oxley. One additional minute.
    Mr. Ganske. I am sympathetic to the gentleman's concern 
about privacy, both in financial services and in health care, 
but the privacy issue is a very, very difficult one that 
relates to Internet, to all sorts of complicated issues. I 
would sort of liken trying to solve this, that problem with the 
financial services, to the gentleman putting a basketball in 
each hand and trying to make both shots at the same time, or 
having two baseballs pitched at you and trying to hit both of 
them at the same time out of the park.
    I pledge to work with the gentleman on these issues. I am 
concerned about trying to marry a very complicated issue to an 
already very complicated issue, and I don't know if the 
gentleman has a response to that.
    Mr. Oxley. The gentleman's time has expired.
    Mr. Markey. I ask the chairman for 1 additional minute.
    Mr. Oxley. One additional minute. Briefly, please.
    Mr. Markey. We have two phenomena here. We have this rapid 
technological revolution which is affecting every industry. It 
forces convergence in the financial industry, yes, but it also 
makes it possible for these data miners to use this electronic 
capacity to be able to glean information about each of us.
    So there is a Dickensian quality to it. It is the best of 
wires and the worst of wires simultaneously. It makes it 
possible to create all of this wonderful progress in financial 
services being put in one place, but it also makes it possible 
for unscrupulous individuals to monitor our private secrets of 
our lives.
    So for a woman who, in order to get an insurance policy, 
has to go in to get a medical exam and there is knowledge here 
that she has breast cancer, it is a very sensitive subject----
    Mr. Oxley. The gentleman's time has expired once again.
    Mr. Markey. If I may, just 30 seconds, with your 
indulgence, I don't think that that person should have waived 
her rights to have that information now transferred over to her 
broker dealer, over to her mortgage banker. It should not be 
affecting every other part of her life without her permission. 
Otherwise I think, whether it be ADD or it be breast cancer or 
it be any other issue, we will put a chilling effect upon 
people trying to gain access to the medical services which they 
need, for fear that it will be spread all over time because one 
institution in town is now able to spread it. And that is why I 
think it has to be merged into one ball and I would like to 
work with the gentleman.
    Mr. Oxley. I would remind the members, this is a hearing 
and not a markup. There will be plenty of time for give and 
take, and I am sure the Secretary would appreciate getting back 
to the issue at hand. I would also say, knowing my friend from 
Massachusetts, the chances of him with two basketballs scoring 
is far higher than passing either one of those basketballs.
    I recognize the gentleman from New York.
    Mr. Fossella. Thank you, Mr. Chairman.
    I stepped out for a few minutes but, Mr. Secretary, I am 
just curious. At the end of the day, you raised some red flags 
in what may happen on this bill. Is there anything that you can 
see where you would urge the President to veto this 
legislation, given some of the amendments that are under 
consideration?
    Mr. Rubin. Any situation in which I would urge it to be 
vetoed? He has issued a veto letter, as you know. The letter 
focused on CRA, and as he said yesterday again in his 
statement, it is imperative that the CRA remain relevant in the 
world that is now developing. The veto letter included the 
failure of the Senate banking bill to provide choice between an 
op-sub and an affiliate, and it involved consumer issues. And 
then he is concerned about banking and commerce issues.
    Mr. Fossella. And that is going to be the party line from 
here on in; is that it?
    Mr. Rubin. Excuse me?
    Mr. Fossella. That is the party line from here on out?
    Mr. Rubin. It is not a party line. That is a veto letter 
that came from the President himself, it was not senior 
advisors, and it reflected the deeply held policy views of the 
President and the administration.
    Mr. Fossella. Thank you very much.
    Mr. Rubin. Okay.
    Mr. Oxley. Does the gentleman yield back?
    Mr. Fossella. I yield back.
    Mr. Oxley. The Chair now recognizes the gentlewoman from 
Colorado.
    Ms. DeGette. Thank you, Mr. Chairman.
    Mr. Oxley. If the gentlewoman would just suspend. The Chair 
would announce there is a 15-minute vote on the floor and then 
a 5-minute vote. We would love to be able to get through the 
panel and get the Secretary on his way if that is at all 
possible, so let's give that a shot.
    The gentlewoman from Colorado.
    Ms. DeGette. I won't have any basketball discussions, Mr. 
Chairman.
    Just very briefly, Mr. Secretary, to take a sort of a 
different angle at this, in your prepared testimony you say 
that you continue to believe that any financial modernization 
bill must have adequate protections for consumers, and you 
point out that you are hoping that this committee will add 
additional protections over the bill that came out of the 
Banking Committee.
    Are you talking specifically there about the Federal Home 
Loan Bank system, and the other issue on affiliations between 
commercial firms and savings associations, or are there 
additional consumer protections you would like to see?
    Mr. Rubin. I was referring there primarily to try to work 
with the SEC in order to better enable them to perform their 
functional regulation. The SEC has concerns and I think they 
are well taken.
    Ms. DeGette. I do too.
    Mr. Rubin. As you know, this bill was designed to eliminate 
the exemption from the SEC of these various securities 
activities conducted in banks. At the same time, then, there 
are all sorts of exceptions to the exemptions, and they could 
be read so broadly as to establish the exemption. That is the 
concern that the SEC has. We share that concern, and what we 
would like to do, if there is a way that it can practically be 
done, is to work with the SEC on these issues. That was my 
primary reference.
    Ms. DeGette. Do you think there is a way that it can 
practically be done?
    Mr. Rubin. I don't fully know the answer to that. We have 
worked with the SEC extensively, we would like to continue to 
work with them, but these are very complicated issues. All I 
can tell you is that we very strongly share their concerns and 
we would like to be constructive in resolving them if there are 
ways to do that.
    Ms. DeGette. You have had ongoing discussions, I guess, and 
you haven't been able to come up with any ideas so far?
    Mr. Rubin. Well, we certainly have had ongoing discussions, 
and I think it would probably be fair to say that there were a 
lot of ideas, and the question is, will any of them work and be 
practical and legislatable and so forth.
    Ms. DeGette. Mr. Chairman, in the interest of getting in 
the other questions, I yield back.
    Mr. Oxley. The gentleman from Wisconsin is next, Mr. 
Barrett.
    Mr. Barrett. I appreciate your comments and the comments 
the administration has made with regard to CRA. My question 
regards central city. I represent a district with a large 
central city, and I am grasping to see in either approach what 
is here to benefit the central city and what is going to 
improve investments in our central cities. Can you make the 
case as to why your approach is better than Mr. Greenspan's 
approach?
    Mr. Rubin. Well, as you know, because we have discussed 
these issues before, I also care deeply about what is happening 
in inner cities and I think that what is happening there is 
going to greatly affect what is happening in the rest of our 
country. I don't know that the op-sub affiliate debate 
particularly affects what happens in the inner cities, although 
I must say, having said that, to the extent that there are 
minority, small minority-owned banks--actually, I hadn't 
thought about it until this moment--but to the extent there are 
small, minority-owned banks that want to get into these new 
financial activities in some measure--and it seems to me it 
might well be advisable to do that in some measure and then 
affiliate with other larger institutions and so forth--what 
they should be allowed to do as long as there is no reason not 
to allow them, and I believe there is zero reason not to allow 
them, is to find the form of organization that is most 
efficient for them. And I suspect that for small banks of the 
kind I have just described, the op-sub probably would be a less 
expensive way of structuring themselves to engage in these 
activities.
    Mr. Barrett. Which approach would have more CRA 
penetration?
    Mr. Rubin. If there is a difference, then it seems to me 
that it may be--I mean, we are totally committed to CRA, as you 
know, but if there is a difference, it may be that by virtue of 
the fact that the sub is an asset of the bank and preserves 
these assets within the bank as opposed to putting them in the 
affiliate, that that might be beneficial or advantageous with 
respect to CRA.
    Mr. Barrett. Okay. Thank you.
    Mr. Oxley. The gentleman's time has expired.
    The gentleman from Illinois, Mr. Rush.
    Mr. Rush. Thank you, Mr. Chairman.
    Secretary Rubin, in the interests of time--well, first of 
all, Mr. Chairman, I do have a number of questions, but I ask 
for unanimous consent to ask that you----
    Mr. Oxley. That has already been provided for, yes.
    Mr. Rush. All right. Secretary Rubin, H.R. 10, as reported 
out of the Banking Committee, carves out and essentially 
protects title insurance from competition under the act. Will 
you discuss the resulting benefits or detriments of such a 
carve-out?
    Mr. Rubin. Let me ask Mr. Carnell to do that, if I may, Mr. 
Rush.
    Mr. Carnell. We think, Mr. Rush, that more competition is 
desirable here, and that singling out this or another line of 
financial services business for special protection from 
competition does not make sense. So we think these provisions 
are discriminatory, and that something that puts different 
providers on a real equal footing and lets them compete would 
be good for consumers.
    Mr. Rush. Thank you, Mr. Chairman. I yield back.
    Mr. Oxley. Thank you. The final questioner, the gentleman 
from New York, Mr. Engel.
    Mr. Engel. Thank you, Mr. Chairman.
    I too have a number of questions which I will submit in the 
interests of time.
    I just wanted to ask the Secretary, in his prepared 
testimony he mentioned the Federal Home Loan Bank system and 
his concerns with that. I am wondering if you could elaborate 
on them. Obviously, the Federal Home Loan Bank system has been 
effective in assisting Americans to obtain homeownership. I 
wonder if you could elaborate on your concerns. You mentioned 
particularly its arbitrage and short-term lending activities.
    Mr. Rubin. We are very much in favor of the Federal Home 
Loan Bank System serving its legislatively determined public 
purpose, which, as you say, is housing. And there are people 
who think it should be expanded to provide more resources to 
communities and community banking and various community 
purposes. That seems to us a sensible judgment for Congress to 
make.
    Our concern is the use of the FHLB's taxpayer subsidy for 
purposes other than those determined by Congress. Arbitrage 
activity is not a benefit to housing and it is not a benefit to 
communities, if that is a purpose Congress should determine. 
And neither is overnight lending. That was the point of my 
comment.
    Mr. Engel. I just want to say I agree with you, and I have 
some other questions which I will submit. Thank you very much.
    Mr. Oxley. The gentleman's time has expired.
    Mr. Secretary, we appreciate your willingness to be with us 
this morning and, as usual, your excellent testimony is 
appreciated and we thank you very much.
    With that, the subcommittee stands in recess until 1 p.m.
    [Brief recess.]
    Mr. Oxley. The subcommittee will reconvene, on time, and we 
welcome our third panel of today. If they will come forward. We 
are honored today to have two distinguished gentlemen. The 
first witness is Commissioner George Nichols, III, the chairman 
of the committee on financial services modernization with the 
National Association of Insurance Commissioners, and our old 
friend, the Honorable Arthur Levitt, chairman of the Securities 
and Exchange Commission.
    Gentleman, welcome to both of you. We appreciate your 
coming before the committee on this important issue. You have 
testified on this issue before this committee in the past. We 
hope fervently that this is the last time that we will ask you 
to participate on a hearing on financial services modernization 
and that you can join us at some future date for a bill signing 
and everything will be fine and we will get on with the rest of 
our lives.
    So with that, let us begin with Commissioner Nichols.

   STATEMENTS OF GEORGE NICHOLS, III, CHAIRMAN, COMMITTEE ON 
   FINANCIAL SERVICES MODERNIZATION, NATIONAL ASSOCIATION OF 
  INSURANCE COMMISSIONERS; AND HON. ARTHUR LEVITT, CHAIRMAN, 
               SECURITIES AND EXCHANGE COMMISSION

    Mr. Nichols. Thank you, Mr. Chairman. My name is George 
Nichols, and I am the commissioner of insurance in the 
Commonwealth of Kentucky; and I serve as vice president of the 
National Association of Insurance Commissioners and chairman of 
the special committee on financial services. We are honored to 
be here today to talk about this important issue----
    Mr. Oxley. Excuse me. Is your mike on?
    Mr. Nichols. Hello? I thought it was.
    Mr. Oxley. No. It is that switch down at the bottom. If you 
could, just pull it a little bit closer. The acoustics are 
tough in this room.
    Mr. Nichols. My name is George Nichols. I am the 
Commissioner of Insurance in the Commonwealth of Kentucky. I am 
representing the National Association of Insurance 
Commissioners, which I serve as vice president and chairman of 
the special committee on financial modernization. We are 
honored to be here today.
    We want to talk about insurance consumers who are a huge 
factor in the H.R. 10 equation. Their interests must not be 
sacrificed in the name of financial modernization services. 
Insurance is a unique product which is purchased to protect 
people during times of their lives when they are most 
vulnerable.
    Figures compiled by our association show that families can 
spend easily upwards of $3,000 for auto, home, and life 
insurance. If you take into consideration health insurance and 
they buy it individually, that amount could double, including 
additional property that they own or additional cars. Seen 
regularly, those are the only protection for America's 
insurance consumers.
    Nationwide we employ some 10,000 people and spend $750 
million annually to be the watchful eyes and helpful hands of 
consumers regarding insurance problems. There is no Federal 
agency for regulating the business of insurance. If Congress 
prevents the States from supervising insurance adequately, this 
vital function will go undone.
    Furthermore, the cost of insurance of any regulatory 
failures of insurance companies would directly affect policy 
holders, claimants, State guarantee funds, and the taxpayers. 
As passed by the House Committee on Banking and Financial 
Services, H.R. 10 is basically hostile to consumers and the 
States. The bill needlessly sweeps away State consumer 
protection authority.
    H.R. 10's broad preemption of State insurance laws is 
clearly shown on a chart that we have prepared for each of the 
members. We have compiled it relating to the specific statutes 
for your given State. State regulators and the NAIC strongly 
oppose the Banking Committee version of H.R. 10.
    To correct these deficiencies, we are submitting specific 
amendments to the Commerce Committee that will preserve our 
central authority to the following areas: affiliations. The 
NAIC amendments preserve the power of State regulators to fully 
review proposed affiliations involving banks, just as we do 
with any other firm that would acquire an insurer. This is 
sensible since we are the only regulators who protect the 
rights of policyholders and claimants.
    Insurance business activities. The NAIC amendments make it 
clear that States can regulate all insurance functions of all 
business entities including banks. Our amendments cover 
important aspects of insurance operations that H.R. 10 fails to 
address such as reinsurance, investments, and claims handling.
    Nondiscrimination. The NAIC amendments make it clear that 
State laws cannot overtly discriminate against banks or 
indirectly be used to prevent them from engaging in business 
activities provided for under H.R. 10.
    Equal standing in the court. The NAIC amendments give State 
regulators equal standing in the court with the Federal 
regulators for all disputes arising over matters relating to 
H.R. 10.
    The NAIC amendments make minimum changes to the existing 
language and structure of the bill. Adopting them will not 
interfere at all with the bill's financial modernization goals. 
The NAIC is also proposing new amendments to H.R. 10 that will 
give us extra tools to quickly achieve the uniformity and 
efficiency of State insurance regulation and supervision.
    Our amendments would use Federal law to help State 
insurance departments to accomplish the following goals: (1) 
establish a streamlined and uniform process for licensing 
nonresident agents; (2) remove State barriers to nonresident 
licensing, including countersignature requirements; (3) 
establish a streamlined and uniform process for licensing of 
insurance companies; and, (4) grant legal protection to city 
and NAIC and State regulators to information sharing data base 
activities and enforcement matters involving Interstate 
Commerce.
    Mr. Chairman, H.R. 10 is now at a crossroads. Congress must 
make a clear choice to protect insurance consumers. If Congress 
adopts the NAIC's consumer protection amendments, the bill can 
proceed with the confidence that policyholders and claimants 
will remain fairly protected by the States. If Congress fails 
to adopt these amendments, the critical interests of insurance 
consumers and State governments will be sacrificed.
    There is one last fact that Congress should consider. In 
1997, insurance products generated 4 million consumer inquiries 
and complaints. If Congress takes away our power to handle 
these complaints, who in the Federal Government will? State 
insurance regulators and the NAIC want to continue keeping 
misguided fraudulent insurance providers from damaging 
consumers, banks, and insurance companies. We ask that Congress 
come in and help us protect consumers by fixing H.R. 10 in 
order to preserve the authority of States they need to get the 
job done.
    That concludes my prepared remarks, Mr. Chairman. I would 
also like to offer a few personal thoughts in the importance of 
the H.R. 10 debate in view of the tragic storm and losses to 
the people in Oklahoma and Kansas.
    We recognize the devastation that has affected those two 
States. Right now those two States both have strong advocates 
in their commissioners of insurance. Both States are setting up 
satellite offices in the locations of the devastation to make 
sure that insurance companies are doing the jobs that they need 
to do, to coordinate the response, to make sure that claims are 
handled in a proper manner, and that they can move as quickly 
as possible to try to help the people in those two areas move 
toward back being whole again.
    We are asking this committee to work with us to assure that 
we do not lose the authority that we have to be the advocate on 
behalf of consumers with this financial service.
    Thank you very much, sir.
    Mr. Oxley. Thank you, Mr. Nichols.
    [The prepared statement of George Nichols III follows:]
   Prepared Statement of Commissioner George Nichols III, Chairman, 
Committee on Financial Services Modernization, National Association of 
                        Insurance Commissioners
Introduction
    My name is George Nichols, and I serve as Commissioner of Insurance 
in Kentucky. I also serve as Vice President of the National Association 
of Insurance Commissioners (NAIC) and Chairman of the NAIC's Special 
Committee on Financial Services Modernization. The NAIC established 
this Special Committee in 1996 to assist State insurance regulators as 
they continue to meet the demands of the Nation's rapidly evolving 
market for financial products.
    Today, I would like to make three points regarding HR 10 and 
financial services modernization.

 First, the interests of insurance consumers in the United 
        States must not be sacrificed in the name of modernizing 
        financial services.
 Second, State insurance regulators strongly oppose the version 
        of HR 10 passed by the House Committee on Banking and Financial 
        Services because the bill sweeps away State authority to 
        protect insurance consumers. We will use every means available 
        to alert the public, Congress, and State officials that HR 10 
        is currently anti-consumer and anti-State government.
 Third, the NAIC is providing the Committee on Commerce with 
        specific amendments that fix the serious regulatory 
        deficiencies in HR 10. The NAIC's amendments will also achieve 
        the goals of uniform licensing procedures for insurers and 
        agents, as well as national enforcement of State and Federal 
        laws that protect insurance consumers.
Insurance Consumers Are a Huge Factor in the HR 10 Equation
    HR 10 has been working its way through Congress with strong backing 
from important segments of the banking, insurance, and securities 
industries. The commercial firms pushing the bill argue that new 
Federal legislation is needed to enable them to develop and market 
better products, as well as to allow them to compete more fairly in a 
global economy. NAIC members also support modernizing financial laws. 
We recognize there are potential business benefits to consumers in our 
respective States.
    However, Congress must also consider the welfare of consumers from 
the standpoint of making sure that their insurance is safe and their 
claims are paid. To our knowledge, the millions of people who buy 
insurance for their homes, cars, health, and financial security are not 
even aware that Congress is considering HR 10. We do not believe the 
public will be complacent about HR 10's negative impact on insurance 
supervision when people learn that it prevents State regulators from 
monitoring insurer solvency and handling customer complaints.
    Paying for insurance products is one of the largest consumer 
expenditures of any kind for most Americans. Figures compiled by the 
NAIC show that an average family can easily spend a combined total of 
$3,000 each year for auto, home, life, and health insurance coverage. 
This substantial expenditure is typically much higher for families with 
several members, more than one car, or additional property.
    Collectively, the insurance premiums paid by American consumers in 
1997 amounted to $116 billion for auto coverage, $29 billion for 
homeowners policies, $107 billion for life insurance, and $216 billion 
for health coverage. Almost half a trillion dollars goes toward buying 
annual personal insurance coverage, a unique product which is purchased 
to protect people during the times in their lives when they are most 
vulnerable.
    Consumers clearly have an enormous financial and emotional stake in 
assuring that the promises made by insurance providers are kept.
State Regulators Are the Only Protection for Insurance Consumers
    As regulators of insurance, State governments are responsible for 
making sure the expectations of American consumers are met regarding 
financial safety and fair treatment by insurance providers. State 
insurance commissioners are the public officials who are appointed or 
elected to perform this consumer protection function. Nationwide, we 
employ 10,000 regulatory personnel and spend $750 million annually to 
be the watchful eyes and helping hands on consumer insurance problems.
    Here are three key factors to keep in mind when considering HR 10 
or other Federal legislation affecting State insurance authority--
1. There is no Federal agency for regulating the business of insurance. 
        If the Federal government prevents the States from supervising 
        insurance adequately, this vital consumer protection function 
        won't get done at all.
2. Individual States and their citizens bear the costs associated with 
        regulating insurance providers, including the costs of any 
        insolvencies that occur. State governments thus have a powerful 
        incentive to do the job well, and the record shows they have 
        done so.
3. Overly broad language and imprecise drafting in Federal laws can 
        easily undermine essential State consumer protection laws which 
        apply to ALL insurance providers. The resulting costs to State 
        governments, taxpayers, policyholders, and claimants can be 
        enormous.
    Some people have framed the debate over financial modernization as 
a conflict between Federal and State regulation, or between the banking 
and insurance regulatory systems. The real issue, however, is whether 
insurance-related activities of financial services companies will be 
regulated at all if Federal law prevents the States from doing the job.
    The Federal Reserve Board, the Office of the Comptroller of the 
Currency (OCC), and the Office of Thrift Supervision (OTS) have each 
said they do not intend to regulate insurance. If State governments are 
prevented from doing it, who will?
HR 10 Prevents State Insurance Regulators from Protecting Consumers
    NAIC pointed out the following serious flaws in HR 10 during NAIC 
President and Connecticut Insurance Commissioner George Reider's 
testimony before the House Banking and Financial Services Committee on 
February 11, 1999.
 HR 10 flatly prohibits States from regulating the insurance 
        activities of banks, except for certain sales practices. There 
        is no justification for giving banks an exemption from proper 
        regulations that apply to other insurance providers.
 HR 10 prohibits States from doing anything that might 
        ``prevent or restrict'' banks from affiliating with traditional 
        insurers or engaging in insurance activities other than sales. 
        This exceedingly broad standard undercuts ALL State supervisory 
        authority because every regulation restricts business activity 
        to some degree. HR 10's total preemption of State consumer 
        protection powers goes far beyond current law, and casts a 
        dangerous cloud over the legitimacy of State authority in 
        countless situations having nothing to do with easing financial 
        integration for commercial interests. It could also throw into 
        question the regulatory cooperation between State insurance 
        regulators and Federal banking agencies being achieved under 
        current law.
 HR 10 uses an ``adverse impact'' test to determine if State 
        laws or regulations are preempted because they discriminate 
        against banks. This unrealistic standard fails to recognize 
        that banks are government-insured institutions which are 
        fundamentally different from other insurance providers. Sound 
        laws and regulations that are neutral on their face and neutral 
        in their intent would still be subject to preemption under such 
        a standard.
 HR 10 does not guarantee that State regulators will always 
        have equal standing in Federal court for disputes which may 
        arise with Federal regulators.
    Frankly, we are quite disappointed and concerned that the House 
Banking and Financial Services Committee chose not to fix these and 
other problems pointed out by NAIC. We were told that all parties 
affected by HR 10 will suffer a certain amount of pain, but nobody has 
informed insurance consumers that they are among the groups who will 
suffer when State laws and regulations are preempted.
Real Examples of HR 10's Harmful Impact
1. Connecticut was involved last year in the regulatory approval 
        process for the merger between Travelers Insurance and 
        Citibank. Operating under State law, Commissioner Reider and 
        his staff reviewed the proposed business plan and a complete 
        filing of corporate financial and operating data before making 
        a final decision that the merger should be approved. He met his 
        responsibility to fully review the merger on behalf of the 
        public, and the matter was handled expeditiously with no 
        complaints from the companies making the application. Under HR 
        10, however, he would automatically be prevented from 
        conducting a proper regulatory review of such a large and 
        influential merger affecting insurance consumers in his State.
2. After extensive input from citizen groups, the State insurance 
        department, and Blue Cross/Blue Shield managers, North 
        Carolina's legislature decided that the $2 billion value of the 
        Blue Cross/Blue Shield plan should be put into a trust for the 
        benefit of the public if it is ever sold to private interests. 
        If a bank or bank-affiliated insurer were involved in such a 
        sale, this State law--passed to address local concerns having 
        nothing to do with Federal banking laws--would be preempted 
        because HR 10 dictates that no State law may prevent or 
        restrict a bank from affiliating with an insurer.
3. Pennsylvania enacted a law in 1996 to correct widespread sales and 
        solicitation abuses found during the State's regulatory 
        examinations of companies marketing life insurance products and 
        annuities. The law sets limitations and minimum standards for 
        illustrations used in marketing such products. It also 
        addresses unfair financial planning practices, and prohibits 
        unqualified agents from holding themselves out as financial 
        planners. Under HR 10, Pennsylvania stands to lose this 
        important tool with respect to the solicitation and sale of 
        life and annuity products by financial institutions, even 
        though the need for the law has been established by State 
        regulators.
4. On a broader level, the NAIC is preparing a specific home-state 
        chart for each Member of this Subcommittee showing more than 30 
        basic insurance laws that HR 10 is likely to preempt if it is 
        not amended. These charts identify State statutes covering such 
        critical areas as examinations, audits, reinsurance, 
        capitalization, valuation, investments, liquidations, guarantee 
        funds, agent licensing, and holding company supervision. NAIC 
        will deliver these graphic illustration charts to the 
        Subcommittee Members when completed.
Current Progress by State Regulators Depends Upon Maintaining Our 
        Authority
    HR 10 threatens the substantial progress now being made by State 
insurance regulators using our existing authority. While Congress and 
industry have been talking about modernizing financial services 
regulation, we have been developing and implementing real changes that 
promote uniformity and efficiency. The process is working because State 
insurance authority is well defined and accepted under the McCarran-
Ferguson Act.
    The NAIC is joining with Federal and State banking agencies to 
develop agreements for cooperating and exchanging information on 
regulatory matters. In addition, special training classes are being 
designed by NAIC to help Federal regulators perform their duties 
better. All-day meetings among top technical experts at the Federal 
Reserve Board, OTS, OCC, and State insurance departments are also 
occurring. Participants in these hands-on exchanges have all agreed 
that they are exactly what is needed to make functional regulation 
work.
    Under HR 10, the extent of State insurance authority will surely be 
questioned and tested, not only by banks and their affiliates, but also 
by traditional insurers that have been complying with present laws for 
many years. Federal and State regulators may start to question whether 
the cooperation arrangements we have made with them remain legal. It 
makes no sense for Congress to undermine State regulatory reforms being 
accomplished today under existing laws.
NAIC's Amendments Preserve Essential State Consumer Protection 
        Authority
    The version of HR 10 passed by the House Banking Committee is very 
harmful to insurance consumers. To correct its deficiencies, the NAIC 
is submitting specific amendments to the Commerce Committee that will 
make HR 10 palatable in the following essential areas--

 Affiliations--The NAIC amendments preserve the power of State 
        regulators to fully review proposed affiliations between banks 
        and insurers, just as we do with any other firm acquiring an 
        insurer. This is sensible, since we are the only regulators who 
        protect the rights of policyholders and claimants. It is also 
        fair, since State guarantee funds are required to pay for any 
        insolvencies which may result from bank-related affiliations.
 Insurance Sales and General Business Activities--The NAIC 
        amendments make it clear that States can regulate the insurance 
        functions of all business entities, including banks. Our 
        amendments cover all aspects of insurance operations, including 
        reinsurance, investments, claims handling, and managing general 
        agents.
 Non-Discrimination--The NAIC agrees that State laws and 
        regulations should not unfairly discriminate against banks on 
        insurance matters, but we also recognize it would be foolish to 
        ignore the fact that they are government-insured deposit 
        institutions which are fundamentally different from other 
        insurance providers. Our amendments make it clear that State 
        laws cannot overtly discriminate against banks or indirectly be 
        used to prevent them from engaging in businesses permitted by 
        HR 10.
 Equal Standing in Court--The NAIC amendments give State 
        regulators equal standing in court with Federal regulators for 
        all disputes arising over matters relating to HR 10. There is 
        no good reason to grant special deference to Federal regulators 
        simply because a matter occurred before September 1998.
    The NAIC's consumer protection amendments are Attachment I to this 
testimony. We carefully crafted the amendments to make minimal changes 
to the existing language and structure of HR 10. Adopting our 
amendments will not interfere at all with the financial modernization 
goals which the bill's sponsors hope to achieve.
NAIC's New Amendments Achieve Uniform Licensing and National 
        Enforcement
    The NAIC has clearly heard the demands in Congress and industry for 
more uniformity and efficiency in State insurance supervision. Since 
NAIC has promoted these same objectives for many years with incomplete 
success, we now believe it is appropriate to ask Congress for new 
amendments to HR 10 that will use Federal law to let State regulators 
get the job done. With these tools, we can overcome the obstacles that 
have hindered our progress.
    The primary benefit of adding these amendments to HR 10 is to 
achieve the goals of uniform regulatory procedures and national 
enforcement quickly by using the existing system of State regulation. 
The extra costs and delays of establishing a NARAB organization could 
thus be avoided, while also preserving the legal certainty of licensing 
and enforcement under State and Federal law.
    Banking and insurer groups advocating broad preemption of State law 
in HR 10 say that uniformity and efficiency are major reasons to 
justify such radical action. However, the NAIC's amendments will 
achieve the same goals without gutting basic State consumer protection 
powers.
    We propose that the Commerce Committee adopt specific amendments to 
direct and authorize State insurance departments and the NAIC to 
accomplish the following goals--

1. Establish a streamlined and uniform non-resident agent licensing 
        process.
2. Remove State law barriers to non-resident licensing, including 
        counter-signature requirements, by a certain date.
3. Establish a streamlined, uniform, and expedited process for 
        insurance company admissions.
4. Authorize the use of social security numbers for licensing purposes, 
        for the producer database, and for use by the Insurance 
        Regulatory Information Network (IRIN).
5. Grant exemptions from the Fair Credit Reporting Act for IRIN, the 
        NAIC, and State insurance departments regarding regulatory 
        licensing activities and related databases.
6. Provide State insurance regulators and NAIC with access to the 
        national criminal history database (NCIC) for regulatory 
        purposes and for checking criminal histories as required by the 
        Federal Insurance Fraud Prevention Act.
7. Grant Federal immunity from liability for NAIC and IRIN database 
        activities.
8. Protect the confidentiality of regulatory communications between 
        among NAIC, State regulators, and Federal agencies.
9. Facilitate the use of regulatory databases, including digital 
        signatures, acceptance of credit cards, and electronic funds 
        transfers.
10. Grant immunity for insurance companies that report agent 
        terminations for cause to State regulators.
    A brief description of these amendments is Attachment II to this 
testimony.
Conclusion--Congress Must Make a Choice to Protect Insurance Consumers
    HR 10 is now at a crossroads. If Congress adopts the NAIC's 
consumer protection and uniform licensing and enforcement amendments, 
the bill can proceed with confidence that insurance policyholders and 
claimants will remain fairly protected by the States. If Congress fails 
to adopt these amendments, the critical interests of insurance 
consumers and State governments will be sacrificed. There must be no 
misunderstanding about what is at stake, and no illusion by anyone that 
insurance consumers will somehow be protected if State regulators are 
removed from the process.
    There is one last fact that Congress should consider. In 1997, 
insurance products generated 3.2 million consumer inquiries and 392,000 
actual complaints made to State regulators. If Congress takes away our 
powers to handle these complaints, we will be forced to turn consumers 
away. Who in the Federal government will take care of them?
    State insurance regulators and the NAIC want to continue keeping 
unsound or rogue insurance operations from damaging consumers, banks, 
and insurance companies. Doing that job will also protect Federal and 
State governments from unnecessary financial exposures caused by weak 
and insolvent institutions. We ask the Commerce Committee to help us 
help consumers by fixing HR 10 in order to preserve the authority 
States need to get the job done.
                              Attachment I
             naic's consumer protection amendments to hr 10
1. Section 104. Operation of State Law.
(a) Affiliations.--
Starting on page 37, delete the entire subsection, and replace with the 
        following:
(1) In General.--Except as provided in paragraph (2), no State may, by 
        statute, regulation, order, interpretation, or other action, 
        prevent or restrict the affiliations authorized or permitted by 
        this Act and the amendments made by this Act.
(2) Insurance.--With respect to affiliations between insured depository 
        institutions, or any subsidiary or affiliate thereof, and 
        persons or entities engaged in the business of insurance, 
        paragraph (1) does not prohibit any State from collecting, 
        reviewing, and taking actions on applications required by the 
        State and other documents or reports the State deems necessary 
        concerning proposed acquisitions of control or the change or 
        continuation of control of any entity engaged in the business 
        of insurance and domiciled in that State, if the State actions 
        do not violate the nondiscrimination requirements of subsection 
        (c).
Analysis:
 This language enables the States to enforce their insurance 
        holding company acts, provided such acts do not discriminate 
        against banks. It is critical that the States retain this 
        authority because no one else will review these affiliations 
        for the purpose of protecting insurance consumers. Note that 
        the Federal Reserve retains the authority to review all bank 
        affiliations with bank holding companies.
 This language is substantially similar to the section 104 
        affiliations language in Senator Gramm's Financial Services 
        Modernization Act.
2. Section 104. Operation of State Law.
(b) Activities.--
In General.--
Delete the following phrase from subsection 104(b)(1), page 44, lines 
        12 and 13:
    ``as provided in paragraph (3) and except''.
On page 44, line 17, delete ``restrict'' and insert ``significantly 
        interfere with the ability of''.
At the end of subsection (b)(1), on page 44, line 22, insert the 
        following:
        ``where the State action discriminates against an insured 
        depository institution or wholesale financial institution based 
        on its status as an insured depository institution or wholesale 
        financial institution, any subsidiary or affiliate thereof, or 
        any person or entity based on its status of affiliation with an 
        insured depository institution, contrary to the 
        nondiscrimination requirements of subsection (c).''
(3) Insurance Activities Other than Sales.--
Delete subsection 104(b)(3) in its entirety, page 55, lines 3-22.
Analysis:
 These changes do not impact the Section 104(b)(2) Sales 
        language in any way.
 These changes are necessary to enable the States to regulate 
        the non-sales insurance activities of banks, bank affiliates 
        and bank subsidiaries, provided such State action does not 
        discriminate against banks. This change is necessary to 
        preserve State authority to regulate non-sales insurance 
        activities in which banks are currently engaged, such as 
        credit-related activities.
3. Section 104. Operation of State Law.
(b) Activities.--
(2) Insurance Sales.--
Delete subsection 104(b)(2)(C)(i) OCC Deference in its entirety, page 
        53, lines 20-25 and page 54, lines 1-3.
Renumber subparagraph (ii) on page 54, line 4, as subparagraph (i).
Renumber subparagraph (iii) on page 54, line 13, as subparagraph (ii).
Renumber subparagraph (iv) on page 54, line 21, as subparagraph (iii).
Analysis:
 This change is needed to ensure that equal deference is 
        accorded to State insurance regulators regarding the 
        interpretation of all State sales laws.
4. Section 104. Operation of State Law.
(c) Nondiscrimination.--
In subparagraph (c), on page 58, line 4, insert ``affiliations or'' 
        after ``insurance''.
In subparagraph (c)(1), on page 58, line 12, insert ``based on their 
        insured status'' after ``thereof''.
Delete subparagraph 104(c)(2), page 58, lines 17-25.
Renumber subparagraph (3) on page 59, line 1, as subparagraph (2).
Renumber subparagraph (4) on page 59, line 6, as subparagraph (3).
Analysis:
 The change to subparagraph (c) is necessary to clarify that 
        affiliations of insured depository institutions authorized 
        under the act are subject to the nondiscrimination requirements 
        of this subsection.
 The change to subparagraph (c)(1) is necessary to clarify that 
        laws that differentiate by their terms between insured 
        depository institutions and other entities are impermissible 
        only if the differentiation is based upon the insured status of 
        those institutions.
 Deletion of subparagraph (c)(2) is necessary to remove the 
        effects test, which would make it impossible to make or enforce 
        insurance laws and regulations. A law or regulation will always 
        impact entities differently for reasons that are wholly 
        unrelated to whether the entities in question are banks.
 These changes leave in the bill strong requirements ensuring 
        that States cannot discriminate against banks.
5. Section 104. Operation of State Law.
(d) Limitation.--
On page 59, line 13, insert ``(i)'' after the word ``affect'' and 
        before the word ``the''.
On page 59, line 19, insert the following at the end of the paragraph:
        ; and (ii) State laws, regulations, orders, interpretations, or 
        other actions of general applicability relating to the 
        governance of corporations, partnerships, limited liability 
        companies, or other business associations incorporated or 
        formed under the laws of that State or domiciled in that State, 
        or the applicability of the antitrust laws of any State or any 
        State law that is similar to the antitrust laws if such laws, 
        regulations, interpretations, orders, or other actions are not 
        inconsistent with the purposes of this Act to authorize or 
        permit certain affiliations and to remove barriers to such 
        affiliations.
Analysis:
 This language was originally in subparagraph (a). This change 
        is necessary so that this subparagraph, which preserves State 
        corporate laws of general applicability and State antitrust 
        laws, modifies both subsection (a) Affiliations and subsection 
        (b) Activities.
 The language has been changed slightly to conform to Senator 
        Gramm's Financial Services Modernization Act. By these changes, 
        the language of subsection (d) is made identical to Senator 
        Gramm's Financial Services Modernization Act.
6. Section 111.--Streamlining Financial Holding Company Supervision.
Page 76, line 11, delete ``in compliance with applicable'' and insert 
        ``subject to''.
Analysis:
 This technical change is needed to ensure that the States 
        retain authority to enforce their capital requirements. As the 
        provision is currently written, the Federal Reserve would be 
        able to step in as soon as a company falls out of compliance 
        with applicable capital requirements, but before the State has 
        had an opportunity to enforce its applicable laws and 
        regulations with respect to such capital requirements.
7. Section 124.--Functional Regulation.
Page 128, line 14, delete ``Agency''.Page 129, line 3, delete 
        ``Agency'' from the heading of subparagraph (b).
Page 129, lines 3-4, delete ``insurance agency or brokerage that is a 
        subsidiary of an insured depository institution'' and insert 
        ``insured depository institution subsidiary that is engaged in 
        insurance activities''.
Page 129, line 7, delete ``insurance agency or brokerage'' and insert 
        ``entity engaged in insurance activities''.
Analysis:
 These changes are necessary to ensure that all insurance 
        activities of bank operating subsidiaries are functionally 
        regulated.
 As the bill is currently written, this provision is limited to 
        insurance agency and brokerage activities. These changes are 
        necessary because HR 10 permits bank operating subsidiaries to 
        engage in credit-related activities as well as agent/broker 
        activities. Such activities should be functionally regulated.
 By this change, the provisions of HR 10 that apply to 
        insurance affiliates of bank holding companies (including, for 
        example, report, examination and capital requirements) also 
        apply to bank operating subsidiaries that are engaged in 
        insurance activities.
8. Section 303.--Functional Regulation of Insurance.
Page 332, line 11, delete ``sales''.
Analysis:
 This technical change is needed to ensure that the bill 
        clearly provides that all insurance activities are functionally 
        regulated by the States.
 This change makes this provision identical to the language in 
        the Bryan amendment to Senator Gramm's Financial Services 
        Modernization Act, which was adopted by the Senate Committee on 
        Banking, Housing, and Urban Affairs on March 4, 1999.
                             Attachment II
    hr 10--summary of naic's proposed amendments related to uniform 
                       licensing and enforcement
1) Establish a streamlined and uniform non-resident agent licensing 
        process.
    The objective of this amendment is a uniform non-resident agent 
licensing process, but not a single licensing decision. States would 
use a common form, which could be submitted electronically and 
distributed to those states where the applicant wants to be licensed. 
However, each state would retain the ability and discretion to decide 
whether to license or not license an agent, based upon uniform 
procedures. Uniform procedures would be developed by the states 
collectively through the NAIC. Standards would focus on consumer 
protection.
2) Remove state law barriers to non-resident licensing, including 
        counter-signature requirements, by a specific date.
    Federal preemption of counter signature laws has been in and out of 
the HR 10 discussions. Many states have repealed these laws over the 
last few years. Only 8 or 9 states still retain these requirements.
3) Establish a streamlined, uniform, and expedited process for 
        insurance company admissions.
    Similar to non-resident agent licensing, there would be a uniform 
process for insurance company admissions, but not a single licensing 
point. States would retain the ability and discretion to decide whether 
or not to admit a company, based upon uniform procedures. The states 
themselves would collectively establish uniform procedures through the 
NAIC. Applications could be submitted electronically to a single point 
for distribution to states where licensure is requested.
4) Authorize the use of social security numbers for licensing purposes, 
        for the producer data base, and for use by IRIN.
    The use of social security numbers (SSN's) is restricted under the 
Federal Privacy Act of 1974. Most states have found ways to supply 
social security numbers for the producer data base, but a few states 
still have significant problems. Use of SSN's is the minimum element 
needed for properly identifying agents. A specific clarification in 
federal law would resolve any problems relating to use of SSN's for 
insurance regulatory purposes.
5) Exemptions from the Fair Credit Reporting Act for IRIN, the NAIC, 
        and state insurance departments regarding regulatory licensing 
        activities and related databases.
    Recent amendments to the Fair Credit Act extended its provisions to 
databases not typically a part of the credit rating process. These 
amendments apply to databases used for both credit rating and 
employment purposes. Expansive interpretations by the Fair Trade 
Commission have extended the Act even to situations involving 
administrative licensing. The Act, if it were determined to apply to 
IRIN, would impose extensive notice and appeal requirements, just as if 
IRIN were a credit bureau. The solution to these problems is simple--
state insurance regulatory activities should be specifically exempted 
from the Act.
6) Nationwide access for insurance regulators to the national criminal 
        history database (NCIC) for regulatory purposes; and use of 
        IRIN/NAIC to access the database so that insurance companies 
        can obtain criminal histories in order to meet their 
        responsibilities under the Insurance Fraud Prevention Act.
    State licensing, fraud, and enforcement staff have long sought 
access to the criminal history databases maintained by the FBI (usually 
referred to as NCIC access). The Department of Justice supplies 
criminal history information to the American Bankers Association so 
banks can run checks on employees, and also supplies the information to 
the securities and commodities trading industries. However, the Justice 
Department has not been willing to extend such authority to state 
insurance regulators, despite years of discussions.
    Only a few states are currently able to access NCIC. In the 
remainder, enforcement personnel have no practical way to check the 
possible criminal background of an individual, even when they suspect a 
serious violation of law.
    Under the Federal Insurance Fraud Prevention Act (18 USC 1033), a 
person with a felony conviction involving dishonesty or breach of trust 
is barred from the business of insurance unless they have a specific 
exemption from a state insurance regulator. Insurance companies also 
have a duty not to employ convicted felons, but there is no reasonable 
means for them to check the criminal records of job applicants and 
employees.
    Statistics from the few states which are able to run criminal 
history checks show that between 10 and 15 percent of agent applicants 
conceal criminal convictions on their applications. Giving authority to 
the NAIC to obtain criminal records checks would provide a mechanism 
for regulators and insurance companies to comply with their legal 
obligations. The industry generally, as well as the IRIN Board, support 
this goal.
7) Immunity for IRIN/NAIC in database related activities.
    The major regulatory databases for insurance, including the 
financial solvency database, the disciplinary actions listings (RIRS), 
the Special Activities Database, and the Complaint Data System, are all 
maintained by the NAIC. Key licensing data is supplied by the states to 
the producer database, which is part of IRIN.
    Although NAIC and IRIN act on behalf of State governmental 
entities, they have no direct tort immunity from suit. This exposes 
IRIN and NAIC to potential legal actions. A number of states do grant 
immunity to the NAIC, but this does not cover all potential suits; a 
plaintiff could simply file in a different state. Federal immunity 
would help protect NAIC assets, and permit NAIC and IRIN funds to be 
spent for their intended purposes, not on lawsuits. Immunity would 
extend to the NAIC as an entity, as well as its members, officers, and 
employees.
8) Confidentiality protections for confidential regulatory 
        communications with Federal agencies.
    Federal law should clearly state that confidential information can 
be exchanged between state insurance regulators and Federal agencies. 
Such protections may also extend to communications with international 
regulators.
9) Measures to facilitate regulatory database uses, including digital 
        signature and acceptance of credit cards or other electronic 
        funds transfers.
    Implementation of efficient electronic processing faces many 
hurdles, including various state requirements on how payments can be 
made, and what form of signatures will be accepted. Many of these 
requirements are in state laws or regulations outside the control of 
the insurance departments.
    In some states, for example, no payments via credit cards can be 
made. Some require payment with each transaction, even if there are 
multiple transactions per day with one entity. Other states will bill 
periodically. Technology exists to use both electronic funds transfers 
and digital signatures, which would make many transactions more 
feasible and cost-effective.
10) Immunity for insurance companies that report agent terminations for 
        cause, to ensure that more complete data is reported.
    Insurers have long sought this immunity, and regulators support the 
idea because it means earlier identification of problem agents. 
Companies simply will not report terminations for cause without strong 
immunity, because an agent may sue them for defamation. There could be 
a process where agents reported by insurers are notified, so that they 
could contest a company's claim for database purposes.

                                             Consumer Complaints and Inquiries by State in the United States
--------------------------------------------------------------------------------------------------------------------------------------------------------
                                                               1994        1994       1995        1995       1996        1996       1997         1997
                           State                             Consumer    Consumer   Consumer    Consumer   Consumer    Consumer   Consumer     Consumer
                                                            Complaints  Inquiries  Complaints  Inquiries  Complaints  Inquiries  Complaints   Inquiries
--------------------------------------------------------------------------------------------------------------------------------------------------------
Alabama...................................................       2,129        569         542      1,522         328      3,804         193        2,784
Alaska....................................................         546         24         634          3         555      3,600         559          202
American Samoa............................................         N/A        N/A         N/A        N/A         N/A        N/A         N/A          N/A
Arizona...................................................       6,608     77,711       7,757     90,767       7,076     97,215       6,034      101,559
Arkansas..................................................       3,428     16,389       3,081     16,937       3,552     31,851       2,981       27,759
California................................................      43,672    623,181      34,480    574,435      30,716    550,394      28,269      453,764
Colorado..................................................       7,715        560       7,409        846       7,626     55,077       8,041       51,678
Connecticut...............................................       6,405     77,000       5,905     78,600       6,519     79,220      10,311       41,000
Delaware..................................................       7,490     10,158       6,326     10,398       6,798      8,925       6,985        9,260
Dist. of Columbia.........................................      22,650     10,216         837          0         908      1,300         856        1,769
Florida...................................................      41,505    482,273      42,480    475,731      45,255    398,777      42,340      318,620
Georgia...................................................      36,194    105,071      18,335     67,894      15,448     79,373      12,290       77,396
Guam......................................................          41        220          50        250         N/A        N/A         N/A          N/A
Hawaii....................................................       1,100     10,400       1,200     10,400       1,900     10,700       1,950       10,800
Idaho.....................................................       1,468     14,320       1,290     12,913       1,303     12,650       1,507       16,722
Illinois..................................................      12,597     70,000      11,587     70,000      13,081     70,000      14,081       70,000
Indiana...................................................       4,491     53,028       4,108     84,911       4,987     94,871       5,278      106,265
Iowa......................................................       2,999     23,342       2,812     23,378       2,569     23,608       2,525       22,171
Kansas....................................................       5,063      6,068       5,336      4,158       5,319      1,354       5,781        1,477
Kentucky..................................................       5,686        N/A       5,399        N/A       6,685        N/A       6,756          N/A
Louisiana.................................................       3,271      1,071       2,898      2,084       3,081      2,278       4,099        2,796
Maine.....................................................       1,673        N/A       1,639        N/A       1,483     11,460       1,333       14,553
Maryland..................................................      18,929        245      12,556        156      19,172        N/A      18,461        2,083
Massachusetts.............................................       4,491      1,388       3,806     67,512       3,686     77,429       3,375       63,784
Michigan..................................................       4,843        255       4,347      1,209       5,185      1,333       4,993        1,075
Minnesota.................................................       5,910     68,384       4,934     43,965       4,543     38,363       3,792       43,647
Mississippi...............................................       7,000     10,000       7,000     10,000       7,000     10,000       7,000       10,000
Missouri..................................................       5,003     58,738       4,556     57,748       4,623     70,591       4,735       78,102
Montana...................................................       1,521        741       1,527        801       1,574        818       1,927          968
Nebraska..................................................       3,293        N/A       3,136        N/A       2,823        N/A       2,733          N/A
Nevada....................................................       1,765     60,634       1,608     47,787       1,817     44,033       2,377       60,125
New Hampshire.............................................       1,208     12,583       1,186     16,075       1,833     20,529       1,418       19,597
New Jersey................................................      12,972      1,711      11,775      1,800      14,078      2,088      14,012        1,976
New Mexico................................................       1,700      2,150       1,470      2,500       1,603      7,830       1,700        8,000
New York..................................................      42,211    565,584      44,883    600,000      41,520    600,000      45,824      600,000
North Carolina............................................       9,669    113,339       8,400     98,419       9,468    112,948      10,100      132,286
North Dakota..............................................         667      9,969         643      9,485         701     11,691         795       13,476
Ohio......................................................       7,079        467       6,907        440       7,172        568       8,105          356
Oklahoma..................................................       5,806        N/A       5,874     55,105       6,371     61,051       6,236       59,667
Oregon....................................................       4,791     29,853       4,458     28,977       4,803     32,836       4,748       27,706
Pennsylvania..............................................      24,463     74,000      24,509    260,000      22,048    275,491      21,305      178,695
Puerto Rico...............................................         717        N/A         N/A        N/A         N/A        N/A         N/A          N/A
Rhode Island..............................................         959        N/A         939        N/A         794        N/A         806          N/A
South Carolina............................................       3,312     58,540       3,002     47,445       3,943     47,258       4,093       51,560
South Dakota..............................................       1,275      2,631       1,218      2,327       1,429      2,740       1,438        4,707
Tennessee.................................................       3,382        141       3,063     25,612       4,020     29,624       4,013       33,077
Texas.....................................................      26,846    290,804      18,125    300,092      17,625    298,754      24,958      348,709
U.S. Virgin Islands.......................................          58         22         300        425         425        615         N/A          N/A
Utah......................................................         930     30,439         853     29,995         952     33,283       1,056       36,267
Vermont...................................................         893        360         854        281         900        300         840        1,652
Virginia..................................................       8,460        N/A       8,260        N/A       8,350        N/A       8,227          N/A
Washington................................................       7,334     97,052       6,826    123,000       8,620    124,545       7,923      114,299
West Virginia.............................................       2,338     47,781       2,651     41,283       3,135     51,128       2,695       44,106
Wisconsin.................................................       9,188     56,144       8,381     45,000       9,135     44,046       9,169       44,528
Wyoming...................................................         823        N/A         613      5,200         475      5,276         524        3,456
  Totals..................................................     446,567  3,175,556     372,765  3,447,866     385,012  3,541,625     391,547    3,314,479
    Total Complaints 1994-1997...................................................  ..........  .........  ..........  .........  ..........    1,595,891
    Total Inquiries 1994-1997....................................................  ..........  .........  ..........  .........  ..........   13,479,526
--------------------------------------------------------------------------------------------------------------------------------------------------------


    Mr. Oxley. We now turn to our distinguished Chairman of the 
Securities and Exchange Commission, Arthur Levitt. Welcome.

                STATEMENT OF HON. ARTHUR LEVITT

    Mr. Levitt. Chairman Oxley, Congressman Towns, members of 
the subcommittee, I appreciate the opportunity to testify today 
regarding H.R. 10. Let me begin, Mr. Chairman, by saying that I 
look forward to continuing to work closely with you and the 
rest of the subcommittee to ensure that any financial 
modernization bill is in the best interests of the Nation's 
investors and protects the integrity of our dynamic securities 
markets.
    The Commission has long supported the goal of modernizing 
the laws that govern our financial services industry. For this 
reason, the SEC worked closely during the last Congress with 
the committee to help craft legislation that would modernize 
the legal structure for financial services, while at the same 
time preserving principles that are fundamental to oversight--
effective oversight--of U.S. securities markets.
    After very difficult and trying negotiations, and 
compromise on all sides, the Commission was able to lend some 
support to the version of H.R. 10 that was passed by the full 
House in May 1998. Although the House-passed version was not 
perfect from our perspective, it did appear to recognize the 
fundamental importance of investor protection as banks and 
securities firms move toward greater closer affiliations.
    However, subsequent negotiations substantially diluted the 
securities provisions contained within H.R. 10 and eroded the 
basic principles that the Commission believes are absolutely 
critical to maintaining securities markets that are strong, 
vibrant, and healthy. Accordingly, the Commission strongly 
opposes the version of H.R. 10 that is now before you. I would 
note for the record that we similarly oppose Senate Bill 900 
which is currently being considered.
    H.R. 10 as it stands now simply contains too many 
loopholes. While everyone is talking about preserving so-called 
functional regulation, functional regulation is made a mockery 
of by this proposal. Too many products are exempted from 
securities regulation. The scope of these loopholes, which are 
ambiguously drafted, creates even greater problems and 
uncertainties in the future.
    For example, under H.R. 10, two investors, one in a bank 
and one in a brokerage firm, could buy the exact same security 
but receive two very different levels of protection. The bank 
investor would not be protected by the SEC's failure to 
supervise doctrine, securities licensing procedures; securities 
arbitration remedies; and, perhaps most importantly, the 
Commission's extremely effective enforcement program. The 
brokerage industry would. The brokerage investor would.
    The bank investor might or might not be able to make claims 
against the bank for unsuitable investments. The brokerage 
investor would. The bank investor would probably not even know 
this state of affairs existed. At best, this is inconsistent. 
At worse, and I think a lot more likely, this is down right 
dangerous.
    By repealing Glass-Steagell, while largely maintaining the 
bank's exemptions from Federal securities laws, H.R. 10 would 
expand the flawed system of bifurcated regulation that 
currently exists. The bank exemptions were in part premised on 
the very existence of the safeguards that Glass-Steagell had 
erected between commercial and investment banking. We should 
not contemplate removing that separation of activity without 
also removing outdated exceptions.
    I have believed for a long, long time that if banks were to 
gain full access to the securities industry, they must also be 
prepared to assume the great responsibilities that come with 
that privilege. Working within a regulatory framework 
painstakingly developed over 65 years, the securities industry 
and the SEC have instilled nothing less than a culture, a 
culture that places the interests of investors above all 
others.
    Banking regulation is not and cannot be a substitute for 
sound securities regulation. I don't have to tell you that our 
markets continue to be the envy of the world. We have moved 
from a Nation of savers to a Nation of investors. American 
families today put more of their savings in mutual funds than 
in insured bank accounts.
    It is crucial to ensure that we have a framework that 
maintains the strength, discipline, and vitality of our 
securities markets. That framework must allow the Commission, 
as the Nation's primary securities regulator, to continue to 
fulfill its mission to protect investors and to safeguard our 
market's integrity.
    The purpose of my testimony is not really to comment on 
each and every one of the provisions of H.R. 10. I probably 
couldn't do that if I wanted to. Our written testimony contains 
much greater detail regarding those parts of the bill that the 
Commission finds most troublesome. However, overall, the 
Commission has come to the conclusion that H.R. 10 runs the 
risk of dramatically undermining investor protection as well as 
the integrity of our capital markets.
    I believe that America's investors deserve a single high 
standard of protection. The current version of H.R. 10, 
however, simply fails to meet that critical standard. In 
addition, I share the financial services industry's call for a 
need to rationalize a system that tends to favor banking 
entities over brokerages. Again, I believe this bill fails to 
meet that basic threshold of fairness.
    There are more investors in our markets today than ever 
before. Every day they choose from an increasingly wider array 
of both products and providers, but they should not have to 
give up basic safeguards in the process.
    I urge the subcommittee to work toward a regulatory 
framework that really fits today's marketplace without 
compromising our Nation's historic commitment to protecting 
investors and preserving market integrity. The Commission would 
look forward to working closely with the Commerce Committee to 
help craft legislation that would bring about these important 
goals. Thank you.
    [The prepared statement of Arthur Levitt follows:]
  Prepared Statement of Hon. Arthur Levitt, Chairman, Securities and 
                          Exchange Commission
    Chairman Oxley, Congressman Towns, and Members of the Subcommittee: 
I appreciate the opportunity to testify on behalf of the Securities and 
Exchange Commission (``SEC'' or ``Commission'') regarding H.R. 10. I am 
pleased to appear before this Subcommittee again to present the 
Commission's views on the important issue of modernizing the nation's 
financial services industries. We look forward to working closely again 
with this Subcommittee and with the full Commerce Committee to ensure 
that the best interests of the nation's investors and the integrity of 
our securities markets are protected.
                              i. overview
    The Commission has long supported the primary goal of H.R. 10--
modernizing the legal framework governing financial services.
    For this reason, the Commission and its staff worked closely during 
the last Congress with the Commerce Committee to help craft legislation 
that would modernize the legal structure for financial services while 
at the same time preserving principles that are fundamental to 
effective oversight of the U.S. securities markets. Our securities 
markets today are strong, vibrant, and healthy. They are relied on by 
both individual investors, who are increasingly putting their savings 
in stocks, bonds, and mutual funds,1 and by American 
businesses that need to raise capital.2 The success of our 
securities markets is based on the high level of public confidence 
inspired by a strong system of investor protection, and on the 
entrepreneurial and innovative efforts of securities firms. As the 
nation's primary securities regulator, it is critical that the 
Commission be able to continue to fulfill its mandate of investor 
protection and to safeguard the integrity, fairness, transparency, and 
liquidity of U.S. securities markets.
---------------------------------------------------------------------------
    \1\ As of December 1998, mutual fund assets totaled $5.5 trillion. 
Investment Company Institute, Trends in Mutual Fund Investing: December 
1998 (Jan. 28, 1999).
    \2\ In 1998, businesses raised a record $1.8 trillion from 
investors, $1.31 trillion in 1997, and $967 billion in 1996. (These 
figures include firm commitment public offerings and private placements 
and do not include best efforts underwritings.) Securities Data 
Corporation.
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    Although the Commission had reservations, it supported the version 
of H.R. 10 that was passed by the full House of Representatives in May 
1998. However, I must firmly state that subsequent negotiations 
substantially eroded the basic principles that the Commission believes 
are critical to maintaining securities markets that are strong, 
vibrant, and healthy. This critical erosion of basic principles is 
continued in the version of H.R. 10 now before you. The Commission, 
therefore, is strongly opposed to the version of H.R. 10 that the House 
Banking Committee reported and that the Commerce Committee is now 
considering.
    As the Commission has testified before, its support of a financial 
modernization bill was contingent on maintaining the ``delicate balance 
inherent in [the House-passed version of] H.R. 10.'' 3 
Unfortunately, the version of H.R. 10 currently before the Commerce 
Committee no longer represents that balance. H.R. 10 now creates too 
many loopholes in securities regulation--too many products are carved 
out, and too many activities are exempted. These loopholes would 
prevent the Commission from effectively monitoring and protecting U.S. 
markets and investors. Moreover, the scope of those loopholes, which 
are ambiguously drafted, may create even greater problems and 
uncertainties in the future. The Commission cannot ensure the integrity 
of U.S. markets if it is only able to supervise a portion of the 
participants in those markets. Neither can it ensure fair and orderly 
markets if market participants operate by different sets of rules and 
investors receive different levels of protection.
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    \3\ Testimony of Arthur Levitt, Chairman, U.S. Securities and 
Exchange Commission, Concerning H.R. 10, the ``Financial Services Act 
of 1998,'' Before the Senate Comm. on Banking, Housing, and Urban 
Affairs (June 25, 1998), at 2.
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    Although the Commission has a long list of concerns with the bill 
in its current form, we would like to limit ourselves at this times to 
pointing out a number of provisions contained in the House Banking 
Committee bill that are particularly troublesome for the Commission. 
These sections would severely impact the ability of the Commission to 
protect investors and the integrity of our markets. As discussed more 
fully in the Appendix to this testimony, the Commission is particularly 
concerned about issues that arise under the following sections of the 
bill:

 New/Hybrid Products--The current provision would permit any 
        bank to automatically stay Commission action (potentially for 
        years) if the Commission determined, through rulemaking, that a 
        new product was a security and warranted the protections of 
        securities regulation.
 Derivatives--The current provision exempting ``any swap 
        agreement'' is so broadly drafted that it could include nearly 
        all securities activities, including securities-based 
        derivatives. It would also permit sales to any type of 
        investor, regardless of the investor's financial 
        sophistication, without securities sales practice regulation.
 Trust Activities--While the Commission recognizes the 
        importance of traditional bank trust activities, the current 
        provision is so broadly drafted that bank trust departments 
        could take a ``salesman's stake'' in securities transactions 
        without complying with basic securities law protections.
 Private Placements--The original private placement exception 
        was designed for small banks without broker-dealer affiliates 
        that conduct limited securities business. The current 
        provision, however, would allow all but the very largest banks 
        to conduct this business--which is a very significant portion 
        of the securities market--outside of the Exchange Act 
        regulatory scheme.
    Perhaps it would be useful at this time to step back and outline 
the broader points the Commission feels should be addressed by any 
financial modernization bill. It is crucial that there be consistent 
regulation of securities activities engaged in by all types of 
entities. The Commission must retain supervisory and regulatory 
authority over the U.S. securities markets and continue to determine 
how securities activities are defined. Our markets are vibrant because 
they are fair, and because investors rely on the protections that are 
offered them under federal securities laws.
    With that goal in mind, the Commission would like to work with the 
Commerce Committee and the Congress to include the following critical 
safeguards in any financial modernization legislation:

 Maintain aggressive SEC policing and oversight of all 
        securities activities;
 Safeguard customers and markets by enabling the SEC to set net 
        capital rules for all securities businesses;
 Protect investors by applying the SEC sales practice rules to 
        all securities activities;
 Protect mutual fund investors with uniform adviser regulations 
        and conflict-of-interest rules; and
 Enhance global competitiveness through broker-dealer holding 
        companies.
    These objectives are not novel; they have been central themes to 
all of the Commission's testimony to date. The Commission is eager to 
work with the Congress and the Commerce Committee to again achieve an 
appropriate balance in H.R. 10, without compromising these important 
principles.
  ii. background on the securities activities of the banking industry
    Before discussing the Commission's objectives in detail, I would 
like to summarize the key points that the Commission has consistently 
raised in considering Glass-Steagall reform.
    The Commission has been the nation's primary securities regulator 
for 65 years. As such, it is the most experienced and best equipped to 
regulate securities activities, regardless of who conducts those 
activities. The Commission's statutory mandate focuses on investor 
protection, the maintenance of fair and orderly markets, and full 
disclosure. Moreover, securities regulation encourages innovation on 
the part of securities firms, subject to securities capital 
requirements that are tailored to support risk-taking activities. 
Significantly, securities regulation--unlike banking regulation--does 
not protect broker-dealers from failure. It relies on market 
discipline, rather than a federal safety net, with an additional 
capital cushion and customer segregation requirements to insulate 
customers and the markets from the losses of broker-dealer firms. 
Moreover, protection of customer funds has been further assured by the 
Securities Investor Protection Corporation (``SIPC'').4
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    \4\ SIPC is a non-profit membership corporation created by the 
Securities Investor Protection Act of 1970. SIPC membership is required 
of nearly all registered broker-dealers, and SIPC is funded by annual 
assessments on its members. If a broker-dealer were to fail and have 
insufficient assets to satisfy the claims of its customers, SIPC funds 
would be used to pay the broker-dealer's customers (up to $100,000 in 
cash, and $500,000 in total claims, per customer).
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    The Commerce Committee is well aware of the many securities 
activities in which the banking industry now engages. While these 
market developments have provided banks with greater flexibility and 
new areas for innovation, they have also left U.S. markets and 
investors potentially at risk. Because banks continue to have a blanket 
exemption from most federal securities laws, their securities 
activities have been governed in a hodge-podge manner by banking 
statutes and regulations that have not kept pace with market practices 
or needs for investor protection. As you know, banking regulation 
properly focuses on preserving the safety and soundness of banking 
institutions and their deposits, and preventing the failure of banks. 
But, because market integrity and investor protection are not principal 
concerns of banking regulation, the Commission believes that banking 
regulation is not an adequate substitute for securities regulation.
    In order for banks to be fully liberated from the outdated Glass-
Steagall Act restrictions on their ability to conduct securities 
activities, banks must be willing to take on the responsibility for 
full compliance with U.S. securities laws, with which all other 
securities market participants must comply. In terms of sound public 
policy, Congress should impose such full responsibility on banks.
         iii. commission objectives for financial modernization
    I will now turn to a more detailed discussion of the fundamental 
securities principles that the Commission believes are necessary 
elements of a truly effective financial modernization bill.
A. Aggressive SEC Policing and Oversight of All Securities Activities
    Public confidence in our securities markets hinges on their 
integrity. As the Supreme Court recently stated: ``an animating purpose 
of the Exchange Act . . . [is] to insure honest securities markets and 
thereby promote investor confidence.'' 5 The Commission has 
an active enforcement division, whose first priority is to investigate 
and prosecute securities fraud. The banking regulators, on the other 
hand, are required to focus their efforts on protecting the safety and 
soundness of banks, not considering the interests of defrauded 
investors. As a former Commission Chairman said in recent Congressional 
testimony, detecting securities fraud is a full-time job, and it is a 
far cry from formulating monetary policy.6
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    \5\ United States v. O'Hagan, 521 U.S. 642, 117 S.Ct. 2199, 2210 
(1997).
    \6\ See Testimony of Richard C. Breeden, President, Richard C. 
Breeden & Co., Before the Subcomm. on Finance and Hazardous Materials, 
House Comm. on Commerce (May 14, 1997).
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    To continue its effective policing and oversight of the markets, 
the Commission must be able to monitor all securities activities 
through regular examinations and inspections, which includes access to 
all books and records involving securities activities. This is 
currently not the case. For example, during recent examinations of bank 
mutual funds, Commission examiners have had difficulty gaining access 
to key documents concerning the securities advisory activities of 
banks.7 The Commission cannot vigorously protect the 
integrity of U.S. markets and adequately protect investors with one 
hand tied behind its back.
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    \7\ The Commission and the federal bank regulatory agencies have 
worked to enhance coordination of their examination and inspection 
programs. See Testimony of Lori Richards, Director, Office of 
Compliance Inspections and Examinations, U.S. Securities and Exchange 
Commission, Concerning the Securities and Exchange Commission's 
Examination Oversight of Securities Firms Affiliated with Banks, Before 
the Subcomm. on Financial Institutions and Consumer Credit, House Comm. 
on Banking and Financial Services (Oct. 8, 1997). Despite these 
initiatives, however, the Commission continues to have difficulty 
obtaining access to all appropriate books and records.
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B. SEC Financial Responsibility Rules for All Securities Businesses
    Securities positions can be highly volatile. The Commission's 
capital requirements recognize this fact and are, with respect to 
protection from market risk, more rigorous than those imposed by bank 
regulators. Market exposures and volatility are risks that the net 
capital rule was designed to address, unlike bank capital requirements, 
which focus more on credit exposure. Thus, the Commission's net capital 
rule better protects the liquidity of any entity engaging in often 
volatile securities transactions.
    In addition to promoting firm liquidity, the Commission's net 
capital rule is a critical tool to protect investors and securities 
markets because the Commission also uses the net capital rule to 
address abusive or problematic practices in the market. For example, 
with respect to penny stock market makers, the Commission can limit 
their activity by raising capital requirements for market-making 
activities. In addition, the Commission can expand on the margin rules 
with respect to particularly risky stocks by increasing capital 
charges. Finally, the net capital rule's 100-percent capital charge for 
illiquid securities serves to constrain the market for securities that 
have no liquidity or transparency. Without the ability to uniformly 
apply its net capital rule, the Commission's ability to oversee and 
influence U.S. securities markets is severely inhibited.
    In addition to detailed net capital requirements that require 
broker-dealers to set aside additional capital for their securities 
positions, the Commission's customer segregation rule prohibits the 
commingling of customer assets with firm assets. Thus, customer funds 
and securities are segregated from firm assets and are well-insulated 
from any potential losses that may occur due to a broker-dealer's 
proprietary activities. Furthermore, federal securities law, unlike 
federal banking law, requires intermediaries to maintain a detailed 
stock record that tracks the location and status of any securities held 
on behalf of customers. For example, broker-dealers must ``close for 
inventory'' every quarter and count and verify the location of all 
securities positions. Because banks are not subject to such explicit 
requirements, the interests of customers in their securities positions 
may not be fully protected.
    Because the Commission's financial responsibility requirements are 
so effective at insulating customers from the risk-taking activities of 
broker-dealers, the back-up protection provided by SIPC is seldomly 
used. Although there have been broker-dealer failures, there have been 
no significant draws on SIPC, and there have been no draws on public 
funds. In fact, because of the few number of draws on SIPC funds, SIPC 
has been able to satisfy the claims of broker-dealer customers solely 
from its interest earnings and has never had to use its member firm 
assessments to protect customers. This is in sharp contrast to the 
many, often extensive, draws on the bank insurance funds to protect 
depositors in failed banks.
    We must continue to protect our markets from systemic risk by 
ensuring that there is enough capital to support the market risk that 
is inherent in securities transactions. In addition, we must ensure 
that customer funds and securities are fully protected by enforceable 
requirements to segregate customer assets from firm assets. To satisfy 
its quest for effective financial modernization, Congress should permit 
the Commission to set financial responsibility requirements for all 
securities activities, in order to better protect investors and U.S. 
markets.
C. SEC Sales Practice Rules Applied to All Securities Activities
    All investors deserve the same protections regardless of where they 
choose to purchase their securities. Unfortunately, gaps in the current 
bifurcated regulatory scheme leave investors at risk. For example, 
broker-dealers are subject to a number of key enforceable requirements 
to which banks are not, including requirements to:

 recommend only suitable investments;
 arbitrate disputes with customers;
 ensure that only fully licensed and qualified personnel sell 
        securities to customers;
 disclose to investors, through the NASD, the disciplinary 
        history of employees; and
 adequately supervise all employees.8
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    \8\ The federal bank regulatory agencies have issued guidelines 
that address some bank sales practice issues. See Board of Governors of 
the Federal Reserve System, Federal Deposit Insurance Corporation, 
Office of the Comptroller of the Currency, and Office of Thrift 
Supervision, ``Interagency Statement on Retail Sales of Nondeposit 
Investment Products'' (Feb. 15, 1994). These guidelines are advisory 
and therefore not legally binding, and they may not be legally 
enforceable by bank regulators.
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Investors are generally not aware of these gaps in regulation and the 
risks that such gaps create.
    In addition, federal banking statutes do not provide customers a 
private right of action for meritorious claims, and banking regulators 
do not routinely fully disclose the details of any and all enforcement 
and disciplinary actions against banks to put customers on alert. 
Although some customer protections have been suggested by the bank 
regulators, they are less comprehensive than the federal securities 
laws and serve to perpetuate the disparities between the bank and 
securities regulatory schemes.9
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    \9\ H.R. 10 does contain a provision (section 204) that requires 
each banking agency to adopt sales practice rules. These rules would 
not be as extensive as securities sales practice rules, and in some 
cases may vary from Commission rules. Moreover, section 204 states that 
the banking agency rules could apply to registered broker-dealer 
subsidiaries or affiliates of banks, which would create regulatory 
overlap and confusion. The Commission strongly objects to this 
approach.
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    Some have suggested a system of parallel securities regulation by 
the banking regulators. However, the Commission notes that the 12(i) 
model for regulation of bank issuer reporting has not achieved the 
objectives of the federal securities laws and, in fact, the Treasury 
Department's 1997 financial modernization proposal suggested 
eliminating section 12(i). Under section 12(i) of the Securities 
Exchange Act,10 banking regulators are required to adopt 
rules ``substantially similar'' to the Commission's rules within 60 
days after the Commission's publication of its final rules. Notably, 
one commentator has stated that ``final action by the [banking] 
regulators in promulgating `substantially similar' 1934 Act rules has 
been delayed in some cases over five years after pertinent SEC 
amendments have been issued.'' 11 In addition, the 12(i) 
model perpetuates a complex scheme of disparate rules offering 
different protections for investors and markets and different levels of 
enforcement efforts.
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    \10\ 15 U.S.C. 78l(i).
    \11\ Michael P. Malloy, The 12(i)'ed Monster: Administration of the 
Securities Exchange Act of 1934 by the Federal Bank Regulatory 
Agencies, 19 Hofstra L. Rev. 269, 285 (1990).
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    I would like to briefly discuss two recent Commission enforcement 
actions that highlight the need for more universal application of 
strict sales practices rules to all entities engaged in securities 
activities.
    In the first case, the Commission is alleging that the portfolio 
manager of two money market mutual funds sponsored by a bank (i) caused 
the funds to purchase volatile derivative instruments, (ii) 
fraudulently transferred the derivatives at inflated values between the 
mutual funds to some of the bank's various trust accounts to cover up 
the mutual funds' losses, and (iii) ultimately caused the funds to 
``break the buck.'' The Commission investigated and has initiated 
enforcement action against the mutual funds' portfolio 
manager.12 However, because of the current bank exemptions 
from federal securities law, the Commission was unable to bring charges 
against the bank or its personnel for failing to adequately supervise 
the fund manager. Under these facts, the Commission ordinarily would 
have brought charges against any of its regulated entities for similar 
misconduct, and the Commission considers its ability to bring ``failure 
to supervise'' claims to be critical to investor protection. Securities 
fraud of this type--where transactions occur both in mutual funds and 
in bank trust accounts--illustrates the need for securities regulators 
to have access to books and records involving all securities activities 
conducted by banks.
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    \12\ See In the Matter of Michael P. Traba, File No. 3-9788, 
Release No. 33-7617 (Dec. 10, 1998).
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    In the second case, employees of a bank and its broker-dealer 
subsidiary blurred the distinction between the two entities and their 
respective products during sales presentations to customers and in 
marketing materials.13 In addition, the broker-dealer's 
employees mischaracterized certain products as conservative investments 
when, in fact, they were highly leveraged funds that invested in 
interest-rate-sensitive derivatives. These actions resulted in 
customers, many of whom were elderly and thought they were purchasing 
investments in stable government bond funds, making unsuitable 
purchases of high-risk funds. The case is also evidence of how 
difficult it is to protect investors when securities regulation is 
split between exempted banks and their related securities firms. When 
there are multiple regulators with different goals, the regulatory 
environment can be easily muddled, leaving investors at risk.
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    \13\ In the Matter of NationsSecurities and NationsBank, N.A., 
Release No. 33-7532 (May 4, 1998).
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    The Commission believes that the protections provided by the high, 
uniform standard of the federal securities laws should benefit all 
investors purchasing securities.
D. Uniform Mutual Fund Adviser Regulation and Conflict-of-Interest 
        Rules
    Mutual fund investors should always receive the protection of the 
federal securities laws. Accordingly, all parties that provide 
investment advice to mutual funds should be subject to the same 
oversight, including Commission inspections and examinations. In 
addition, any type of entity that is affiliated with a mutual fund 
should be subject to the strict conflict-of-interest provisions of the 
federal securities laws. For these reasons, the Commission supports 
provisions that would address the increasing involvement of banks in 
the mutual fund business and reduce potential conflicts of interest. 
Fortunately, the House Banking Committee version of H.R. 10 contains 
the same important mutual fund provisions that we supported in the 
House-passed version of H.R. 10.
    Banks that act as investment advisers currently enjoy an exemption 
from the registration and other requirements of the Investment Advisers 
Act of 1940. As a result, bank investment advisers are not subject to 
the substantive requirements applicable to registered investment 
advisers, including: (i) regulation of advertising, solicitation, and 
receipt of performance fees; (ii) establishing procedures to prevent 
misuse of non-public information; (iii) books and records and employee 
supervision requirements; (iv) the general anti-fraud provisions; and 
(v) statutory disqualification from performing certain services for a 
mutual fund if the adviser violates the law. All but (v), which came to 
our attention in a recent matter, are already included in the bill 
before the Commerce Committee.
    In addition, as banks increasingly advise mutual funds, the 
Commission grows more concerned that its examiners do not have ready 
access to information regarding bank advisory activities that could 
affect bank-advised mutual funds. Such access is necessary in order to 
detect front-running, abusive trading by portfolio managers, and 
conflicts of interest (involving, for example, soft-dollar 
arrangements, allocation of orders, and personal securities 
transactions by fund managers). As part of its review for conflicts of 
interest with respect to a bank mutual fund adviser's activities, 
Commission examiners must be able to compare trading activity in a 
mutual fund portfolio to that in the bank's trust accounts. As 
discussed above, the Commission has had difficulty obtaining full 
access to all relevant information when reviewing the securities 
activities of banks that advise mutual funds.14 The 
Commission must be able to review records relating to all securities 
activities relating to mutual fund advisers, just as it does for all 
other non-bank fund advisers.
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    \14\ See note 7 and accompanying text above.
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    The Commission is also concerned about the unique conflicts of 
interest resulting from increased bank involvement in the mutual fund 
business. Currently, the Investment Company Act of 1940 places 
restrictions on certain transactions between investment companies and 
their affiliates. These restrictions were crafted, however, at a time 
when Congress could not have anticipated the dramatic change in the 
scope of bank securities activities. Specifically, the Commission is 
concerned about conflicts of interest that may arise from:

 bank lending to affiliated mutual funds, possibly on 
        unfavorable terms, to the detriment of fund investors;
 bank holding company personnel serving on the boards of 
        directors of affiliated mutual funds;
 personnel of an entity that lends to, or distributes shares 
        of, a mutual fund also serving on the fund's board; and
 bank trust departments that hold shares in an affiliated 
        mutual fund in a trustee or fiduciary capacity and that have 
        the power to vote such shares.
    Legislation that targets such conflicts of interest is necessary. 
Banks that lend to, advise, and/or sell mutual funds should be subject 
to rules governing conflicts of interest that arise when banks act in 
multiple capacities. The Commission supports the provisions of H.R. 10 
that address these conflicts of interest.
    Finally, the Commission advocates adding a new section to H.R. 10 
in order to protect mutual fund investors from banks that engage in 
misconduct. Currently, the Investment Company Act statutorily 
disqualifies certain types of entities (such as brokers, dealers, 
advisers, and transfer agents) and employees of such entities 
(including employees of banks) who have been convicted of a felony or 
are subject to a civil injunction. However, the Investment Company Act 
does not contain a similar statutory disqualification that would apply 
to a bank (the entity itself, as opposed to its employees) that had 
engaged in wrongdoing. In order to ensure that the protections of the 
Investment Company Act extend to investors in bank-advised mutual 
funds, the statutory disqualification provisions of the Act should be 
amended to include banks.
E. Broker-Dealer Holding Companies
    In order to expand overseas, U.S. broker-dealer firms generally 
must demonstrate to foreign regulators that they are subject to 
comprehensive supervision on a worldwide basis. Thus, the Commission 
strongly supports the ability of U.S. broker-dealers to voluntarily 
subject their activities to Commission supervision on a holding company 
basis. The Commission's ``umbrella'' oversight would be based on a 
risk-supervision model that more appropriately reflects the predominant 
risk-taking securities activities of the consolidated entity. Of 
course, any regulated subsidiaries of a broker-dealer holding company 
would continue to be regulated by the appropriate statutory regulator.
    The Commission believes that a supervisory framework for holding 
companies substantially engaged in securities activities would permit 
securities firms the flexibility to innovate and keep pace with the 
rapid changes in today's capital markets. This structure would impose 
risk-based supervision, consistent with the firm's principal business, 
and would help protect market integrity by ensuring that there are no 
supervisory gaps. Notably, the Commerce Committee markup of H.R. 10 in 
October 1997 also contained a provision allowing for broker-dealer 
holding companies that include a wholesale financial institution 
(``WFI'') but that are primarily engaged in the securities business. 
The Commission strongly supports these provisions, which also enjoy the 
backing of Chairman Greenspan.15
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    \15\ In response to a question posed to Alan Greenspan during the 
April 28, 1999 hearing of the House Commerce Subcommittee on Finance 
and Hazardous Materials on the subject of financial modernization, 
Chairman Greenspan indicated his support for Commission-supervised 
broker-dealer holding companies.
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                            iv. conclusions
    The Commission has testified many times during the past decade in 
support of financial modernization.16 However, H.R. 10 as 
currently drafted provides for a labyrinth of complicated, technical 
exemptions from federal securities law regulation--the loopholes in the 
regulatory scheme are now larger than the scheme itself; this could 
dramatically undermine market integrity. Furthermore, as a practical 
matter, H.R. 10's securities exemptions have become so complex that it 
would be a ``compliance nightmare'' for banks to implement and for the 
Commission to monitor.
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    \16\ See, e.g., Testimony of Arthur Levitt, Chairman, U.S. 
Securities and Exchange Committee, Concerning Financial Modernization 
Legislation Before the Senate Comm. on Banking, Housing, and Urban 
Affairs (Feb. 24, 1999); Testimony of Harvey J. Goldschmid, General 
Counsel, U.S. Securities and Exchange Commission, Concerning H.R. 10, 
The ``Financial Services Act of 1999'' Before the House Comm. on 
Banking and Financial Services (Feb. 12, 1999); Testimony of Arthur 
Levitt, Chairman, U.S. Securities and Exchange Commission, Concerning 
H.R. 10, The ``Financial Services Act of 1998,'' Before the Senate 
Comm. on Banking, Housing, and Urban Affairs (June 25, 1998); Testimony 
of Arthur Levitt, Chairman, U.S. Securities and Exchange Commission, 
Concerning Financial Modernization and H.R. 10, the ``Financial 
Services Competition Act of 1997,'' Before the Subcomm. on Finance and 
Hazardous Materials of the House Comm. on Commerce (July 17, 1997); 
Testimony of Arthur Levitt, Chairman, U.S. Securities and Exchange 
Commission, Concerning Financial Modernization, Before House Comm. on 
Banking and Financial Services (May 22, 1997); Testimony of Arthur 
Levitt, Chairman, U.S. Securities and Exchange Commission, Regarding 
H.R. 1062, the ``Financial Services Competitiveness Act of 1995,'' 
Before the Subcomm. on Telecommunications and Finance and the Subcomm. 
on Commerce, Trade and Hazardous Materials of the House Comm. on 
Commerce (June 6, 1995); Testimony of Arthur Levitt, Chairman, U.S. 
Securities and Exchange Commission, Concerning the ``Financial Services 
Competitiveness Act of 1995'' and Related Issues, Before the House 
Comm. on Banking and Financial Services (Mar. 15, 1995); Testimony of 
Arthur Levitt, Chairman, U.S. Securities and Exchange Commission, 
Concerning H.R. 3447 and Related Functional Regulation Issues, Before 
the Subcomm. on Telecommunications and Finance of the House Comm. on 
Energy and Commerce (Apr. 14, 1994); Testimony of Richard C. Breeden, 
Chairman, U.S. Securities and Exchange Commission, Concerning Financial 
Services Modernization, Before the Subcomm. on Telecommunications and 
Finance of the House Comm. on Energy and Commerce (July 11, 1990); 
Memorandum of the Securities and Exchange Commission (under Chairman 
David Ruder) to the Subcomm. on Telecommunications and Finance of the 
House Comm. on Energy and Commerce, Concerning Financial Services 
Deregulation and Repeal of the Glass-Steagall Act (Apr. 11, 1988); 
Testimony of David S. Ruder, Chairman, U.S. Securities and Exchange 
Commission, Concerning the Structure and Regulation of the Financial 
Services Industry, Before the Subcomm. on Telecommunications and 
Finance of the House Comm. on Energy and Commerce (Oct. 5, 1987).
---------------------------------------------------------------------------
    In the debates surrounding this issue, the Commission's primary 
concerns have been the protection of the integrity of U.S. markets and 
those who invest in them. Unfortunately, H.R. 10 as reported by the 
Banking Committee would prevent the Commission from effectively 
carrying out its statutory mandates, and the Commission is therefore 
strongly opposed to this bill. However, the Commission supports the 
effort to advance this process and is eager to continue to work with 
the Commerce Committee and the Congress on these issues.
    The Commission encourages all involved to step back and look at the 
securities issues arising out of financial modernization and the 
complexity of the current rigid structure. We must not lose sight of 
basic securities law protections and goals, which have served to ensure 
that the U.S. markets are the fairest, safest, most vibrant, most 
transparent, and most liquid markets in the world.
    As it has stated in its principles, the Commission believes that it 
may be time to rethink the approach to the functional regulation 
provisions of financial modernization legislation. They have become too 
complicated and may not be flexible enough to deal with developments 
over time. Rather than an inflexible laundry list of complex exceptions 
and loopholes, the Commission suggests we consider deleting many, if 
not all, of the exceptions and instead adopt exemptive rules in areas 
of traditional bank securities activities, an approach that would pose 
fewer investor protection and market integrity concerns.
    We thank you for offering the Commission the opportunity to appear 
here today. I would be happy to answer questions that you may have.
                                APPENDIX
                    Commission Concerns with H.R. 10
    This appendix discusses specific provisions in the version of H.R. 
10 reported by the House Banking Committee that pose some of the most 
serious threats to the Commission's ability to protect investors and 
the integrity of our markets.
A. Broker-Dealer Activities
    1. New Products--The new products provision was originally designed 
to provide a fair process for handling new products sold by banks that 
might have securities elements. Briefly, this process is as follows. 
With respect to a new product sold by a bank, the Commission would be 
required to conduct a rulemaking in consultation with the appropriate 
banking regulators. Before requiring a bank to move any new activities 
into a separate entity, the Commission would have to formally 
demonstrate that the new product is a security and that investor 
protection concerns warrant requiring activities with respect to such 
new product to be conducted through a registered broker-dealer. The 
rulemaking process is designed to give fair notice to the banking 
industry and opportunity for all interested persons to comment.
    However, this process has now been expanded to include requirements 
that are unacceptable to the Commission. H.R. 10 now includes a 
provision that permits any bank to obtain an automatic stay of the 
Commission's action, if the bank challenges the Commission's 
determination. The Commission does not object to judicial review of its 
actions, and, in fact, any aggrieved party can currently go to court to 
seek a stay of Commission action if it feels one is warranted. However, 
the automatic stay in H.R. 10 would act to delay Commission enforcement 
or regulatory action against a bank, perhaps for years. This is an 
unreasonable burden to place on the Commission, particularly given the 
speed with which this industry innovates and the fact that the 
rulemaking process--in lieu of enforcement actions or use of the 
Commission's interpretive authority--would already delay significantly 
the Commission's actions. The Commission's hands should not be tied 
indefinitely while the judicial review process winds its way through 
the courts. Moreover, as the nation's securities regulator, the 
Commission is bewildered by a new provision that would appear to give 
bank regulators deference in determining which products are securities, 
and subject to securities regulation.
    2. Derivatives Activities--The Commission's principal concern in 
this area involves derivatives activities where the derivatives are 
securities or involve delivery of securities. Earlier bills have 
allowed these products to be booked by banks, but required the 
transactions to be conducted only with qualified investors, and 
effected through a registered broker-dealer. This scheme carefully 
permitted banks to maintain most of their derivatives activities ``as 
is''--securities law protections would only apply where the derivative 
product was a security or involved delivery of a security. Moreover, it 
recognized investor protection concerns by restricting such derivatives 
dealing activities to qualified investors.
    However, the version of H.R. 10 reported by the Banking Committee 
wreaks havoc with this delicate balance. It would exempt ``any swap 
agreement'' from the broker-dealer registration requirements, even 
swaps that are securities or that involve delivery of securities. Swap 
agreement is defined broadly and, as markets develop, could include 
standardized products that are used for price discovery purposes in 
equity and debt markets, all outside the scope of federal securities 
law. This open-ended exemption is unacceptable to the Commission 
because all securities can be recast as derivatives--a callable bond 
could be viewed as a derivative.
    Because those derivatives that are securities or that involve the 
delivery of securities no longer would need to be sold through a 
registered broker-dealer, many of the protections of federal securities 
laws would not apply. Thus, the sales practice, net capital and other 
investor and market protection requirements of the federal securities 
laws will not govern sales of securities derivatives. In addition, the 
current version of H.R. 10 would eliminate the statutory requirement 
that securities-based derivatives be sold only to qualified investors, 
thus permitting an expanded class of products to be sold to any type of 
investor, regardless of the level of sophistication.
    Finally, the banking regulators, rather than the Commission, would 
control the scope of this exemption for securities-based derivatives. 
For example, bank regulators would decide whether investor protection 
concerns warranted limiting bank sales of credit and equity derivatives 
to sophisticated investors.
    3. Receipt of Brokerage Commissions for Trust and Transfer Agency 
Activities--Banks have traditionally provided trust services. Previous 
versions of H.R. 10 contained an exemption tailored to cover 
traditional trust activities. Specifically, this provision covered 
instances where a bank executed securities transactions in a fiduciary 
or trustee capacity through its trust department, or in employee 
benefit plans, dividend reinvestment plans, and issuer plans, but was 
not compensated on an incentive basis for such activity. In order to 
protect trust customers from banks having a ``salesman's stake'' in 
their transactions, previous bills did permit banks to charge an annual 
fee, an assets-under-management fee, or an order processing fee, but 
expressly prohibited a bank trust department and transfer agent from 
charging brokerage commissions that exceeded execution costs.
    H.R. 10 has since been rewritten to permit banks, provided they are 
``primarily'' compensated by fees other than brokerage commissions, to 
accept commissions in excess of their execution costs. The vague term 
``primarily'' makes this a potentially huge loophole. Even though the 
current version of H.R. 10 attempts to limit potential excess by 
further requiring that additional compensation be ``consistent with 
fiduciary principles,'' this is shallow protection. Any protections 
afforded to investors under fiduciary law will vary by state. In 
addition, fiduciary law may permit investor protections to be lessened, 
if not eliminated entirely, by contractual provisions. Significantly, 
we understand that banks also have been effective recently in lobbying 
state legislatures to statutorily relax some state fiduciary law 
requirements.
    It is not enough to say that banks are ``fiduciaries.'' Broker-
dealers are also ``fiduciaries;'' nonetheless, Congress has determined 
that the protections of federal securities laws are necessary and 
integral to provide customers with full investor protection. Under the 
current version of H.R. 10, a bank and its personnel could have 
economic incentives--a so-called ``salesman's stake''--in a customer 
account, without being subject to the strict suitability, best 
execution, sales practices, supervision, and accountability 
requirements that are imposed by the federal securities laws. As the 
Commission has stated, consistent regulation of securities activities 
is imperative in order for the nation's investors to be fully 
protected.
    Moreover, investor protections with respect to bank activities in 
certain stock purchase plans were even further eroded under the current 
version of H.R. 10. The bill would delete the prohibition on a bank 
accepting brokerage commissions that exceed its execution costs, 
without even a requirement that any brokerage commissions that the bank 
receives be ``consistent with fiduciary principles.'' In fact, transfer 
agents involved in sales of issuer stock purchase plans owe a fiduciary 
duty to issuers, not to investors, and the investor protections of the 
federal securities laws would not apply to bank customers.
    4. Private Placement Activities--Small banks have traditionally 
conducted private placements in order to assist local business clients 
in capital formation. Accordingly, previous versions of this bill have 
permitted a bank that was not affiliated with a registered broker-
dealer to engage in private placement activities with qualified 
investors.
    The version of H.R. 10 reported by the Banking Committee would 
abandon this focus on small banks. H.R. 10 has been rewritten to allow 
all but the very largest banks to conduct private placement activities. 
The only restriction is that a bank that wishes to engage in private 
placements directly cannot be affiliated with a broker-dealer that 
underwrites corporate debt and equity securities. This would permit a 
large universe of banks (regardless of their size and history of 
private placement activities) to conduct private placement activities 
directly, outside of the reach of many of the investor protections 
provided under federal securities law. As it is, private placements are 
subject to fewer disclosure requirements under federal securities laws 
because they qualify for an exemption from the Securities Act of 1933.
    Although banks have been permitted to engage in private placement 
activities for about 25 years, most big banks have moved such 
activities to their registered broker-dealer section 20 affiliates 
(where private placement activities count toward the 75 percent of 
``permissible'' revenue). Once Glass-Steagall barriers (and the 75 
percent revenue test) are eliminated, this significant market will be 
moved back into banks, outside of the protections of federal securities 
regulation.
    5. Definition of ``Qualified Investor''--Many of the exceptions 
provided for bank securities activities in previous bills have relied 
on the fact that less sophisticated investors would continue to have 
the protections of the federal securities laws governing their 
transactions. Thus, earlier versions of this legislation generally 
defined ``qualified investor'' narrowly with respect to complex 
instruments, like derivatives (essentially institutional investors), 
and more broadly with respect to private placements, asset-backed 
securities and loan participations.
    Unfortunately, the current version of H.R. 10 defines ``qualified 
investor'' broadly with respect to all products, including derivatives, 
to include corporations, natural persons with more than $10 million and 
governments with more than $50 million. By significantly expanding the 
definition of ``qualified investor,'' the current version of H.R. 10 
would permit banks to offer derivative instruments to a broader class 
of investors, including individuals, fully outside the protections of 
federal securities law. This means a less sophisticated class of 
investors will not be protected by the additional supervisory, sales 
practices and suitability requirements imposed by federal securities 
laws, at the very time they would need them most. Moreover, certain 
municipalities and the Government Finance Officers Association 
(``GFOA'') have stated that even sophisticated investors require the 
protections of federal securities laws, particularly suitability, with 
respect to derivatives trading activities.
B. Mutual Fund Advisory Activities
    The Commission is pleased to see that the current version of H.R. 
10 maintains important amendments to the federal securities laws to 
close the loopholes that banks enjoy with respect to their mutual fund 
advisory activities. These provisions were non-controversial and are 
necessary to evenly protect all mutual fund investors. In addition, 
these provisions are important because they would afford Commission 
examiners greater access to information regarding bank advisory 
activities that could affect bank-advised mutual funds. Such access is 
necessary to detect and prevent front-running, abusive trading by 
portfolio managers, and conflicts of interest. In addition, the 
Commission suggests one additional technical change discussed below.
    Currently, the Investment Company Act statutorily disqualifies 
certain types of entities (such as brokers, dealers, advisers, transfer 
agents) and employees of such entities (including employees of banks) 
who have been convicted of a felony or have been subject to a civil 
injunction. However, the Act does not contain a similar statutory 
disqualification that would apply to a bank (as opposed to employees of 
the bank) that had engaged in wrongdoing. Commission staff have drafted 
a brief amendment that would accomplish this, and we encourage the 
Commerce Committee to adopt such an amendment, which is important to 
provide investors in bank-advised funds the same protections provided 
to investors in other funds.
C. Broker-Dealer Holding Company
    In order to provide an effective two-way street between the banking 
and securities industries, securities firms must have the ability to 
affiliate with banking institutions without subjecting their entire 
holding company to top-down, bank safety and soundness supervision by 
the Federal Reserve. Accordingly, a broker-dealer holding company 
(``BDHC'') must have the ability to affiliate with a wholesale 
financial institution (``WFI''), and BDHCs that engage primarily in 
securities activities (regardless of whether they are affiliated with a 
WFI) must be able to choose Commission supervision of the holding 
company. In addition, the Commission should retain backup examination 
authority over WFI holding companies to ensure compliance with 
securities laws. The Commission advocates the addition of broker-dealer 
holding company provisions to H.R. 10, and notes that an effective 
provision of this nature was included in the Commerce Committee's H.R. 
10 report of October 1997.

    Mr. Oxley. Thank you, Chairman Levitt. Let me begin a round 
of questions for both of you gentlemen. Commissioner Nichols, 
the NAIC just for the record did not support last year's bill 
as it came out of the Commerce Committee; is that correct?
    Mr. Nichols. That is correct, sir.
    Mr. Oxley. If you were to compare from your perspective the 
bill that we have before us now that we have from the Banking 
Committee this year as opposed to last year's bill, what are 
your general thoughts and what would we, this committee, 
essentially have to do to earn the support of the 
commissioners?
    Mr. Nichols. First of all, I would like to say that we 
appreciate the bipartisan support that has occurred this year, 
and we do think that the bill has made improvements. However, 
the struggle that we have in terms of our role is, one, it does 
not adequately address our authority related to affiliations. 
There is broad language in there that preempts our authority as 
it relates to banks and bank affiliates.
    We believe there is a need for you to address the issue of 
deference with our Federal regulators. Specifically, by putting 
in any laws that occur prior to September 1998 basically takes 
and calls into question everything that we do that is on the 
books today.
    We also are concerned from our perspective that the whole 
tone of this actually, as Chairman Levitt has said, is more 
focused on the banks. If we are going to truly do financial 
services and you want functional regulation to work, we believe 
that it should be a level playing field. The same as you are 
addressing on the market side and the same on the regulatory 
side.
    If there is the deference issue addressed, the language is 
cleaned up not to have sweeping preemption of our authority if 
you are a bank or affiliated with a bank, and then again 
address the issue of true financial service and functional 
regulation. I think that it is something that we could support.
    Mr. Oxley. Your testimony, as I recall, you also said that 
you would eliminate the--I forgot what term you used--eliminate 
the difficulty of out-of-state insurance sales.
    Mr. Nichols. The issue of re-domestication you may be 
discussing. What it was is it was allowing companies to move to 
a State that would allow them to go into a different 
organizational structure.
    We believe that it's important for individual States to 
maintain that level of control. If you have you a State that 
has investigated quite a bit, whether it be tax structures or 
other things, to organizationally make it appropriate for large 
insurance entities to function there, we would hate to see them 
to be able to move somewhere just because they don't like the 
rules.
    We think that insurance rules based on a State basis are 
those unique to the people that live there. When you think of 
insurance and the uniqueness of it, we think that it is very, 
very critical that you focus on the individual needs of the 
States. My need for crop insurance and other things in Kentucky 
may be totally different than what you have in New York. Let us 
recognize the differences that our States offer and make sure 
that each State can protect its citizens in relation to the 
business of insurance.
    Mr. Oxley. Chairman Levitt, you indicated that there were 
too many products exempted under securities laws in the version 
that we have inherited from the Banking Committee. Do you 
believe that there are any exemptions that should be allowed 
for banks under securities laws?
    Mr. Levitt. Well, I think, if those exemptions were 
tailored very rigorously, that is possible. But the exemptions 
in this bill are so broad that the cleanest way to approach 
this, it seems to me, would be to look at them anew. These 
exemptions have come down the pike over the past 12 or 15 
years, and it is very hard to be able to take them and 
streamline them and pick from column A and column B. I think we 
have to take a fresher approach to them.
    Certainly we would be willing to sit down and work with you 
on the specific details. The ones that we have the greatest 
problems with, of course, are future products, private 
placements, trust activities, and the treatment of derivatives 
and swaps. Those are the ones that really open up the banks to 
dealing with securities issues directly and freezing out 
securities regulators. They could use these exemptions to, in 
effect, open the door for securities activities to go 
unregulated by securities regulators and to be under the 
jurisdiction of the banks.
    Mr. Oxley. How would you argue with those folks who say, 
for example, that within the trust department that there ought 
to be some exemptions from the securities laws based on the 
fact that you are dealing with generally sophisticated 
investors; you are dealing with trust departments and banks 
that have been there for a number of years; that the 
protections are adequate currently to deal with that without 
having another layer of regulation by the Securities and 
Exchange Commission?
    Mr. Levitt. The trust activities of banks have been part of 
banking as long as we have had a banking system. I think they 
operate reasonably and fairly, and we certainly would not 
propose sweeping away trust departments from banks.
    But, the way this bill is written today, a full service 
broker could be run out of the trust department of a bank, 
which could charge commissions for securities activities. We 
would have to carefully address that provision in a way that 
would not broaden and extend the trust activities that are 
presently under the jurisdiction of banks to include consumer 
securities activities.
    Mr. Oxley. Thank you. My time has expired. Let me now 
recognize the gentleman from Michigan, the ranking member of 
the full committee, Mr. Dingell.
    Mr. Dingell. Mr. Chairman, thank you. Welcome to our panel, 
Mr. Chairman and Mr. Nichols. Thank you both for being here. I 
would like to focus with you, if you would, please, Mr. 
Nichols, on some very important questions since you have the 
expertise that has been denied this committee through a series 
of circumstances for a considerable while.
    First of all, insurance is now regulated by the States, is 
it not?
    Mr. Nichols. Yes, that is correct.
    Mr. Dingell. To the best of my knowledge, there is only 
Federal statute that relates to insurance regulation, and that 
is one which confers the basic authority over insurance 
regulation on the States; is that correct?
    Mr. Nichols. Yes, sir, that is correct.
    Mr. Dingell. So if States are not permitted to regulate 
bank insurance sales, then who would regulate bank insurance 
sales?
    Mr. Nichols. No one, from our perspective, sir.
    Mr. Dingell. So if we were to move to deny State insurance 
commissions the authority to regulate bank sales of insurance, 
we could guarantee that there would be no regulation of 
insurance sales at any level; is that correct?
    Mr. Nichols. That is correct.
    Mr. Dingell. Sales made by the banks?
    Mr. Nichols. That is correct, sir.
    Mr. Dingell. That would completely strip the consumers of 
insurance services of any place to complain, would it not?
    Mr. Nichols. That is correct, sir.
    Mr. Dingell. The Federal Reserve, the Treasury, the 
Comptroller of the Currency have no statutory authority 
whatsoever to regulate sales of insurance; is that right?
    Mr. Nichols. That is correct. And they also informed us 
they would not----
    Mr. Dingell. They would have no authority to deal with the 
questions of actuarial soundness of the insurance plans; is 
that correct?
    Mr. Nichols. That is correct, sir.
    Mr. Dingell. Now, having said that, how many of Michigan's 
insurance laws would be preempted by the bill that has been 
sent to us by the Banking Committee?
    Mr. Nichols. Thirty-three.
    Mr. Dingell. Thirty-three. Would you submit the list of 
those, please, for the committee.
    Mr. Nichols. Yes, sir. I think they have been handed out, 
sir.
    Mr. Dingell. If you would hand them out, Mr. Chairman, I 
would ask that they be inserted into the record.
    Mr. Oxley. Without objection.

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    Mr. Dingell. Now, Commissioner Nichols, please tell us what 
is the Unfair Claim Settlement Practices Act?
    Mr. Nichols. That is an act that establishes the minimum 
standards for how insurance companies are required to handle 
the claim, paying it promptly, making sure they are 
communicating with you, making sure that you get what you 
deserve.
    Mr. Dingell. A version of that is in each State enforced by 
the State insurance commissioner; is that not so?
    Mr. Nichols. That is correct, sir.
    Mr. Dingell. If the State insurance commissioners were to 
be denied the authority to sell or, rather, to regulate 
insurance sales and insurance sales practices and practices of 
insurance companies with regard to consumers, there would be no 
one then to regulate that particular aspect of insurance 
company activities; is that right?
    Mr. Nichols. That is correct, sir.
    Mr. Dingell. Is there any other regulatory authority that 
can give Michigan consumers the same protections that this law 
provides?
    Mr. Nichols. No, sir.
    Mr. Dingell. Now, let us look at another one. The Life and 
Health Insurance Guarantee Association Law and the 
Postassessment Property and Liability Insurance Guarantee 
Association Law, how do those benefit consumers?
    Mr. Nichols. Those benefit consumers by if there is an 
insolvent insurer, those funds are made available to ensure 
that any policies that they have are fully enforced up to a 
financial limit. It is for their protection.
    Mr. Dingell. If these laws were to be preempted, what 
protection would be substituted, and what authority would 
either the Federal Reserve or the Comptroller of the Currency 
have to require protection of consumers with regard to these 
matters?
    Mr. Nichols. There would be none, sir.
    Mr. Dingell. There would be none. So the consumers would be 
stripped naked of two very important protections, would they 
not?
    Mr. Nichols. That is correct.
    Mr. Dingell. What is the Third Party Administrator's Law, 
and why should consumers be troubled if it were to be preempted 
by this legislation?
    Mr. Nichols. The Third Party Administrative Law allows an 
insurance company to farm out or source out to another company 
the processing of claims and collection of premium. This makes 
sure that once that is done we are still allowed to hold full 
authority over the insurance company and they must assume 
responsibility for their claimants.
    Mr. Dingell. That is also administered by the State 
insurance commissioners, is it not?
    Mr. Nichols. Yes, it is.
    Mr. Dingell. And State insurance commissioners, in most 
instances, administer similar, if not identical, statutes in 
each and every one of the States; is that not so?
    Mr. Nichols. That is correct, sir.
    Mr. Dingell. Now, if that were to be repealed by the action 
in this Congress in passing the legislation before us, there 
would be no one to provide that protection for American 
insurance consumers; is that correct?
    Mr. Nichols. That is correct, sir.
    Mr. Dingell. Now, Commissioner Nichols, some of these laws 
have been on the books for more than 40 years; is that correct?
    Mr. Nichols. That is correct.
    Mr. Dingell. Is there any authority or expertise at the 
Federal level--now, I said authority and expertise at the 
Federal level which is comparable to the body of insurance law 
and regulations that now exists at the State level?
    Mr. Nichols. There is none.
    Mr. Dingell. Is there any expertise in the Fed to do this?
    Mr. Nichols. No, sir.
    Mr. Dingell. Is there any expertise in the Office of the 
Comptroller of the Currency or elsewhere in the Treasury 
Department?
    Mr. Nichols. No, sir.
    Mr. Dingell. In a word, are you aware of any actions that 
have ever been taken by the Department of the Treasury or the 
Fed to regulate insurance matters?
    Mr. Nichols. No, sir. But they have attempted to expand the 
ability of banks to do certain things in insurance.
    Mr. Dingell. In ways which would ofttimes deny you and the 
other State insurance commissioners the authority to regulate 
for the protection of consumers in your several States; is that 
right?
    Mr. Nichols. That is correct, sir.
    Mr. Dingell. Now it would seem that the Banking Committee's 
bill, therefore, lets the banks engage in insurance activities 
without regulations; is that correct?
    Mr. Nichols. That is the way that we see it, sir.
    Mr. Dingell. And I would go on to note that while insurance 
companies are not bank related insurance agents would continue 
to be subject to Michigan's 33 insurance laws; is that right?
    Mr. Nichols. That is correct, sir.
    Mr. Dingell. And to regulation by the insurance 
commissioner; is that right?
    Mr. Nichols. That is correct.
    Mr. Dingell. That would leave the insurance consumer in the 
State of Michigan afflicted with something of a Hobson's choice 
between banks totally exempt from regulation and an insurance 
salesman who would be subject to State regulations; is that 
right?
    Mr. Nichols. That is correct, sir.
    Mr. Dingell. So the banks could promise any damn thing they 
liked and deliver as little as possible; is that right?
    Mr. Nichols. That is right.
    Mr. Dingell. There would be no place that the insurance 
consumer could go for redress; is that correct?
    Mr. Nichols. That is correct, sir.
    Mr. Dingell. Now, is there any reason in your mind why we 
ought to abate the historic protection afforded to consumers by 
State insurance laws when they buy insurance at their bank?
    Mr. Nichols. There is no reason, sir.
    Mr. Dingell. Banks are now subject to at least some of 
these insurance laws even while under the administration of the 
Comptroller of the Currency and the Federal Reserve Board; is 
that right?
    Mr. Nichols. That is correct.
    Mr. Dingell. Is there any reason in your mind that would 
justify us coming to the conclusion that banks should be 
subject to less regulation than insurance companies and 
insurance agents?
    Mr. Nichols. Not if you want to protect your consumers.
    Mr. Dingell. But if you want to scare them, letting the 
banks out from under regulation would be a fine way to begin, 
would it not?
    Mr. Nichols. It would be an excellent way to do it, sir.
    Mr. Dingell. Thank you.
    Mr. Oxley. The gentleman's time has expired. The gentleman 
from Iowa, Dr. Ganske.
    Mr. Ganske. Thank you, Mr. Chairman. I must commend Mr. 
Dingell for his thoroughness. If there were more members of the 
committee here, they each would have obtained their own 
personal handout on their own State insurance laws.
    I appreciate Commissioner Nichols being here and Chairman 
Levitt. I want to follow up on a question that I asked 
Secretary of the Treasury Rubin; and that has to do with the 
NationsBank case.
    And so, Chairman Levitt, I wonder--I understand that the 
NationsBank settled claims of $50 million for defrauding 
investors with securities sold by an op-sub. When I asked the 
Secretary Treasurer about this, he referred us to his assistant 
who then said rather blithely, said, Well, that was handled by 
the SEC, which actually I thought made my point in terms of 
functional regulation.
    But I wonder if you could share with us the facts of that 
case; and specifically I would like to know, in your opinion, 
were investors confused by the sales of securities by a bank 
operating subsidy?
    Mr. Levitt. Yes. They clearly were. I think that, as Mr. 
Dingell pointed out, time and time again some years ago when 
banks began the sale of mutual funds to customers----
    Mr. Ganske. Mr. Chairman, can you pull the mike just a 
little closer.
    Mr. Levitt. That when banks began to sell mutual funds to 
individual customers, it became very easy to blur the lines 
between the banks, the insured deposits, the guarantees that 
went with so many banking activities, but clearly did not 
extend to money market funds or other funds that were being 
marketed to customers of banks.
    And NationsBank was a clear case of blurring the lines, 
where investors were led to make purchases that they believed 
were totally secure. They thought that it was like a deposit; 
therefore, they couldn't lose any money. They were not told 
that the fund involved the purchase of very risky derivatives 
instruments. Furthermore, the sales of that fund--and I think 
this was the most repugnant part of all of it--were targeted 
toward elderly people, people who could ill afford to lose 
their funds, people who were really victimized by bank 
personnel using the prestige and power of the institution to 
imply a level of security that simply did not exist. It was 
fraud. It was misleading. It was a very bad performance.
    Mr. Ganske. Chairman Levitt, at the hearing before this 
committee on the last Congress, you stated, ``It would be bad 
public policy to have the safety net extended over securities 
activities,'' that you thought the use of an affiliate was far 
preferable to having a subsidiary's structure. You were 
referring to bank securities underwriting in an op-sub. Do you 
still maintain that view in light of this case that you just 
told me about?
    Mr. Levitt. You know, I have learned--maybe I learn slowly, 
but I have learned after many years of dealing with complicated 
issues before the Congress that focus is all important. Any 
participant in any piece of legislation tends to have different 
interests. But here my interest is almost obsessional in terms 
of protecting investors.
    This bill, as I see it, leaves investors naked, dangerously 
naked. If choosing an op-sub or choosing an affiliate were the 
central decision to be made, I don't think that bears as 
significantly on the well being of investors as other parts of 
the bill.
    Yes, I believe that the affiliate structure certainly has 
administrative advantages. I am concerned about the fact that 
the op-subs are considered part of the bank for capital 
purposes and that the bank parent can suck out capital from the 
brokerage subs to help a weak bank. I think that, as I see it, 
is a shortcoming of the subsidiary structure. But overall, that 
is not our key issue.
    Mr. Ganske. Let me just follow up with one final question 
then because I want to get you on the record, the same as I did 
Secretary Rubin, on this issue of op-subs. And That is that you 
indicated that last year's committee print had your support to 
some degree.
    The last--the Commerce Committee print from the last 
Congress provided for limited operating op-subs and these op-
subs were limited to agency activities, as I said, to address 
Chairman Greenspan's concern about government coverage of 
taxpayer money. Can you give us your opinion? Would you be 
willing to support agency-only op-subs as a compromise?
    Mr. Levitt. I would have to think about that. My feeling is 
this: if this Congress is mindful of the importance to our 
markets of giving investors the basic protections that they 
have had for 65 years and extends to investors those same 
protections that they have had before and doesn't sweep them up 
in terms of calling something functional regulation which is 
not functional regulation, frankly, I would support any kind of 
structure that did that. I'm not going to get bogged down on 
one over the other.
    We are most concerned with securities activities that 
remain in the bank. That is where our problem lies and our 
inability to get at that. That was one of the problems in 
NationsBank. It was one of the problems that we faced in terms 
of bank-marketed mutual funds. Clearly, I'm not going to be 
dogmatic about affiliates versus subsidiaries. I do feel that 
there are some administrative advantages to the affiliates, and 
it is for that reason that I gave support to that in the past.
    Mr. Ganske. Commissioner Nichols, would you concur with 
that?
    Mr. Nichols. I think for the most part. That is clearly 
where our concern is; we cannot get to the situation occurring 
within the bank.
    Mr. Ganske. I thank you.
    Mr. Oxley. The gentleman's time has expired. The gentleman 
from Wisconsin, Mr. Barrett.
    Mr. Barrett. Thank you, Mr. Chairman. Welcome, gentlemen. 
Prior to being on this committee I spent 6 years on the Banking 
Committee. One of the major reasons I left that committee was 
this legislation. So it is nice to see it again. I often 
described it as the legislative equivalent of the movie 
Groundhog Day. I don't know if you have seen that, a Bill 
Murray movie where every day was the same and the same thing 
would happen.
    So now this is my fourth term in Congress and the fourth 
time I have seen this legislation, and I think your people have 
seen it for decades. Certainly careers are built around this 
legislation. But each time I go through it, I have to go back 
through a little primer and remind myself as to what we are 
doing.
    I look at the various industries and those industries that 
may have the greatest incentives for this legislation and the 
ones that have the least incentive. In fact, I think of the 
securities and your office in particular as having one of the 
least incentives for this legislation. Maybe I'm wrong, but 
that is just my perception.
    As I look through your testimony today, it is unclear to me 
as to whether your opposition is primarily that you don't think 
that the banks should be performing some of these functions or 
the fact, at least under your scenario, that they would be 
performing them without appropriate regulation. Can you help me 
with that?
    Mr. Levitt. Yes. I think the banking regulators of the 
United States do a superb job of protecting the safety and 
soundness of banks. I have sat on the boards of several banks. 
I have worked with banking regulators. I have listened to them 
make presentations to the boards. And the focus of their 
interests and their activity and their commitment has been the 
safety and the soundness of the bank.
    Having been in the securities business for much of my life 
and now being a securities regulator, I understand what I have 
described as a cultural difference, where the interests of 
investment banks ad brokerage firms are entrepreneurial 
interests. The number of jobs that have been created in this 
economy and the strength of our economy are a function of a 
combination of risk-taking on the part of brokerage firms and 
capital extended by banks.
    But they are two very different cultures. Now, the banking 
regulators--for instance, just to give you an example of some 
of the differences--don't impose enforceable sales practice 
rules. They don't have a duty to supervise. They don't have a 
system of arbitration enabling individual investors to bring 
their cases to arbitrators to decide them. They don't subject 
their supervisory and their sales personnel to testing and 
mandatory continuing education, and they don't require the 
disclosure to investors of a disciplinary history of those 
people selling products. They don't insure securities as SIPC 
insures the securities of investors at brokerage firms.
    So my reason for so passionately opposing this bill is 
this: if you have the growing securities activities of banks 
involving individual investors subject to the oversight of 
examiners who are concerned primarily for the banks' interests 
and for the safety and soundness of the banks rather than for 
the investors' interests, that is just wrong. It represents a 
threat not just to investors, but I believe a threat to our 
markets.
    Mr. Barrett. So it is not, per se, an opposition to banks 
performing these functions?
    Mr. Levitt. Absolutely not. I think banks should perform 
this and other functions. I have no problem with that any more 
than I have a problem with allowing brokerage firms to perform 
banking functions. But I think it would be as wrong to ask the 
SEC to supervise banking activities of brokerage firms, because 
of the cultural difference, as it would be to ask banks to 
supervise the securities activities within the banks.
    Mr. Barrett. One of the other concerns that we often hear, 
of course, is then it becomes a fight among the regulators. We 
have heard from Mr. Greenspan; we have heard from yourself, all 
people of good will, obviously people who are committed to 
this. And it concerns me that there doesn't seem to be an 
acknowledgement or a belief that another regulatory agency can 
perform some of the same regulatory functions, for example, 
that your commission does.
    Mr. Levitt. Absolutely. And no doubt in time we could train 
the National Endowment of the Arts to supervise some of these 
activities. But why? To what end? We have contradictory 
objectives in some instances here. That is good; That is 
desirable to have that.
    But to suggest that you take a 65-year history that is 
committed to investor protection--no such agency any place in 
the world can replicate the protection to investors extended by 
the SEC--and in one fell swoop, for whatever reason, you want 
to wipe that out in favor of having banking regulators do this? 
To what end? What reason do you have not to ask that securities 
activities be supervised by those who have been trained for 65 
years to do them and not change cultures in midstream?
    Mr. Barrett. You make a passionate case for your agency.
    Mr. Levitt. I make a passionate case for investors, not for 
our agency.
    Mr. Barrett. Let me continue because I think if you look at 
it, if one looks at it from a perspective of a regulator from 
the government, you make all the sense in the world. But if one 
were to look at it from the standpoint of the business to say, 
well, this week we have got SEC in here and this week we have 
got the comptroller, this week this agency in here.
    I'm not one who is considered a big lover of business, but 
I am sensitive to their concern that they are just going to be 
regulated to death. I just want you to respond to that.
    Mr. Levitt. Yes. If you look at the system of regulation 
involving financial services in the country today and you 
examine, for instance, a large multifaceted brokerage firm, a 
firm that is subjected to the inspection of State regulators, 
the SEC, Federal regulators, and self-regulatory organizations 
such as the New York Stock Exchange, that system works pretty 
darn well.
    If you took away any element of it, if you remove the 
States, if you remove the self-regulatory organization, or if 
you remove the SEC, you would severely cripple the ability to 
police those markets; and the safety of those markets and the 
efficiency and the trust in those markets would evaporate 
virtually overnight. The same holds true here.
    If banks are going to get into brokerage services, there is 
no reason to suddenly substitute a bank regulatory culture 
which is so different on those services. The bank regulatory 
culture is intended to protect the banks. The culture of 
securities regulation is intended to protect investors. Those 
two can work in a complimentary fashion, and there is no reason 
to substitute one for the other.
    If we look at this 5 years from now and Merrill Lynch owns 
a large bank, I see no reason to suggest at that point in time 
that the SEC supervise Merrill's banking activities. That is 
not our experience; that is not our culture. That would not be 
in the best interests of banks or their customers.
    Mr. Oxley. The gentleman's time has expired. The gentleman 
from Staten Island.
    Mr. Fossella. Thank you, Mr. Chairman. Chairman Levitt, let 
me concentrate briefly on securities regulation. I gather from 
your words you support SEC regulation of credit derivatives or 
swaps. Correct?
    Mr. Levitt. Yes, I do.
    Mr. Fossella. You state one of the principles at least for 
SEC support is that of sales practice regulation. Explain to me 
what the sales practice regulation is, please.
    Mr. Levitt. Well, the current provision allows banks to 
sell all derivatives to all investors without sales practice 
requirements. I think, to the extent that derivatives may be 
sold to nonsophisticated investors, to noninstitutional 
investors, there would clearly be the need to have certain 
disclosures.
    Mr. Fossella. With respect to the investor, I guess in some 
people's mind that would depend on the investor. I appreciate 
your advocacy clearly, in private and public, your support of 
protecting investors. But if you have a bank like a Citibank 
selling a derivative instrument to a sophisticated investor 
like a hedge fund, how does SEC sales practice regulation enter 
into that equation?
    Mr. Levitt. I think what the SEC has done with respect to 
the marketing of derivatives has been a very reasoned approach. 
We convened the largest derivatives dealers in the country, 
securities dealers representing nearly 90 percent of the 
securities activity in the derivatives market, and asked them 
to come up with a voluntary program of disclosure, of risk 
disclosure. That was called the Derivatives Policy Group. That 
has worked effectively without the need for regulatory 
oversight. I have said on a number of occasions that I'm not 
looking to develop a new series of regulations in the 
derivatives markets.
    Mr. Fossella. So where in there lies the sophisticated 
investor? They should self-regulate it?
    Mr. Levitt. I wouldn't use the word self-regulate. I think 
there is a need for greater disclosure, and we are getting that 
now with the Derivatives Policy Group, which up to now has 
worked reasonable effectively. The President's Working Group 
has made some suggestions, which Chairman Greenspan, Secretary 
Rubin, and I all support, for more disclosure. We simply cannot 
have enough disclosure in this regard, and I think I would use 
that expression rather than----
    Mr. Fossella. In an unrelated topic while I have you, 
however, I would like to get your opinion on what is commonly 
referred to as section 31 fees which support the SEC.
    Mr. Levitt. That is an easy one.
    Mr. Fossella. I beg your pardon?
    Mr. Levitt. That is an easy one.
    Mr. Fossella. That is what I am here to do, throw some 
softballs your way. It has been, I guess, demonstrated that 
section 31 fees generated are now in the area of $1.7 billion. 
There is different approaches as to what to do with the fees, I 
guess, on capital investment or tax on capital investment, 
depending on how you look at it.
    Do you have a belief as to what should happen with the 
section 31 fees? There are different approaches that are being 
discussed, the rate cap, cap on fees. I would be interested to 
hear your opinion.
    Mr. Levitt. The section 31 fees changed their complexion 
when we extended those fees to include over-the-counter 
transactions. That happened as part of a funding mechanism for 
the SEC that Chairman Bliley devised. I guess it was 3 or 4 
years ago.
    There were a half dozen committees involved in this in both 
the House and the Senate, and I understand the desirability of 
reducing those fees. Indeed, by eliminating the double-counting 
that took place in the over-the-counter market, we have been 
able to constructively reduce those fees, I guess, by $10 or 
$15 million a year.
    I think to further address that issue, the proposal to 
place a cap on the fees appears to be the most reasonable of 
the various proposals that I have seen. And the trick is to get 
the various committees that have an interest in these fees to 
come to the table and agree. But I think, of the various 
proposals that I have seen, that appears to be the one most 
likely to produce a consensus.
    Mr. Fossella. Thank you very much for your time, Mr. 
Chairman. I yield back.
    Mr. Oxley. The gentleman yields back time. The gentleman 
from New York, Mr. Engel.
    Mr. Engel. Thank you, Mr. Chairman. Good afternoon, 
gentlemen. Chairman Levitt, this morning Secretary Rubin both 
in his written statement and his oral response to a question 
from Congresswoman DeGette indicated that the Banking 
Committee's security provisions in the bill provided inadequate 
consumer protections. I believe that he said that the 
exceptions swallowed the rules. And he indicated his 
willingness to work with you and with us to provide stronger 
investor protections.
    I am wondering if you could help us understand what the 
sticking points are. I guess that is my question. He said there 
had been ongoing discussions with you and the bankers, but he 
felt there was still no solution.
    Mr. Levitt. That is true. We have had extensive discussions 
with Secretary Rubin and with Chairman Greenspan. And we have 
told them that we feel this bill does great, great harm to 
investor interest. With respect to the exemptions that have 
been created through the years, various changes that were made 
in the Senate version of this bill last year would, in effect, 
just substitute banking regulation for securities regulation 
over securities activities conducted within the walls of the 
banks.
    Now, I don't have to tell you that any piece of complex 
legislation is a function of various interest groups that have 
an axe to grind. The insurance companies have an interest. You 
have heard about them. The banks have an overwhelming interest, 
and heaven knows we have heard about that. We have an interest. 
But the most powerful interest of all, in terms of the 
implications for the economy, is investor interest.
    It is a question of who is willing to stand up, who is 
willing to say to the banks, look, I know you are not going to 
give in, but if you are not, you are not going to get a bill if 
you are going to hurt investors.
    I have outlined before the loopholes created with respect 
to future products, trust activities, the way that derivatives 
and swaps are handled and private placements--private 
placements alone could be a proxy for investment banking 
activity. It's just there. It is there to happen. I understand 
Secretary Rubin is sympathetic and Chairman Greenspan is 
sympathetic. But will they say this issue is as important to 
them as the various issues that concern them? Time will tell.
    Mr. Engel. One of the things that he also mentioned is that 
it would be cheaper for a small minority-owned bank to get into 
insurance and securities through an operating subsidiary versus 
a separate affiliate. I was wondering if that was your view as 
well.
    Mr. Levitt. I don't believe that. I think there are ways 
that an affiliate could be comparable. And certainly the 
Commission would be responsive to encouraging that in any way 
that we could.
    Mr. Engel. What are the costs associated with setting up a 
broker-dealer as a separate affiliate?
    Mr. Levitt. I don't know precisely. I would have to do some 
work on that and get back to you, if I might.
    Mr. Engel. The Secretary also said in his opinion the 
problem that our financial services face abroad is lack of 
access and not lack of competitiveness. I know it is a trade 
issue obviously in large part, but several large broker-dealers 
have told us that their access in some countries is hindered 
because they don't have a consolidated regulator or an umbrella 
supervisor.
    Is there anything in H.R. 10 that would address this 
concern, and if not, should this concern be addressed? Do you 
have any suggestions for us on that?
    Mr. Levitt. I think to some extent the WFI might be one way 
to do this, and I think the problem that the Secretary mentions 
is a legitimate problem and something that I think we have to 
be mindful of.
    Mr. Engel. Thank you very much. Thank you, Mr. Chairman.
    Mr. Levitt. By that I meant the broker-dealer holding 
company containing a WFI, which I think this committee 
considered seriously the last time out.
    Mr. Engel. Thank you.
    Mr. Oxley. The gentleman's time has expired.
    The gentleman from Florida, Mr. Deutsch.
    Mr. Deutsch. Thank you, Mr. Chairman.
    I thank the Commissioner as well.
    Mr. Levitt, if you could, I have read through your 
testimony and I have heard some of the responses to questions 
in the last couple minutes as well, but just for a couple 
seconds, you have discussed the current bill's possible adverse 
effect on the economy. In layman's terms, could you maybe get 
into some analysis of the dif-

ference between the effect of the House banking bill versus the 
effect of the bill that this committee passed last year in 
terms of the market and in terms of the average consumer in 
America?
    Mr. Levitt. Last year's bill, which we supported as a 
better alternative than something which we felt was pretty bad, 
was by no means perfect. The reason that we favor the Commerce 
Committee's approach to this bill is that it respects the 
primacy of consistent regulation. I no longer use functional 
regulation because that word has been so misused by people who 
have other reasons for using it. This committee, in terms of 
its approach has respected consistent regulation, and its 
proposal last time was intended to see to it that all 
securities activities that take place within the banks are 
supervised and regulated by securities regulators. That is the 
fundamental difference between the bill that came out of the 
House which creates a situation where banking regulators 
supervise virtually everything that goes on within the walls of 
the banks.
    I have mentioned specific areas which we find the most 
dangerous from that point of view. If anything, this year's 
bill is more troublesome, but the bill that is winding its way 
around the Senate is probably the worst of all.
    Mr. Deutsch. My understanding, and you have testified to 
this effect of negotiations that you are in the process of 
having with Secretary Rubin as well as Mr. Greenspan regarding 
the--and I will use the term, because I guess that is a term 
that we are still using, the ``functional regulation'' issue, 
can you give us any report on the progress of those 
negotiations?
    Mr. Levitt. I think I said before that intellectually I am 
sure that I know that both of them share the concerns for 
investors that we have expressed, but their interests in and 
their versions of the bill have other aspects, with other 
constituencies.
    As far as I am concerned, our only constituent is the 
investing public, and whether their interest is in coming to 
some sort of a consensus arrangement which has the chance of 
legislative reality and executive passage, signature, I simply 
don't know. I think that they have expressed support for our 
position, but how far that support will go in terms of its 
tradeoff for other interests, only time will well.
    Mr. Deutsch. Is it fair to say that you are continuing in 
this process?
    Mr. Levitt. Is it fair to say what?
    Mr. Deutsch. That you are continuing in these discussions, 
these negotiations?
    Mr. Levitt. Yes.
    Mr. Deutsch. So these discussions are ongoing?
    Mr. Levitt. Absolutely.
    Mr. Deutsch. Is there anything we can do to be helpful?
    Mr. Levitt. I will think about that.
    Mr. Deutsch. Let me ask you--and again you talked a little 
bit about it in your testimony, and this is just, you know, as 
I try to understand what is actually going on in the world 
today, my understanding is that, in fact, banks are using 
swaps, using derivatives in equities, which have the equivalent 
of basically sales of securities. That is going on today. Would 
you say that is accurate, and if it is accurate, how does the 
SEC view that activity? My understanding is that it is going on 
without SEC interaction at all.
    Mr. Levitt. If there are derivative activities going on 
with securities involving fraud, the SEC would obviously have 
jurisdiction. I believe that the derivatives activities of 
banks are by and large being done with institutional investors. 
We have a much greater understanding of the nature and extent 
of those activities as a result of the establishment of the DPG 
which I mentioned before.
    Mr. Deutsch. But again, if I can just follow up with just 
one final question, your answer seems to infer that only in 
cases of fraud would you be involved.
    Mr. Levitt. No, no, fraud in the swaps market is a rare 
occurrence.
    Mr. Deutsch. Right. So again, if in fact they are trading 
securities, equities, through swaps, in effect you have no 
jurisdiction today; or are you not using what you might infer 
as jurisdiction? In other words, I guess my point is, isn't 
this already occurring and it is occurring within the banking 
laws without the SEC really being involved in this today?
    Mr. Levitt. Most swaps, I would point out, don't represent 
securities, and those that do should follow the same rules as 
securities that are sold by brokers.
    Mr. Deutsch. I don't--I am still not hearing the answer. My 
understanding is that is going on today, but you are not 
regulating it, you are not involved.
    Mr. Levitt. You are correct, there is a blanket exemption 
now.
    Mr. Deutsch. And if that is the case and we don't really 
see issues of fraud, then I mean why do we think there would be 
problems? I mean, in other words, it is already going on. 
Shouldn't all these parades of horribles that you described, 
shouldn't they be taking place already?
    Mr. Levitt. Because I think in the world as I see it 
developing, with more and more securities activities going into 
banks and the increasing likelihood of acquisitions of 
brokerage firms by banks, this will become far more important 
in terms of securities activities than it is today.
    Mr. Deutsch. Okay. Thank you, Mr. Chairman.
    Mr. Oxley. The gentleman's time has expired.
    The gentleman from Illinois, Mr. Shimkus.
    Mr. Shimkus. Real quickly. Thank you, Mr. Chairman, and I 
welcome to the committee Chairman Levitt who graced us with his 
hospitality maybe 6 weeks ago at the SEC and I enjoyed that 
visit. I learned a lot too, and I think that is important.
    I have been focusing on this issue, on safety and 
soundness, and now consistent regulation. Politicians--you have 
to be careful about changing words for us, because I am very 
comfortable with ``functional,'' but I will use ``consistent.'' 
And my focus has been on the operating sub and really the FDIC 
insurance and how that might impact safety and soundness.
    Your predecessor, Richard Breeden, when asked about the 
operating subsidiary before the Commerce Committee made the 
following statement: ``If government subsidies such as the 
operating subsidiary are introduced into the securities market, 
then the dulling narcotic effect of these subsidies and the 
related bureaucratic nannyisms will work a prompt and 
significant alteration on the culture of Wall Street.'' Do you 
agree with that?
    Mr. Levitt. My predecessor, whom I respect and admire a 
great deal, was much more confrontational than I am. Again, it 
is not my primary issue. My issue is again consistent 
regulation, and I have expressed, for administrative purposes, 
some preference for the affiliate structure. Will western 
civilization rise or fall on that decision? I don't know. 
Again, I don't want to divert from something that I consider to 
be of much greater importance.
    Mr. Shimkus. I think why members of the committee may be 
focusing on this is because there seems to be an impression 
that last year it was an issue which you were concerned about, 
and if the answer is no to this question, or to the view that 
they may be different than the position taken last year----
    Mr. Levitt. I think the difference is simply that the 
threat that I see to our markets and to investors in a bill 
which so blurs the line between banking and securities 
regulation is of such compelling and immediate importance that 
it overrides my concern for the structural issue. Again, I have 
some preference for the affiliate structure, but that is of a 
much lower level of concern than the other, and I am going to 
stick with that.
    Mr. Shimkus. That answers my question. Or it doesn't--it 
addresses my question, so I will yield back my time, Mr. 
Chairman.
    Mr. Oxley. The gentleman's time has expired.
    The gentleman from Michigan wishes to be recognized.
    Mr. Dingell. I thank you for that courtesy and I thank you 
for your patience.
    Under the exemptions, Mr. Chairman, I note that private 
placements would be one of the exemptions. The Fed would be 
required to come up with certain rules, and the Fed, the OCC 
and the Treasury would be required to come up with certain 
rules with regard to these matters. Now, private placements are 
kind of peculiar. First of all, the number of people who can 
participate in them are very small, they have to be highly 
sophisticated, they have to have a lot of money, which makes 
them presume to be very sophisticated and smart. But there is 
much less in the way of protection for the rights of the 
investor in that situation.
    In instances where there are private placements, the rules 
that are now in place under the SEC would not necessarily be in 
place under the new regime under the legislation. The practical 
result of that would be that every one of the placements could 
essentially become private placements playing under the rules 
which afford vastly less protection for the investor. Indeed, 
zero protection for the investor on the assumption that anybody 
who is silly enough to go into one of these private placements 
would be smart enough to protect himself and have enough money 
even if he missed it, isn't that right?
    Mr. Levitt. Absolutely.
    Mr. Dingell. Now, just one other thing. Your current 
authority over private placements regarding suitability, 
disclosure, failure to supervise, and the requirements with 
regard to keeping books and records would be significantly 
modified as to activities within the banks and also as to 
activities within the wholly owned op-subs, isn't that so?
    Mr. Levitt. That is correct, and I might say that a 
majority of the corporate debt you spoke of before is placed 
privately. A majority of corporate debt is privately placed.
    Mr. Dingell. Not subject to disclosure and not subject to 
other rules to protect the investor; isn't that right?
    Mr. Levitt. Not under this configuration.
    Mr. Dingell. Thank you.
    Thank you, Mr. Chairman.
    Mr. Oxley. The committee wishes to thank both of you for, 
once again, excellent testimony. As I indicated when you first 
arrived, we hope this is the last time that you will be here 
testifying on this particular issue, although we welcome you on 
many issues in the future other than financial services 
modernization. Thank you very much.
    Mr. Nichols. Can I make a comment, sir, before we go?
    Mr. Oxley. Please.
    Mr. Nichols. I hope that as you all move forward on this, 
that you recognize that as we have addressed the issue of 
banking, we have talked about the business of banking, but on 
this panel you have heard from Arthur Levitt whose focus has 
been on the end result, the investor, and my focus has been on 
the insurance consumer. As we go through financial 
modernization, we should allow them to commingle, but let us 
keep that in perspective: that two of the pieces of the three-
legged stool are very, very critical to the ones that are 
actually investing the money.
    Mr. Oxley. And two of those legs are under the jurisdiction 
of this committee, so I appreciate your remarks. Again, I thank 
you so much for your testimony.
    The subcommittee will stand in recess for 5 minutes so that 
we can have the other panel come up to the witness table.
    [Brief recess.]
    Mr. Oxley. The subcommittee will reconvene. I know that we 
have our final panel here, because they have been waiting 
patiently all day, since 10 o'clock this morning. So we are 
pleased to have you here. Let me introduce the panel. Mr. 
Arnold Schultz, Board Chairman for the Grundy National Bank 
from Grundy Center, Iowa; Mr. Mark Sutton, President of the 
Private Client Group from PaineWebber, from Weehawkin, New 
Jersey; and formerly mentioned and introduced by my colleague, 
Paul Gillmor, Mr. Craig Zimpher, Vice President of Government 
Regulations, Nationwide Insurance Corporation. I agree with 
most of the things that Congressman Gillmor said about you. Mr. 
Scott A. Sinder, partner of Baker and Hostetler, a good 
Cleveland-based firm located here in Washington, on behalf of 
the Independent Insurance Agents, the National Association of 
Life Underwriters, and the National Association of Professional 
Insurance Agents of America.
    So gentlemen, thank you all for your patience. It is always 
difficult to be on the last panel, but we thank you for your 
patience and your understanding.
    Mr. Sutton, I am going to begin with you, as I understand 
you might have a plane to catch. So let me begin with your 
testimony. After your testimony, again, feel free to stay as 
long as you can, but I understand your commitment as well.

STATEMENTS OF MARK B. SUTTON, PRESIDENT, PRIVATE CLIENT GROUP, 
 PAINEWEBBER INC.; ARNOLD SCHULTZ, BOARD CHAIRMAN, THE GRUNDY 
  NATIONAL BANK; W. CRAIG ZIMPHER, VICE PRESIDENT, GOVERNMENT 
   RELATIONS, NATIONWIDE INSURANCE CORPORATION; AND SCOTT A. 
    SINDER, PARTNER, BAKER AND HOSTETLER, LLP, ON BEHALF OF 
 INDEPENDENT INSURANCE AGENTS OF AMERICA, NATIONAL ASSOCIATION 
OF LIFE UNDERWRITERS, AND NATIONAL ASSOCIATION OF PROFESSIONAL 
                  INSURANCE AGENTS OF AMERICA

    Mr. Sutton. Thank you very much. I appreciate it.
    Chairman Oxley and members of the subcommittee, I am Mark 
Sutton, Executive Vice President of PaineWebber Group and 
President of PaineWebber's Private Client Group. I am also a 
member of the Board of Directors of the Securities Industry 
Association.
    First of all, let me say I appreciate the opportunity to 
present PaineWebber's views on H.R. 10 and the Financial 
Services Act of 1999. PaineWebber commends you for your efforts 
and those of this subcommittee to enact desperately needed 
legislation to modernize the regulation of the United States 
financial services industry.
    I manage PaineWebber's retail brokerage business. We have 
over 18,000 employees in 300 offices around the United States. 
Passage of H.R. 10 is essential to providing PaineWebber and 
the entire securities industry fair access to compete globally 
and nationally. This is a dynamic time in the financial 
services industry with the demographic shifts in the aging baby 
boomers and the increasing numbers of companies changing their 
pension plans from defined benefit to defined contribution. 
Each of these actions contribute to the creation of 50 million 
individual pension plan managers. These significant domestic 
shifts, along with global competitive challenges, present the 
platform for my appearance today, urging you to pass H.R. 10 
this year.
    Mr. Chairman, my message is simple. The securities industry 
strongly supports financial services modernization and urges 
this subcommittee, the Commerce Committee, the House, and the 
Senate to pass it promptly.
    Last year, the House capitalized on a unique opportunity 
for the passage of financial services modernization legislation 
when large segments of the banking, securities and insurance 
industries were able to reach a series of compromise positions 
on issues that had previously divided them and that had 
previously prevented legislation from being enacted. We believe 
the opportunity created last year for passage of financial 
services legislation still exists, and we urge the House to act 
swiftly to pass this legislation.
    PaineWebber believes that there is more than one approach 
to modernize the regulatory framework for the financial 
services industry. For the securities industry to support the 
legislation, it should satisfy three fundamental principles: 
first, maintaining functional regulation; second, providing a 
two-way street; and finally, fostering competition without 
Federal subsidies. For the legislation to be successful, it 
should incorporate the compromise provisions agreed to by 
industry and also by Members of Congress.
    These provisions, particularly the functional regulation of 
bank securities activities are not only good public policy, but 
they also remove the disagreements that have derailed this 
legislation many times in the past. Today, financial 
institutions are affiliating with one another at an 
accelerating speed under a regulatory system that was intended 
to ban such affiliations. In the last 2 years, banks have 
acquired more than 50 securities firms. Mergers and 
acquisitions are occurring in spite of significant and 
anticompetitive regulatory obstacles.
    For example, currently, banks can acquire securities firms 
while securities firms generally cannot acquire commercial 
banks. The financial services industry will continue to evolve 
in response to customers' demands, but it is simply not 
desirable, nor possible, to maintain the status quo. The 
fundamental policy question for Congress is not whether these 
affiliations should occur, but what regulatory systems should 
govern the combined entities. Surely it should not be the 
current patchwork regulatory structure that gives some 
financial institutions unfair and irrational competitive 
advantage over others.
    PaineWebber supports key provisions of H.R. 10 because they 
go a long way toward meeting the three principles upon which 
any new financial legislation should be built. The first 
principle, functional regulation, would require one regulatory 
agency to apply the same set of rules to the same activity 
engaged in by any financial institution regardless of the type 
of financial institution it may be. Under H.R. 10, most 
securities activities would be performed outside of a bank, 
except for a small number of carefully defined securities 
activities that traditionally have been conducted in banks with 
the benefit of SEC, SRO, and State securities regulation.
    After years of negotiation, the securities and banking 
industries developed a set of functional regulation provisions 
that permitted banks to continue to engage in certain 
securities activities that banks had traditionally provided to 
their customers as an adjunct to their banking services, but 
that required full-scale brokerage operations be conducted 
outside of the bank in an SEC- and NASD-regulated brokerage 
affiliate. Notably, PaineWebber is not aware of any significant 
opposition in either the banking or the securities industries 
to these functional regulation provisions. PaineWebber supports 
the strong regulation provisions in H.R. 10.
    Second, the legislation generally provides for a two-way 
street by permitting securities firms, insurance firms and 
banks to freely affiliate with one another on the same terms 
and conditions and to engage in any activity that is financial 
in nature.
    Third, PaineWebber supports the holding company affiliate 
structure. But importantly, H.R. 10 allows for the SEC to 
regulate securities activities whether they are conducted in an 
affiliate under a holding company structure or in an operating 
subsidiary of a bank. PaineWebber believes that this would, at 
a minimum, ensure that securities activities are regulated by 
the appropriate experienced authority.
    Mr. Chairman, in the last session, PaineWebber supported 
H.R. 10 and worked actively to pass it. The bill presented a 
series of compromises by every sector of the financial services 
industry. We supported the bill because we were, and we are, 
committed to maintaining the delicate consensus compromise that 
emerged among all of the participants. PaineWebber has worked 
with you, Chairman Oxley, members of this subcommittee, others 
in Congress and many in the financial services community to 
reach a number of the compromise positions that are reflected 
in H.R. 10. The progress we have made cannot be overstated. 
Passage of the financial services modernization legislation is 
vital to maintaining the global competitiveness as well as the 
financial products and services for our individual customers.
    Mr. Chairman, we look forward to working with you, members 
of your subcommittee, as well as the House, Senate and 
administration to enact financial services legislation reform 
this year. Thank you.
    [The prepared statement of Mark B. Sutton follows:]
Prepared Statement of Mark B. Sutton, President, Private Client Group, 
                        PaineWebber Group, Inc.
    Chairman Oxley and members of the Subcommittee, I am Mark B. 
Sutton, President Private Client Group, PaineWebber Group, Inc. I am 
also a member of the Board of Directors of the Securities Industry 
Association. I appreciate the opportunity to present the views of 
PaineWebber on H.R. 10, the Financial Services Act of 1999. PaineWebber 
commends you for your efforts Mr. Chairman, and those of this 
Subcommittee, to enact desperately needed legislation to modernize the 
regulation of the United States financial services industry. 
PaineWebber is optimistic that this year Congress will pass, and the 
President will sign into law, widely supported financial services 
modernization legislation. We look forward to working with you and 
members of this Subcommittee to achieve this result.
    I manage PaineWebber's entire retail brokerage business. We have 
over 7000 financial advisors and over 300 offices around the United 
States. Passage of H.R. 10 is essential to providing PaineWebber and 
the entire securities industry fair access to compete globally and 
nationally. This is a dynamic time in the financial services industry 
with the demographic shifts in the aging baby boomers and the 
increasing shifts in companies' pension plans from defined benefit to 
defined contribution in effect, contributing to the creation of 50 
million individual pension planners. These significant domestic shifts, 
along with global competitive challenges, present the platform for my 
appearance today in urging you to pass H.R. 10 this year.
    My message today is simple. The securities industry strongly 
supports financial services modernization legislation and urges this 
Subcommittee, the Commerce Committee, the House, and the Senate to pass 
it promptly. Last year, the House capitalized on a unique opportunity 
for the passage of financial services modernization legislation when 
large segments of the banking, securities and insurance industries were 
able to reach a series of compromise positions on issues that 
previously had divided them. We believe the opportunity created last 
year for passage of financial services modernization legislation still 
exists, and we urge the House to act swiftly to pass legislation this 
session.
    PaineWebber shares the concerns of certain members of this 
Subcommittee that H.R. 10 has flaws. But reform of existing financial 
services regulations must be viewed in a realistic context. After more 
than 60 years of operating under the current regulatory structure, 
banks, thrifts, insurance companies and agents, securities firms, 
consumer groups, financial services regulators, executive agencies and 
others have legitimate, competing and often conflicting views of how 
the financial services industry should be regulated. Due in part to the 
large number of competing interests, financial services modernization 
legislation has stalled in every congressional session in recent 
memory. In this environment, no bill can be ``perfect,'' because each 
bill will represent a compromise in which each industry may get some, 
but not all, of its favored solutions. It, therefore, is left to 
Congress to resolve these competing interests and develop legislation 
that is in the national interest.
    Under the current regulatory system, banks are rapidly acquiring 
securities firms and banking regulators are being forced to devise new 
ways to regulate and supervise their bank securities affiliates--a role 
previously the exclusive domain of the Securities and Exchange 
Commission (SEC). Neither securities customers nor the financial 
services industry benefits from the ad hoc and duplicative regulatory 
scheme that has developed. And the longer regulators debate ever finer 
points of jurisdiction and competing regulatory schemes, the more 
deeply and permanently entrenched the banking industry and regulators 
become in the securities industry. The regulatory system under H.R. 10, 
warts and all, is significantly superior to the current system for 
financial services consumers and firms alike.
    Congress has the opportunity to build upon the momentum generated 
last year and act swiftly to pass legislation. To lose this opportunity 
would be highly unfortunate for the financial services industry, which 
is laboring under an antiquated and often counterproductive regulatory 
system. Moreover, it would be a loss for the American public, who, as 
consumers of financial products and services, are not receiving the 
benefits of competition and innovation that would result from financial 
services modernization legislation.
    The need for prompt financial services modernization legislation is 
compelling. As I mentioned earlier, today financial institutions are 
affiliating with one another at a dizzying speed. What's more, these 
affiliations are occurring under a statutory system that originally was 
intended to ban such affiliations. These affiliations are the result of 
ad hoc decisions by banking regulators that have permitted banking 
organizations to acquire securities firms, while securities firms 
generally remain prohibited from acquiring commercial banks. This is 
the case, because, under current law, if a securities firm were to 
acquire a bank, the combined entity would become subject to the Bank 
Holding Company Act and the Glass Steagall Act, even though these laws 
were not designed to accommodate many of the ordinary and customary 
activities of securities firms (such as securities underwriting and 
dealing, the distribution of mutual funds, merchant banking, venture 
capital, commodities and various other activities). Also, many of the 
current restrictions on bank affiliates were imposed prior to the 
invention of computers, fax machines, ATMs, the Internet, and various 
other technological innovations that have transformed the financial 
services industry. Statutory impediments more than 60 years old make 
little sense in today's technologically sophisticated highly 
competitive and global financial world.
    Still, financial services providers continue to affiliate under the 
current regulatory framework, despite outdated restrictions that 
unfortunately increase the cost of affiliations and limit the 
competitiveness of the combined firms. In the last two years, banks 
have acquired more than 50 securities firms. Financial services firms 
affiliate in response to their customers' and clients' demands and to 
remain competitive in the financial marketplace. The financial services 
industry will continue to evolve regardless of whether financial 
services modernization legislation is enacted. It is simply not 
desirable or possible to maintain the status quo. The fundamental 
policy question for Congress is not whether these affiliations should 
occur, but what regulatory system should govern the combined entities. 
Surely, it should not be the current patchwork regulatory scheme that 
gives some financial institutions unfair and irrational competitive 
advantages over other financial institutions. PaineWebber believes 
these combined entities should be regulated under a system similar to 
that contemplated under H.R. 10. Providing financial services in 
functionally regulated entities that may affiliate with one another in 
a holding company structure will enhance the competitiveness of all 
financial services firms, ensure investor protection, and assure the 
appropriate level of protection for depositors and the deposit 
insurance fund.
    The U.S. securities industry is perhaps as competitive as any 
industry in the world. It is in part a result of that competition--
including the ability to affiliate with entities other than banks--that 
the U.S. capital markets are the world's largest and most liquid. In 
the securities markets, one need only look at the vast choices in 
products, services, providers, and methods of compensation to see how 
competition has greatly benefited investors. Consumers can invest in 
stocks, bonds, and thousands of mutual funds. They can choose a full-
service provider or a financial planner to receive advice on managing 
their assets. More independent and knowledgeable investors can use a 
discount firm to execute their transactions. Alternatively, consumers 
can make their trades electronically over the Internet for a fraction 
of the cost of just a few years ago. Investors can choose to compensate 
their broker in a traditional commission arrangement, a flat-fee basis, 
or as a percentage of assets under management. These changes greatly 
benefit investors and are the direct result of a highly diverse, 
competitive industry that is willing and able to invest the capital 
needed to meet the demands of its customers. Passage of financial 
services modernization legislation would bring the benefits of 
competition, including cost savings estimated at $15 billion over three 
years, to the entire financial services marketplace.
    Mr. Chairman, PaineWebber generally supports H.R. 10 for several 
reasons.
    First, H.R. 10 has an appropriate definition of ``financial in 
nature,'' which governs the types of activities in which financial 
holding companies may engage. Permissible activities also would include 
activities that are incidental or complementary to activities that are 
financial in nature, in order to permit securities, insurance and other 
types of financial services firms to continue providing long-standing 
and important services to their customers.
    Second, H.R. 10 would create a new regulatory structure that would 
enhance the competitiveness of financial services firms by permitting 
securities firms, insurance companies, and banks to freely affiliate in 
a holding company structure. This would increase competition between 
financial services firms, thus reducing costs and giving consumers more 
choices. It also would help the U.S. financial services industry 
maintain its preeminent status in the global economy. Under H.R. 10, 
the holding company would be regulated by the Federal Reserve Board. 
Each of the subsidiary financial institutions engaging in a securities 
business would be registered as a broker-dealer and would be 
functionally regulated by the SEC, thereby bolstering investor 
protection and fair competition.
    Third, H.R. 10 would give customers more choices. Many individuals 
and corporate customers worldwide are demanding to have all their 
financial needs met by a single firm. The ability of securities firms, 
insurance companies, and banks to affiliate would allow a single 
financial services firm to meet those needs. Individuals could choose a 
full-service provider because they value something as simple as a 
single monthly statement showing their checking account balances, 
securities holdings, retirement account investments and insurance 
policy values.
    Fourth, the legislation generally provides for a two-way street, by 
permitting securities firms, insurance companies, and banks to freely 
affiliate with one another, on the same terms and conditions, and to 
engage in any activity that is financial in nature.
    Fifth, H.R. 10 would create wholesale financial institutions 
(``WFIs''), which are banks that do not accept deposits that are 
insured by the federal government--that is, they generally do not 
accept deposits under $100,000. WFIs would provide commercial banking 
services to institutional customers without imposing any risk to the 
bank insurance fund or U.S. taxpayers.
    Significantly, the legislation would require each financial 
institution to be functionally regulated. One regulatory agency should 
apply the same set of rules to the same activity engaged in by any 
financial institution, regardless of the type of institution it may be. 
PaineWebber strongly believes that the SEC, the securities self-
regulatory organizations (``SROs''), and the state securities 
regulators should oversee securities activities regardless of what 
entity performs those activities. Similarly, the appropriate federal or 
state-banking regulator should regulate banking activities, and the 
appropriate state insurance regulator should regulate insurance 
activities.
    Functional regulation assures that the most knowledgeable regulator 
is supervising a financial services institution's diverse activities. 
In the securities markets, all participants would be equally subject to 
the principle of complete and full disclosure and regulation by the SEC 
and SROs. The guiding principle of disclosure protects investors, 
encourages innovation, and promotes fair markets. Indeed, under this 
regulatory structure, the U.S. capital markets have set the global 
standard for integrity, liquidity, and fairness. Investors understand 
the protections they are afforded and market participants understand 
their obligations.
    Moreover, functional regulation eliminates regulatory discrepancies 
and the resulting competitive advantages between financial services 
firms engaging in the same activities. Under H.R. 10, all securities 
activities would be performed outside of a bank, with the benefit of 
SEC, SRO and state securities administration regulation, except for a 
small number of carefully defined securities activities that 
traditionally have been conducted in banks.
    After years of negotiation, the securities and banking industries 
developed a set of functional regulation provisions (1) that permit 
banks to continue to engage in certain limited securities activities 
that banks traditionally have provided to their customers as an adjunct 
to their banking services, but (2) require all other securities 
activities be conducted outside of the bank in an SEC- and SRO-
regulated brokerage affiliate. Notably, PaineWebber is not aware of any 
significant opposition--in either the banking or securities 
industries--to these functional regulation provisions. PaineWebber 
supports H.R. 10 in part because it incorporates the functional 
regulation provisions.
    I would note that PaineWebber supports the holding company/
affiliate structure. Importantly, however, although H.R. 10 allows for 
securities activities to be conducted in an operating subsidiary of the 
bank, the SEC is expressly authorized to regulate the securities 
activities of the operating subsidiary, as well as to regulate such 
activities if conducted elsewhere in the holding company. PaineWebber 
believes that this ensures that securities activities are regulated by 
the appropriate, experienced authority-the SEC, the National 
Association of Securities Dealers, Inc., New York Stock Exchange, and 
other securities regulators.
    Mr. Chairman, last session PaineWebber and many other securities 
firms supported H.R. 10 and worked actively to pass it. That bill, 
while not perfect, represented a series of compromises by every sector 
of the financial services industry. Although there were a number of 
provisions that PaineWebber believed could be improved, we supported 
the bill because we were committed to maintaining the delicate 
compromise that had achieved consensus among all the participants. H.R. 
10 represented a fair and thoughtful approach to balancing the 
competing interests of a wide range of financial services providers and 
regulators, and it is a vast improvement over our current regulatory 
system.
    PaineWebber remains committed to working with the Commerce 
Committee to pass a consensus version of H.R. 10. However, if changes 
are to be made to the bill, we recommend the following:

 Increasing securities firms' ability to affiliate. Securities 
        firms, insurance companies, and other diversified financial 
        firms currently may affiliate with non-financial firms. 
        PaineWebber believes that financial services modernization 
        legislation should reflect current market practices and permit 
        commercial affiliations to continue. Existing commercial 
        affiliations have not weakened securities, insurance, and other 
        financial services firms, and there is no reason to believe 
        that permitting banks to similarly affiliate with commercial 
        companies will endanger banks. Indeed, the experience under the 
        unitary thrift charter, which currently permits commercial 
        firms to own or affiliate with a thrift, is powerful empirical 
        support for this view.
 Broadening the description of permissible merchant banking 
        activities to assure that current market practices are not 
        inadvertently restricted. For example, because of the 
        restrictions in H.R. 10 against a securities firm becoming 
        involved in a company's day-to-day management operations, the 
        securities firm might be unduly limited in its ability to 
        interact with the management of a company it acquired in a 
        merchant banking transaction. Similarly, the securities firm 
        might be required to divest that company in a ``fire sale'' 
        because of the bill's restrictions on the length of time the 
        company could be owned.
    PaineWebber has worked with you, Mr. Chairman, members of this 
Subcommittee, others in Congress, and many in the financial services 
community to reach a number of the compromise positions that were 
reflected in H.R. 10. The progress we made cannot be overstated. 
Passage of financial services modernization legislation is vital to the 
financial services industry in general and to the securities community 
in particular.
    Mr. Chairman, we look forward to working with you, members of your 
Subcommittee, as well as the House, Senate, and Administration to enact 
financial services reform legislation this year.

    Mr. Oxley. Thank you, Mr. Sutton.
    Let's go now to Iowa and hear from Mr. Arnold Schultz.

                  STATEMENT OF ARNOLD SCHULTZ

    Mr. Schultz. Thank you, Mr. Chairman, members of the 
committee. I am Arnie Schultz, Chairman of the Grundy National 
Bank, a $106 million community bank in Grundy Center, Iowa. We 
have been in business since 1934, serving the consumer, 
business and agriculture needs of our community. Thank you for 
giving me the opportunity to share my views on the financial 
reform legislation currently before your committee.
    You asked that I testify on the operating sub issue. Let me 
say I support the position of Fed Chairman Alan Greenspan that 
risky, new activities that are authorized under this bill 
should be pushed out into separate capitalized affiliates of 
the holding company. Chairman Greenspan argues that the holding 
company structure is superior for two reasons. One of those 
reasons is to minimize the Federal subsidy arising from the 
Federal safety net that would flow to operating subs. The 
second is to protect the safety and soundness of our banking 
and financial system. I will limit my comments today to the 
safety and soundness issue.
    One of the consequences of this bill will be for the 
emergence of large financial conglomerates. For example, a 
large commercial bank could merge with a securities firm that 
deals in derivatives which, in my judgment, is a risky line of 
business. If an op-sub incurred a rapid loss of capital from 
its derivative activities, it would immediately put pressure on 
the commercial bank to come to its rescue. The same reasoning 
applies to risky merchant banking activities. If trouble 
arises, and if the bank was also too big to fail, the Federal 
Reserve discount window would likely feel the pressure first, 
followed by the FDIC and ultimately, depending upon the size of 
the institution, the taxpayer.
    Protection of the Federal safety net is crucial and is best 
served by the holding company structure. Shielding risky 
activities from the bank will provide maximum protection for 
the deposit insurance fund.
    I would hate to see the failure of a large multinational 
bank jeopardize the solvency of the FDIC Fund because of its 
involvement in risky, nontraditional bank activities. As a 
community banker who is not protected by the ``Too Big To 
Fail'' doctrine, deposit insurance is the lifeblood of my 
operation. The bill that was reported out of the House Banking 
Committee would give the Fed some oversight over op-sub 
activities, but it doesn't provide maximum insulation of risky 
activities from the core bank and from the Federal safety net, 
as would the holding company structure.
    Mr. Chairman, I would like to also briefly comment on the 
unitary thrift issue, which is a major significant public 
policy issue that risks getting lost in the shuffle as the most 
powerful men in the world fight over CRA and op-sub. How this 
issue is resolved will have a profound impact on our future 
economic and financial structure and on our diversified 
financial system.
    Under current law, there are no restrictions on what a 
unitary thrift company can own or who can own a unitary thrift, 
including commercial firms. The case against mixing banking and 
commerce is well established.
    Taking this issue to the community banking level, if a bank 
such as mine owned a grocery store, why would I want to lend 
money to someone else who wanted to open a competing grocery 
store in our community? While the bill before you partially 
closes the unitary thrift holding company loophole by 
prohibiting the chartering of new unitaries owned by commercial 
firms, it fails to close the loophole completely and allows 
each of the 600 or so grandfathered unitary thrifts, most of 
which are not currently owned by commercial companies, it 
allows them to be acquired by commercial firms.
    Chairman Greenspan has warned that these kinds of 
affiliations pose serious safety and soundness hazards. We 
believe it, and I think I heard Secretary Rubin state this 
morning that he would also concur. I believe strongly that the 
unitary thrift holding company loophole should be closed, and 
that grandfathered unitaries should not be allowed to be 
acquired by commercial firms.
    Finally, Mr. Chairman, my written testimony spells out my 
concerns with the insurance language in the House Banking 
Committee version of H.R. 10. Community banks like mine will be 
facing cross-marketing competition from financial conglomerates 
like Citigroup and it is important that our ability to retail 
insurance products not be undermined.
    Mr. Chairman, that concludes my testimony. Thank you for 
the opportunity to present my views. I would be pleased to 
respond to questions at a later time.
    [The prepared statement of Arnold Schultz follows:]
 Prepared Statement of Arnold Schultz, Board Chairman, Grundy National 
                                  Bank
    Mr. Chairman, Members of the Committee, my name is Arnold Schultz, 
and I am Board Chairman of The Grundy National Bank in Grundy Center, 
Iowa. I am also president and CEO of GNB Bancorporation, a two-bank 
holding company that owns 100 percent of Grundy National Bank and 
Ackley State Bank, a state-chartered bank in Ackley, Iowa. Both banks 
have multiple-line insurance agencies. In addition, Ackley State Bank 
recently formed an operating subsidiary that purchased Kastendick and 
Associates, which holds a general agents contract for the sale of Blue 
Cross and Blue Shield health insurance products directly and through 20 
sub-agents in Iowa.
    My bank, which is located in a farming community of 2,500 people in 
central Iowa, has approximately $106 million in assets and $85 million 
in deposits. We have two branches and 37 full time employees. We have 
been in business, serving the consumer, business and agricultural needs 
of our community, since 1934.
    Thank you for giving me this opportunity to share my views on the 
financial reform legislation currently before this Committee. By way of 
background, I have just completed my second 3-year term as a member of 
the Board of the Federal Reserve Bank of Chicago--an elected position. 
I am also the first community banker to serve on FASAC, the advisory 
council to FASB, and I am the present chairman of the Bank Operations 
Committee of the Independent Community Bankers of America (ICBA).
    You asked that I testify on the operating subsidiary issue, that 
is, what activities are appropriate to be conducted in an operating 
subsidiary of a national bank, versus what activities should be pushed 
out into an affiliate of the bank's holding company. I would be pleased 
to respond to this issue, and share with you my views on several other 
aspects of the legislation that is before you, H.R. 10, the Financial 
Services Act of 1999.
Op-Sub Issue
    Mr. Chairman, I support the position of Federal Reserve Board 
Chairman Alan Greenspan that new, risky activities--those other than 
agency activities that are not now permissible for national banks but 
would be authorized under this bill--should be shielded as much as 
possible from the national bank itself and conducted in a separately 
capitalized affiliate of the holding company.
    The formation of a holding company is not that difficult and, in my 
case--like many other community banks--it was done originally for the 
purpose of maintaining a market for company stock which enables us to 
continue to operate as a locally owned community bank.
    Chairman Greenspan argues that the holding company structure is 
superior for two reasons--to minimize the federal subsidy arising from 
the Federal safety net that would flow to operating subsidiaries, 
thereby creating a competitive advantage over non-bank entities; and to 
protect the safety and soundness of our banking and financial system.
    Mr. Chairman, I do not feel qualified to comment on whether or not 
the sovereign credit of the United States produces a subsidy that would 
accrue to an operating subsidiary to the competitive detriment of other 
corporate structures. There appears to be some disagreement on this 
subject.
    As a national banker, I am more qualified to make observations on 
whether or not these risky new activities would pose a safety and 
soundness problem to the bank.
    One of the consequences of this bill will undoubtedly be the 
emergence of more very large financial conglomerates combining various 
elements of the financial services industry and more cross-financial 
services industry mergers generally. For example, a large commercial 
bank could merge with an insurance company underwriting property and 
casualty insurance and a securities firm that deals in derivatives. 
Insurance underwriting and derivatives are very risky activities. If 
either the insurance component or the securities component got into 
financial trouble, it would immediately impact the commercial bank 
component that is in the universal bank structure, and put pressure on 
the commercial bank to directly fund the insurance and securities 
departments out of their difficulties. In the event of failure or too-
big-to-fail rescue, this would put immediate pressure on the federal 
safety net. The Federal Reserve discount window would likely feel the 
pressure first. Then, the FDIC would feel the pressure, and 
ultimately--depending on the size of the too-big-to-fail institution--
the taxpayer.
    In these situations, we believe it is imperative to build in 
maximum insulation of the risky activities from the bank component of 
the financial conglomerate. The holding company structure does this.
    If the risky activities were conducted in an operating subsidiary 
of a universal bank structure, the threat to the bank is even greater. 
Any losses experienced in the subs would impact the bank's capital. By 
contrast, losses incurred by a holding company affiliate would not 
impact the bank's capital. Thus, the holding company structure better 
insulates the bank.
Deposit Insurance Protection
    Protection of the deposit insurance fund is and will remain the top 
priority of all community bankers. As a community banker who is not 
protected by the too-big-to-fail doctrine, deposit insurance is the 
lifeblood of my operation.
    Community banking is not what it was 30 years ago, when in many 
communities the only place to invest your money was in the local bank. 
Today, we compete with tax-free credit unions and farm credit 
associations, with mutual funds you can buy over the Internet, with 
Edward Jones offices in virtually every small community that soon may 
be offering a full array of banking services under its unitary thrift 
charter, and with a public equities market that has not faced a real 
down market in more than a decade.
    We pay an insurance premium for deposit insurance and we would 
differ with Chairman Greenspan that there is a subsidy. It would damage 
the FDIC and be a misuse of banker premiums to stretch the deposit 
insurance safety net to cover losses of merchant banking or securities 
underwriting subsidiaries that threaten to bring down a universal bank.
    The bill that was reported out of the House Banking Committee and 
is before you now would permit an operating subsidiary of a national 
bank to engage in any banking activity, and in any activity that is 
financial in nature or incidental to financial in nature, except 
insurance underwriting and real estate development. Requiring, as the 
bill does, that a bank over $10 billion in assets must have a holding 
company if it wants to engage in financial activities through an op 
sub, does give the Federal Reserve some oversight over the entire 
entity. But this doesn't provide maximum insulation of merchant banking 
and securities underwriting activities, and losses from the core bank, 
as the holding company structure would.
    The House bill also provides the Federal Reserve sole authority to 
prescribe regulations and issue interpretations regarding merchant 
banking activities. The bank I am associated with does not engage in 
merchant banking activities, but my gut instinct tells me that these 
are risky indeed. And one must look with great concern at the Senate 
Banking Committee bill which permits commercial banks to hold 
indefinitely the securities of a commercial firm underwritten by a 
different component of a financial conglomerate while operating the 
commercial firm on a daily basis.
    Again, allowing such activities through a universal bank structure 
brings them that much closer to the federal safety net. I would much 
prefer to see the bill amended to push all risky new activities, 
including merchant banking and non-government securities underwriting, 
into a separately capitalized affiliate of the holding company, thus 
providing maximum insulation of the safety net, including the deposit 
insurance fund. This is Chairman Greenspan's position and we support 
this position.
    Down the road, small national banks like mine could become 
interested in underwriting local government issues directly from the 
bank--but I don't believe this detracts from my strong support of 
Chairman Greenspan's position. I also applaud the initiatives of the 
OCC in bringing about a heightened awareness of the opportunities 
afforded banks by forming operating subsidiaries for activities that do 
not pose safety and soundness problems.
Mixing Banking and Commerce
    Mr. Chairman, with your indulgence I would like to briefly comment 
on two other provisions in the bill that trouble community banks 
greatly. The first is the mixing of banking and commerce. This is an 
enormously significant public policy issue that risks getting lost in 
the shuffle as the most powerful men in the world fight over CRA and 
the operating subsidiary. How this issue is resolved will have a 
profound impact on our economic and financial structure, which is the 
envy of the world, and on our diversified financial system which has 
created the remarkable small business infrastructure of our Nation.
    The case against mixing banking and commerce is well established, 
with both Chairman Greenspan and Secretary Rubin, in congressional 
testimony earlier this year, raising serious concerns about eroding the 
walls separating banking and commerce. Allowing the common ownership of 
banks and commercial firms could lead to ``crony capitalism,'' and 
undermine the impartial allocation of credit, which is the foundation 
upon which our financial system is based. Taking this issue to the 
community banking level, why would a bank that owned a grocery store 
want to lend money to someone who wanted to open a competing grocery 
story in the community? Credit must be allocated impartially and on 
merit--not on the basis of ownership considerations.
    There are two ways in which banking and commerce can be mixed. The 
first is through a ``commercial basket,'' which would allow banks to 
acquire a ``basket'' of commercial holdings with certain restrictions 
based on asset size or earnings. Wisely, this concept was rejected by 
the full House and the Senate Banking Committee last year and has not 
been reincarnated in this legislation. It was, unfortunately, kept very 
much alive in the merchant banking language in this year's Senate 
Banking Committee bill.
Unitary Thrift Holding Company Loophole
    The second way in which banking and commerce can be, and is, mixed, 
is through the unitary thrift holding company loophole. Under current 
law, there are no restrictions on what a unitary thrift holding company 
can own, or who can own a unitary thrift, including commercial firms. 
This, of course, runs counter to the prohibition against bank and 
commercial affiliations, despite the fact that there is very little 
difference between a bank and a thrift.
    While the bill before you partially closes this loophole by 
prohibiting the chartering of new unitaries owned by commercial firms, 
it fails to close the loophole completely and allows each of the 600-or 
so grandfathered unitary thrifts (most of which are not currently owned 
by commercial companies) to be acquired by commercial firms. Equally 
troubling is the fact that under the bill, there are no restrictions on 
who could buy what unitary, leaving open the possibility, for example, 
for a large commercial firm to buy Washington Mutual, the largest 
unitary thrift in the world.
    Chairman Greenspan has warned that these kinds of affiliations pose 
serious safety and soundness hazards. We believe Secretary Rubin 
concurs. In the current strong economic climate, commercial firms have 
shown considerable interest in getting into the banking business. But 
we all know that this boom period will not last forever. Commercial 
firm ownership of banking could have negative consequences in the 
future because of their lack of experience in assessing credit and 
other bank-related risk. Again, let's not follow the failed paths of 
Japan and other Pacific Rim nations.
    I believe strongly that the unitary thrift holding company loophole 
should be closed completely and for good. Grandfathered unitaries 
should not be allowed to be acquired by commercial firms.
Discriminatory Insurance Provisions
    I also would like to comment briefly on the insurance sales 
provisions in this legislation. A fair reading of the insurance sales 
language in this bill has to conclude that banks seeking to retail 
insurance products are disadvantaged. For example, the bill spells out 
in thirteen separate paragraphs thirteen specific ways in which states 
can pass laws that discriminate against insurance sales by national 
banks. These so-called ``safe harbors'' range from permitting 
discriminatory restrictions in advertising, to rules governing the 
payment of commissions, to where a customer's files may be kept in a 
bank. In addition, the bill provides that a state may impose any other 
restrictions on insurance sales in banks that are no more burdensome 
than these 13 ``safe harbors.''
    These ``safe harbors'' will have the effect of making it very 
difficult for a national bank to get into, or remain in, the insurance 
business. It seems to me that in today's financial world, where 
regulators have authorized the common ownership of Citicorp and 
Travelers, such restrictions are not only anti-competitive, but also 
absurd.
    We also note that without judicial deference being accorded to the 
OCC (just as it is any other federal agency), any challenges relating 
to interpretations of how future state laws impact national banks could 
end up in the courts for years.
    What banks get in return is a shell of the Barnett standard. We get 
a ``non-discrimination'' standard that applies only if state laws 
expressly distinguish and discriminate against depository institutions, 
have a ``substantially more adverse'' im-

pact on banks, or if the state law ``effectively prevents'' the bank 
from selling insurance.
    This is what Comptroller of the Currency John Hawke had to say 
about these provisions at a recent banking convention:
          ``One of the most controversial issues in the financial 
        modernization legislation has arisen from the efforts of the 
        independent insurance agents to burden banks with restrictions 
        that would encumber their ability to sell insurance as agents 
        in a free and competitive marketplace. And the most recent 
        formulations of those efforts have been embodied in H.R. 10 and 
        they include a list of so-called sale harbors--13 paragraphs 
        describing areas in which states will be free to discriminate 
        against banks with impunity. We think that banks should be 
        treated on a completely non-discriminatory basis with respect 
        to the sale of insurance--they shouldn't be treated differently 
        from any other individual or entity licensed to sell insurance 
        in the state. And we certainly should not tolerate laws that 
        prohibit bank-related entities from selling insurance and as 
        I'm sure you know that Comptroller of the Currency's office has 
        taken a vigorous position on that issue in litigation. But this 
        legislation would essentially empower the states--state 
        legislatures--to adopt with impunity legislation that 
        discriminates against banks . . .''
    Most banking lawyers agree with Comptroller Hawke's interpretation.
    Mr. Chairman, selling insurance as an agent is not a risky 
activity. We are not talking about underwriting insurance and assuming 
the actuarial risks. We are talking about selling a policy across a 
counter for a fee. Many community banks, like mine, already struggling 
to maintain their core deposits and compete with tax-free credit unions 
and farm credit associations, will want to get into this activity to 
diversify their earnings if they are not already there. And our getting 
into the business is very pro-competitive and pro-consumer in the 
emerging world where any large insurance company will be able to own a 
bank and cross market all its products. But if the language in this 
legislation remains intact, insurance sales in banks will be in real 
jeopardy in many states.
Closing
    Mr. Chairman, that concludes my testimony. Thank you, again, for 
the opportunity to present my views. I would be pleased to respond to 
any questions.

    Mr. Oxley. Thank you, Mr. Schultz. Thank you for coming all 
the way from Iowa for this.
    Mr. Zimpher.

                  STATEMENT OF CRAIG W. ZIMPHER

    Mr. Zimpher. Mr. Chairman, members of the subcommittee, 
thank you very much for the opportunity to be here today. This 
is the second opportunity and privilege I have had to appear 
before your committee on this important issue. So on my behalf 
and Nationwide's behalf, we appreciate the opportunity for 
input today. I just trust that today's experience and prior 
experiences will not prove to be the victory of hope over 
experience, however, on final enactment and passage and 
enactment of H.R. 10, which we certainly are pleased to endorse 
today and endorse and support your efforts.
    Mr. Chairman, my testimony has been submitted and I am 
going to try to just very briefly summarize a couple of key 
points in that testimony that we are interested in.
    First, as we testified last year and we want to do again 
today, is our strong support and belief in the issue of 
functional regulation which you have heard a great deal about 
already by preceding witnesses and testimony. My predecessor on 
the prior panel, Mr. Nichols and his organization, the NAIC, 
outlined what could be serious consequences if functional 
regulation were eroded, or if it were eroded by this bill.
    We would certainly agree with their testimony and support 
any effort to prevent that. As a matter of fact, on page 10 of 
our testi-

mony, we make the statement that to exempt, either advertently 
or inadvertently, insurance offered by banks from State 
regulation would be unsound and counterproductive to protecting 
consumers of insurance products.
    Just as important as we believe functional regulation is 
for leveling the playing field through which and on which 
various financial products will ultimately be offered by 
different industries, we believe there are very strong and 
compelling consumer protection interests to continue the regime 
of State-based insurance regulation.
    Several instances come to mind, Mr. Chairman. Those 
safeguards include market-conduct examinations conducted by 
every State insurance department; triennial financial and 
solvency examinations conducted of all companies by 
departments; the applications of fair claims practice laws; 
guarantee funds in place in every State for both property 
casualty and life insurance policies for payments in cases of 
insolvencies; licensing and continuing education requirements 
for agents; consumer complaint and inquiry resolution 
procedures in place in all 50 States; and policyholder surplus 
investment regulations and supervision in place in all 50 
States. So we strongly encourage the continuation of functional 
regulation by State insurance departments as it relates to the 
delivery--to the manufacturing and delivery of insurance 
products.
    Second, Mr. Chairman, we would encourage the subcommittee 
to maintain the holding company structure that is contained in 
H.R. 10 for mutual companies such as Nationwide. As it is 
currently structured and governed, this is the only practical 
governance structure for them to participate under the bill's 
affiliation opportunities if it were to become law and avoid 
the dilemma of dual regulation, both at the State and the 
Federal level.
    Mr. Chairman, I will just conclude my comments there, and 
again I appreciate the opportunity to be here.
    [The prepared statement of W. Craig Zimpher follows:]
 Prepared Statement of W. Craig Zimpher, Vice President of Government 
               Relations, Nationwide Insurance Enterprise
    Mr. Chairman and members of the subcommittee, my name is Craig 
Zimpher. I am Vice President of Government Relations for Nationwide 
Insurance, headquartered in Columbus, Ohio. Nationwide Insurance is a 
group of core insurance companies, including Nationwide Mutual 
Insurance Company, Nationwide Life Insurance Company, Nationwide 
Financial Services. Our products range from personal auto, homeowners, 
commercial/workers' compensation to life insurance, annuities, 
financial services, and health insurance. Our companies are licensed to 
engage in the business of insurance in all 50 states. In addition, 
Nationwide operates several affiliated insurance operations in Europe 
and has entered into partnerships with other companies to market our 
products in Asia and Latin America.
    I am honored to be with you today and intend to discuss Nationwide 
Insurance's perspective on financial services modernization. These 
issues are significant and have vast public policy ramifications for 
they affect the financial security of millions of Americans. Overall, 
we are encouraged by the direction that Congress is taking on financial 
services reform. But, there are three major areas where we believe that 
problems could arise. I would like to discuss these areas today, 
specifically:

1. The need to retain the mutual holding company structure for mutual 
        insurers;
2. The risk the use of operating subsidiaries pose to the solvency of 
        financial service entities; and,
3. The need for continued consumer protection at the state level.
    Nationwide continues to support H.R. 10. We believe that the bill 
represents a good compromise and an excellent place to begin the 
process of modernizing the nation's financial services laws. However, 
absent the mutual holding company struc-

ture, mutual insurers that retain their unique corporate 
characteristics cannot participate fully in a post-financial services 
reform world.
    Under current law, utilization of the unitary savings and loan 
holding company is currently the only structural model available for an 
insurance company to affiliate with a depository institution. Some 
state laws may prohibit or impede the ability of a mutual insurance 
company to affiliate with a unitary savings and loan holding company.
    Mutual insurance companies are incorporated under state law for the 
benefit of their policyholders. Because mutuals do not have 
stockholders, they utilize a holding company structure, unless 
domiciled in a state that has adopted a mutual holding company act. 
Such statutes provide for the conversion of the mutual insurer into a 
stock company controlled by its mutual holding company parent. In 
addition, mutual insurers are subject to a variety of state laws that 
prohibit or limit the size of an investment the insurer can make in a 
bank subsidiary.
    While the language contained in H.R. 10 would allow any financial 
services company to become a bank financial services holding company, 
for regulatory reasons there are only two practical ways a mutual 
insurer could affiliate with a depository institution:

 Demutualize and create an upstream holding company; or,
 Create a mutual insurance holding company.
    A mutual insurer could demutualize and create an upstream stock 
holding company, which could form or acquire a bank as an affiliate of 
the insurance company. However, demutualization is not a solution many 
mutual insurers would be eager to adopt, as they are either committed 
to the mutual concept or do not want to undergo the disruption and 
significant costs posed by demutualization. The second option is to 
permit a bank and an insurance company to become affiliates of one 
another and subsidiaries of a parent holding company.
    As you know, while the Bank Holding Company Act currently prohibits 
such affiliations, federal financial services reform proposals would 
amend that Act to allow affiliations and, therefore, preempt state 
laws. This means that the state insurance laws would not apply to stock 
companies; however, mutual insurance companies, like Nationwide, still 
could not avail themselves of the holding company affiliation model 
unless they are domiciled in one of the 21 states that have laws 
permitting mutual insurance companies to convert to a mutual holding 
company structure. These include Iowa, Minnesota, Ohio, Pennsylvania, 
Rhode Island, Vermont, Missouri and California.
    As we understand it, some would like to prohibit the use of mutual 
holding companies. We would strongly oppose such a move and urge 
Congress not to prohibit mutual life and mutual property/casualty 
insurance companies from creating mutual holding companies under state 
law, in order to affiliate with depository institutions. Otherwise, you 
would condemn an entire sector of the financial services sector to a 
slow death, because mutual insurers would not be able to fully 
participate in the new financial services arena.
    Nationwide believes that all insurance activities should occur 
within an affiliate of a bank or financial services holding company, 
because this is the only way to guarantee functional regulation. 
Allowing these operations to occur in an operating subsidiary would 
defeat the concept of functional regulation and would lead to a dual 
regulatory system.
    Appealing features of the affiliate model include the following:

1. It is consistent with functional regulation and so entails minimum 
        federal intrusion into the affairs of insurance company 
        affiliates of the depository institution.
2. There is no restriction on the types of activities that can be 
        conducted in the holding company; i.e. affiliations with non-
        financial commercial companies are permitted.
3. It provides sufficient supervisory mechanisms and authority for 
        appropriate oversight for financial system stability.
    Nationwide believes that expansion of banking powers into the 
insurance business, absent continued state regulation of such business, 
would be misguided. We believe that state insurance regulation has 
worked effectively and efficiently for both those regulated and those 
protected, the consumers. To exempt the bank-owned insurance operations 
from such regulation would disrupt and distort the insurance 
marketplace across the country.
    Nationwide strongly endorses appropriate safeguards and provisions 
for state regulation of insurance products, regardless of risk bearer 
or distributor of such products. Our concern about bank exemption from 
insurance regulation has been heightened by a series of rules and 
opinions issued by the Comptroller of the Currency over the past 
several years, that have unilaterally expanded insurance authority of 
national banks. These rulings have allowed banks to extend their reach 
into the insurance area without proper regulatory oversight.
    One of the worst decisions by the OCC was the rule that would allow 
banks to engage in non-banking activities, including insurance 
underwriting, through downstream operating subsidiaries.
    This last development, known as the final Operating Subsidiary 
Rule, is the most serious expansion of regulatory power yet undertaken 
by the OCC. The purpose of these regulations is to provide banks with 
the opportunity to engage in non-banking activities though downstream 
operating subsidiaries, without oversight by state insurance 
regulators.
    The Op-Sub rules, as they have become known, are purposely vague 
when it comes to who would regulate a bank's insurance subsidiary. The 
OCC contends that certain safeguards would be imposed on an operating 
subsidiary engaging in activities not permissible for the bank, 
including requiring the operating subsidiary to be adequately 
capitalized under ``relevant industry measures''. However, it is 
unclear what industry measures are intended to apply and which 
regulatory entity would be applying them. Moreover, certain 
prohibitions on affiliated transactions would apply, but the rules do 
not go so far as to prohibit tie-in sales.
    The Op-Sub rule makes it very clear that the OCC will consider any 
application from banks to engage in any ``non-bank'' activities, 
including insurance underwriting. Furthermore, taking a cue from its 
past actions, the OCC could very well use these rules to establish 
itself as the regulator of all bank-operating subsidiaries, including 
insurance subsidiaries. I believe that the OCC overstepped its 
authority when it issued its Op-Sub rule and that their rule, unless 
curtailed by Congress, might very well serve as the foundation for 
future and drastically expanded erosion of state insurance regulation 
and consumer protection.
    It should be abundantly clear to all that the OCC is engaged in a 
policy of incremental preemption of state insurance regulation, while 
expanding its own regulatory power. This policy benefits national banks 
at the expense of consumers, agents and insurers, creating anything but 
a level playing field.
    We strongly believe that if banks engage in any phase of the 
insurance business, it should be conducted on a level playing field. To 
pre-empt state regulation or exempt the banking industry from state 
regulation of insurance is not a two-way street . . . it is not even a 
one-way street . . . it would be nothing more than a cul de sac . . . 
which would not provide consumers with adequate protections. Regulation 
of financial services must be focused on the specific function being 
performed and not on the corporate form.
    True functional regulation focuses on the activity rather than the 
entity engaged in that activity. Under functional regulation, bank 
regulators regulate banking and the states regulate insurance 
activities, regardless of whether the activity is being conducted in a 
bank or an insurance company. Bank regulators lack the specialized 
experience and expertise needed for effective regulation of insurance 
activities of banks, just as insurance regulators are not competent to 
regulate banking activities of insurance companies or their affiliates.
    Consumer protection is an important aspect of insurance regulation. 
This is due in part to the long-term relationship between a consumer 
and his or her insurance company in which the benefits of an insurance 
policy are not enjoyed until the risk the policy protects against has 
been realized. This period can be as long as one's lifetime, in the 
case of a life insurance policy. Generally, insurance claims can be 
made only under a policy that was in place at the time the loss or 
damage occurred. An insurance customer unhappy with the performance of 
a company cannot take his or her claim to another company.
    Most consumers have a much different relationship with depository 
institutions. Checking and savings accounts can easily be moved from 
one institution to another. Once a loan has been made, the borrower's 
relationship with the lender ends except for payment and recordkeeping. 
In neither case does the bank customer pay today for a promise of long-
term future performance, as is the case with insurance customers.
    Consequently, state insurance laws and departments emphasize 
consumer protections in substance and procedure. Consumer protections 
imposed by bank regulators regarding bank customers purchasing 
insurance pale in comparison to those mandated by state insurance laws. 
Examples of state rules include the following:

1. Licensing. Insurance agents must be licensed by each state in which 
        they sell insurance and are subject to the rules and 
        regulations of that state. Agent applicants are subject to a 
        back-ground investigation and must pass a licensing 
        examination. Most states require agents to take pre-licensing 
        educational courses before taking the licensing exam. To 
        maintain their licenses, agents must meet continuing education 
        requirements designed to ensure that they are knowledge-

    able about their product and professional in their conduct. State 
        insurance regulators' enforcement authority includes the 
        ability to deny, suspend and revoke a license as well as impose 
        fines against wrongdoers. States share information about agents 
        and applicants through the NAIC.
2. Marketing. Unfair Trade Practices and Competition Acts adopted by 
        the states prohibit deceptive acts and practices by insurance 
        agents and companies. Regulated practices include tying, 
        rebating, advertising, manner of sale, privacy protection, and 
        any other practice a state insurance regulator deems to be 
        unfair or anticompetitive.
3. Underwriting. Insurers are required to file policy forms and rates 
        either at the time of use or before, and in both cases, are 
        subject to the state insurance regulator's review and approval. 
        States also set minimum values on auto liability insurance 
        policies sold within the state. States require insurers selling 
        certain types of insurance, e.g. automobile liability, 
        homeowners', and workers compensation, to participate in shared 
        risk pools, thus promoting consumer access and affordability. 
        Insurance companies are subject generally to stringent 
        regulations relating to cancellation and nonrenewal of 
        insurance policies.
4. Guaranty Funds. Most insurers are required to participate in 
        guaranty funds so that claims against an insolvent company will 
        be paid at least in part and the consumer so protected. Acts 
        governing the rehabilitation or liquidation of insolvent 
        insurers exist in all jurisdictions.
5. Company Service. Each state has a process to address complaints made 
        against an insurer. Complaints received by the state regulator 
        are automatically forwarded to the company and must be answered 
        within time restrictions mandated by the state. A full 
        explanation is required from the insurer regardless of the 
        apparent merits of the complaint. The insurance regulator will 
        continue to demand further explanations from the company and to 
        encourage resolution between the complainant and the company.
6. Claims. Insurance companies also are subject to state fair claims 
        practices acts. These acts require all claims to be handled 
        fairly, timely and in compliance with the policy.
7. Market Conduct. The states examine for market conduct as part of the 
        regularly scheduled financial examinations and at any other 
        time determined by the state regulator. Companies that fail to 
        comply with applicable statutes can be fined or have their 
        certificates of authority suspended or revoked.
    Federal banking rules do not include the type of insurance customer 
service and complaint resolution provisions found in state insurance 
laws. For example, the OCC guidelines provide that a bank should have 
an ``orderly process for assessing and addressing customer complaints 
and resolving compliance issues.'' The guidelines suggest that banks 
use a complaint tracking process or complaint file and comply with 
state laws that require copies of customer complaints to be forwarded 
to the state insurance regulator, but do not impose the substantive and 
procedural provisions found in state insurance laws. The guidelines 
also state that the OCC expects bank insurance sales personnel to be 
licensed in accordance with state law. However, compliance with these 
guidelines is essentially voluntary for banks. Compliance with state 
laws is mandatory for insurance companies and agents
    Federal rules prohibit a bank from tying, either by restricting the 
availability or varying the consideration, of a product or service on 
the condition that a customer purchase another product or service 
offered by the bank or by any of its affiliates. The Federal Reserve 
and the OCC have extended the tying prohibition to bank holding 
companies and their nonbank subsidiaries, and to operating subsidiaries 
of national banks, respectively. The anti-tying prohibition can be 
enforced by the bank regulators, the Justice Department or aggrieved 
private parties, although enforcement actions are rare.
    This brief comparison between the insurance consumer provisions of 
federal banking rules and the consumer provisions of state insurance 
law illustrates the superiority of the states' consumer protections.
    State regulation has a two-fold purpose. First, it is designed to 
assure that insurance providers treat customers fairly. Second, it is 
designed to protect consumers, and their long term financial needs, 
through solvency regulation and oversight of insurance companies.
    During the last several years, significant strides and progress 
have been made in standardizing state financial reporting and 
monitoring requirements. Minimum standards of insurance company 
capitalization to assure individual company solvency are in place. 
These capitalization requirements differentiate among insurance product 
lines and their associated degrees of risks. Included in these 
standards are specific reserving requirements for various types of 
claims with which companies must comply. If banks were to be exempted 
from state insurance regulation, such as the one I just noted, such 
reserving or other solvency provisions of state law would not be 
applicable to banks, creating an extremely dangerous situation for the 
public.
    All states have rate regulations laws that assure insurance rates 
are not unfair, excessive, or inadequate. Exemption from such rate 
regulation would, it is so obviously clear, create an unfair and 
unlevel competitive environment in a particular state.
    Through various ``market conduct'' regulations the various 
insurance departments of this country have promulgated a series of 
requirements and regulations designed to ensure that agents and 
companies comply with state laws and regulations in the marketplace. 
Market conduct laws and regulations apply to insurance practices and 
operations including: insurance nonrenewals and cancellations; review 
of agent conduct and activities; claims handling and processing 
procedures; compliance with unfair claims practices provisions; 
individual company underwriting practices; and assurance that 
appropriate rates are being charged for various lines of insurance. 
Such state regulations ensures that insurance products are being 
offered in a way so as not to create discrimination, that fair and 
prompt claims handling practices are being adhered to, and that honest 
marketing and sales practices are conducted. The fact is that these 
regulations effectively serve to protect consumers and assure the long 
term financial viability of those offering customers insurance 
products.
    One additional feature unique to the state regulatory scheme has 
been the development and successful operation of state guaranty funds. 
These funds are in place in the various states and are funded by 
assessments of existing insurance companies. They are designed to 
assure long term protection of policyholders whose insurance companies 
may become insolvent. Any company involved in the insurance business 
must participate in such guaranty funds.
    The United States does not need a dual system of regulation for 
insurance. A steady and sound insurance regulatory system has been in 
place for decades. State regulation of insurance is getting the job 
done effectively and efficiently. To exempt insurance offered by banks 
from state regulation would be unsound and counter-productive to 
protecting consumers of insurance products.
    In conclusion, Nationwide supports H.R. 10, as it is currently 
drafted. However, we believe that several key elements are necessary to 
the success of financial services reform efforts, including:

1. All insurance activities should be conducted by an entity or 
        entities separate from any depository institution, preferably 
        in an affiliate of a bank or financial services holding 
        company.
2. All such insurance affiliates should be subject to all the 
        requirements of the appropriate state insurance regulatory 
        authority;
3. Any structure permitting such affiliations should permit both stock 
        and mutual insurance companies to engage equally in the 
        business of banking and other activities in which depository 
        institutions are permitted to engage, including the option of 
        allowing mutual insurers to use a mutual holding company 
        structure.
    Mr. Chairman and members of the Subcommittee, that concludes my 
testimony today and I wish to express, on Nationwide's and my own 
behalf, our deepest appreciation for the opportunity to appear before 
you today. We stand ready to assist you and other members in any way 
possible to affect positive and practical reform of the financial 
services industry. Thank you.

    Mr. Oxley. Thank you, Mr. Zimpher.
    Our final witness, Mr. Scott Sinder, representing several 
insurance groups.

                  STATEMENT OF SCOTT A. SINDER

    Mr. Sinder. Good afternoon, Mr. Chairman and members of the 
committee. My name is Scott Sinder. I am testifying today on 
behalf of the Independent Insurance Agents of America, the 
National Association of Life Underwriters, and the National 
Association of Professional Insurance Agents, which together 
represent virtually all of the insurance agents of America and 
their employees, nearly 1 million men and women who work in 
every part of the United States.
    First, Mr. Chairman, let me thank you for holding this 
hearing today. Before proceeding with my comments, I must 
commend you for the role you played last term in brokering an 
historic agreement that resulted in a bill that was eventually 
passed by the House. Without your commitment and heavy 
involvement, no bill would have proceeded to the floor and, in 
all likelihood, we would be no closer to the enactment of a 
financial services reform bill today.
    The insurance agents want you to know that they intend to 
do everything within their power to help you mold a bill that 
can take flight and become the law of the land. We want a bill 
to pass.
    As you know, Mr. Chairman, the insurance agents strongly 
supported the H.R. 10 bill that you brokered and shepherded 
through the House. We recognize the need for eliminating the 
barriers that still exist between the banking and insurance and 
securities industries. We believe, however, that this concern 
also mandates insuring that consumer choices are well informed 
and freely made, and State regulators have been virtually the 
exclusive protectors of such interests since the creation of an 
insurance industry in this country. We, thus, have one basic 
concern: Ensure that every entity that is involved in the 
insurance business is subject to State regulation. Federal 
banking regulators are in no position to substitute for the 
comprehensive State insurance laws that have developed over the 
last 100 years.
    The bill that you shaped last term included several 
provisions that the insurance agents believe to be essential to 
ensure adequate functional regulation of insurance sales 
activities. After that bill was passed by the House, however, 
the Senate Banking Committee drastically revised many of its 
most essential provisions, especially in the insurance sales 
context. For that reason, the insurance agents actively opposed 
the bill that was passed out of that committee.
    After the Senate Banking Committee completed its work on 
the bill, Senator D'Amato mediated a negotiation among selected 
banking and insurance industry representatives. The insurance 
agents participated in those negotiations, but State insurance 
regulators were excluded. The exclusive focus of those 
negotiations in the insurance sales context was on the scope of 
the preemption safe harbors.
    At the conclusion of the negotiations, the insurance agents 
made clear that they could not support the Senate proposal, but 
through the safe harbor improvements that had been agreed upon 
were sufficient to remove our outright opposition.
    The Senate proposal was never considered on the Senate 
floor. When this Congress convened in January, however, the 
proposal was reintroduced as the 1999 version of H.R. 10. The 
Senate package was largely untouched by its consideration of 
the House Banking Committee. We therefore sit before you today 
in virtually the same position that we were in at the close of 
the Senate last year. The insurance agents do not support the 
current proposal, but we believe it can be improved in a manner 
sufficient to gain our support.
    Banking industry representatives have been quite vocal in 
recent weeks regarding their belief that any changes that are 
made to the current proposal will eliminate any prospects for 
passage. At the same time, however, many of the same 
representatives have them-

selves been requesting that some changes be made in the 
insurance sales provisions.
    Many things have changed since last October. First and 
foremost, State insurance regulators, through the NAIC, have 
taken a harder look at the compromised proposal and have 
concluded that it would dramatically undermine their ability to 
adequately regulate insurance activities. In addition, the 
issuance of two recent court decisions calls into question the 
ability of the Comptroller, an ability that many had begun to 
take for granted, to unilaterally authorize national banks to 
engage in expanded insurance sales and underwriting activities 
absent congressional action.
    It should be clear that both the insurance industry and the 
banking industry believe that the current proposal can be 
improved, and the insurance agents want a bill to be enacted. 
The current H.R. 10 proposal, however, would jeopardize many of 
the consumer protections already in place in as many as 30 
States. In addition to the noninsurance sales amendments that 
the NAIC has presented for your consideration, the agents 
believe that three sets of changes also championed by the NAIC 
would alleviate these shortcomings.
    First, clarify that State insurance regulators are entitled 
to receive consideration of their views in court when disputes 
arise between regulators, regardless of when a State law that 
is challenged on preemptory grounds was enacted. The bill as 
currently drafted permits the views of State insurance 
regulators to be considered only in court challenges to laws 
enacted in the future. The inevitable deference to any OCC 
preemption opinions regarding current laws would place many 
longstanding State laws in jeopardy.
    Second, the so-called nondiscrimination provision that 
blanketly prohibits the imposition of any rules that treat 
banks differently on their face, or that inadvertently treat 
banks differently, should be narrowed to delete the inadvertent 
treatment prohibitions set forth in section 104(c)2, and to 
clarify that the core nondiscrimination provision prohibits 
treating federally insured depository institutions differently 
based on their insured financial status. Contrary to the 
suggestions of some members of the banking industry, consumer 
protection provisions that specifically address bank insurance 
sales practices are not impermissibly discriminatory, as 30 
States and even the OCC itself have explicitly recognized in 
their enactment and support of such provisions.
    Third and finally, the safe harbor provisions should be 
clarified. In our written comments we have outlined four small 
changes that we believe should be made to improve the existing 
safe harbor provisions and we have suggested that two more be 
added. One, protecting State laws that require execution of 
acknowledgment form of requisite disclosures already protected 
by the existing safe harbors where provided, and a second, 
protecting State laws to require banking institutions to 
separate their banking activities from their insurance 
activities within the bank. Both new safe harbors, like many of 
the other existing safe harbors, encompass provisions already 
mandated under the section 176 Federal consumer protection 
provisions.
    Without enactment of legislation that includes changes such 
as those that we have outlined, the emerging regulatory void in 
portions of this industry will continue to fester.
    Mr. Chairman, we look forward to working with you to pass a 
financial services reform bill.
    [The prepared statement of Scott A. Sinder follows:]
  Prepared Statement of Scott A. Sinder on Behalf of the Independent 
  Insurance Agents of America, Inc., the National Association of Life 
 Underwriters, and the National Association of Professional Insurance 
                                 Agents
    Mr. Chairman, and members of the Committee, my name is Scott 
Sinder. I am a partner in the Washington, D.C. office of the Baker & 
Hostetler law firm. I appear today on behalf of the insurance agents of 
America, and their employees--nearly 1,000,000 men and women who work 
in every part of the United States. These people are represented by the 
Independent Insurance Agents of America, Inc. (IIAA), the National 
Association of Life Underwriters (NALU) and the National Association of 
Professional Insurance Agents (PIA), on whose behalf I testify today 
and for whom I serve as outside counsel. Their members sell and service 
all lines of insurance.
                              introduction
    First, Mr. Chairman, let me thank you for holding this hearing 
today. Throughout your career, you have been a friend to the insurance 
industry and you have been sensitive to the interests and concerns of 
insurance agents. It is those interests and concerns that I would like 
to focus your attention on today once again.
    IIAA, NALU and PIA are appearing before you today to comment on the 
newest version of H.R. 10, the ``Financial Services Act of 1999,'' that 
was reintroduced on the very first day of this new Congressional term. 
Before proceeding with my comments, I must commend you for the role you 
played last term in brokering an historic agreement that resulted in a 
bill that was eventually passed by the House of Representatives by a 
razor-thin one vote margin. Without your commitment and heavy 
involvement, no bill would have proceeded to the floor and, in all 
likelihood, we would be no closer to the enactment of a financial 
services reform bill today than we were during the many past 
legislative terms in which such a bill was discussed and debated but 
was repeatedly unable to take flight.
    One message that I have been asked to deliver to you today, Mr. 
Chairman, is that the insurance agents want you to know that they 
intend to do everything within their power to help you mold a bill that 
can take flight and become the law of the land.
    As you know, Mr. Chairman, the insurance agents strongly supported 
the H.R. 10 bill that you brokered and shepherded through the House of 
Representatives last term. That bill included several provisions that 
the insurance agents believed to be essential to ensure adequate 
functional regulation of insurance sales activities. The bill, for 
example, included a provision that would ensure that the opinions of 
state insurance regulators were given equal consideration with those of 
federal banking regulators in any preemption challenges asserted 
against state insurance consumer protection provisions; established 
preemption ``safe harbors'' that would shield any provision similar to 
provisions included in the Illinois bank sales of insurance consumer 
protection provisions from preemption challenge; and did not impose a 
blanket prohibition on insurance sales provisions that addressed many 
of the unique consumer protection concerns that arise when insured 
depository institutions engage in insurance sales activities.
    After that bill was passed by the House, however, the Senate 
Banking Bill drastically re-wrote and revised many of its most 
essential provisions, especially in the insurance sales context. That 
bill, for example, drastically limited the application of the ``no 
unequal deference'' provision; drastically reduced the scope of the 
preemption ``safe harbors''; and imposed a blanket 
``nondiscrimination'' requirement on state laws or regulations enacted 
in the future that would prohibit those provisions from specifically 
addressing bank insurance sales activities and from having a greater 
regulatory impact on those activities than on the insurance sales 
activities of other agents. The insurance agents actively opposed the 
bill that was passed out of that Committee.
    After the Senate Banking Committee completed its work on the bill, 
Senator D'amato mediated a negotiation among selected banking and 
insurance industry representatives. The insurance agents participated 
in those negotiations but state insurance regulators were excluded. The 
exclusive focus of those negotiations in the insurance sales context 
was on the scope of the preemption safe harbors. The banking industry 
representatives made clear that the deference and ``nondiscrimination'' 
sections of the bill were not open for debate during those 
negotiations. During those negotiations, the safe harbor provisions had 
been improved but they still did not provide the protection of the 
Illinois-based preemption safe harbor provisions that were included in 
the House bill.
    At the conclusion of the negotiations, the insurance agents made 
clear that they still had serious concerns and problems with the Senate 
proposal, and they could not support the bill, although there would be 
no active opposition either.
    As you know, the Senate proposal was never considered on the Senate 
floor. When this Congress convened in January, however, that proposal 
was re-introduced as the 1999 version of H.R. 10. The Senate package 
was largely untouched during its consideration by the House Banking 
Committee. We therefore sit before you today in virtually the same 
position we were in at the close of the Senate last year--the insurance 
agents do not support the current proposal and we urge this Committee 
to improve the proposal by adopting the amendments outlined below.
    Banking industry representatives have been quite vocal in recent 
weeks regarding their belief that any changes that are made to the 
current proposal will eliminate any prospects for ultimate passage. 
They argue that agreements were reached in the fall and that those 
agreements should be maintained. At the same time, however, many of 
these same representatives have themselves been requesting that some 
changes be made in the insurance sales provisions.
    Many things have changed since last October. First and foremost, 
state insurance regulators, through the National Association of 
Insurance Commissioners, have taken a harder look at the compromise 
proposal and have concluded that it would dramatically undermine their 
ability to adequately regulate insurance activities if it is enacted. 
In addition, the issuance of two recent court decisions calls into 
question the ability of the Comptroller --that many had begun to take 
for granted--to unilaterally authorize national banks to engage in 
expanded insurance sales and underwriting activities absent 
Congressional action.1
---------------------------------------------------------------------------
    \1\ See Independent Insurance Agents of America, Inc., et al. v. 
Hawke, Civil Action No. 98-cv-0562 (U.S.D.C. D.C.) (slip op issued 
March 29, 1999) (granting the Plaintiffs' Motion for Summary Judgment 
and concluding that the OCC's ruling that national banks located 
outside of small towns were authorized to sell crop insurance products 
was precluded by the applicable provisions of the National Bank Act); 
Blackfeet Nat'l Bank v. Nelson, No. 96-3021 (11th Cir. April 4, 1999) 
(concluding in its primary holding that the OCC's ruling that national 
banks are authorized to underwrite an annuity product was precluded by 
the applicable provisions of the National Bank Act).
---------------------------------------------------------------------------
    It is against the backdrop of the tortured history of Congress' 
consideration of financial services reform proposals and the ever-
evolving world in which those proposals are generated that this 
Committee must consider the latest iteration of H.R. 10. In undertaking 
that consideration, it should be clear that both the insurance industry 
and the banking industry believe that the current proposal can be 
improved. The insurance agents want a bill to be enacted and we have 
been falsely accused of trying to block passage of a viable proposal.
    The remaining portions of this testimony will focus on the 
improvements the insurance agents seek to ensure that state authority 
and expertise in the regulation of the business of insurance is not 
overturned or undermined in any way as other industries become more 
heavily involved in providing insurance services. This statement is 
divided into four parts. Part I summarizes the basis of the insurance 
agents' historical support for the continued separation of the banking, 
insurance and securities industries and the reasons that we are now 
prepared to embrace reform provided that it ensures adequate regulation 
of all who seek to engage in the business of insurance. Part II 
explains why the regulation of insurance activities of everyone should 
be left to the States. Part III what is at stake if the bill fails to 
leave that regulation to the States. And Part IV explains the changes 
that we believe must be made to ensure the requisite functional 
regulation.
I. The Insurance Agents' Historical Support For Continued Separation
    As you know, Mr. Chairman, we have in the past advocated that the 
traditional separation between the banking and insurance industries 
should be maintained. During your consideration of H.R. 10 last term, 
however, we for the first time came to you prepared to support 
financial modernization in the form of affiliations between banking, 
securities, and insurance entities. The market is evolving even in the 
absence of new legislation and today more than ever before agents are 
entering into an increasing number of relationships with members of the 
banking and securities communities. We can accept formal affiliation 
relationships, however, only if there is clear functional regulation of 
the insurance activities of every entity, and only if insurance 
consumer protections are addressed.
    The monumental shift in our position has not come easily. As small 
business people, we are painfully aware that, as a practical matter, 
such affiliations will be a one-way-street. That is, the average 
insurance agency is not going to be in the position to acquire a bank; 
the acquisition will run the other way. But we are convinced that we 
can not only survive, but thrive, in such a new world. True competition 
can work and consumers will benefit, however, only if the rules of the 
game establish a level playing field for all participants. It is only 
that which we seek.
    The historic change in our position on affiliations has been 
prompted by marketplace and political reality. The Supreme Court's 
decision in Barnett Bank of Marion County, N.A. v. Nelson 2 
holding that the Section 92 power 3 granted to town-of-5000 
national banks to act as insurance agents preempts State laws that 
would otherwise prohibit such conduct, coupled with the Comptroller of 
the Currency's ever-broadening interpretations of Section 92, 
effectively vitiate the separation between the industries. And 
Congressional inaction to reign in the OCC's creation of new policy by 
administrative fiat has exacerbated the situation.
---------------------------------------------------------------------------
    \2\ 116 S. Ct. 1103 (1996).
    \3\ 12 U.S.C. Sec. 92.
---------------------------------------------------------------------------
    At the same time, the Barnett decision has created a great deal of 
uncertainty regarding who has regulatory authority over bank sales of 
insurance and what is the extent of any such authority. This 
uncertainty is undermining the efforts of all of the participants in 
the insurance sales arena--insurance companies, insurance agents, banks 
and State regulators--to move the insurance industry into the twenty-
first century. The remaining portions of this statement will therefore 
focus not on whether financial institutions should be permitted to 
affiliate with insurance providers--we do not oppose such 
relationships--but on the need for the functional regulation of all 
members of the financial and insurance industries. Especially in the 
insurance context, we believe that it is essential that all insurance 
activities continue to be regulated at the State level--where they have 
been regulated for nearly two centuries. In championing this approach, 
we recognize the pressing need for eliminating the barriers that still 
exist between the banking, insurance and securities industries so that 
members with roots in all three sectors will better be able to serve 
the needs of their customers. We believe, however, that this concern 
also mandates ensuring that consumer choices are well-informed and 
freely made and, in the insurance context, state regulators have been 
the virtually exclusive protectors of such interests since the creation 
of an insurance industry in this country. This bill must ensure that 
their authority and expertise in the regulation of the business of 
insurance is not overturned or undermined in any way as other 
industries become more heavily involved in providing insurance 
services.
II. Regulation of the Business of Insurance Should be Left to the 
        States
    Because no insurance licensing and regulatory scheme exists at the 
federal level, the only available regulators of the participants in the 
insurance industry are the States themselves. Some national banks, 
however, appear to believe that they are exempt from at least some of 
the governing insurance regulations in States in which they are 
currently engaging in the business of insurance. Although the OCC has 
recognized that State laws generally apply to national bank sales of 
insurance, it also has emphasized that national banks need not comply 
with State laws that interfere with their activities. Without the 
creation of a federal regulatory authority or a reaffirmation of the 
absolute right of States to regulate such insurance activity, the scope 
of this ``exemption'' will remain unsettled and national banks may be 
free to engage in the business of insurance without significant 
oversight.
    Given the sophisticated insurance licensing and regulatory 
structure developed exclusively at the State level over the past 200 
years and given the current climate disfavoring the creation of more 
federal regulatory authority (especially when it is duplicative of 
current State efforts), reaffirmation of the right of States to 
regulate the insurance business appears to be the only viable solution. 
Such reaffirmation is required to ensure that all entities involved in 
the insurance industry are on a level playing field; to ensure that 
they are all subject to effective consumer protection requirements; and 
to ensure that the insurance-buying public has consistent assurances of 
quality.
    Any such reaffirmation would not be new or radical. To the 
contrary, it merely would build upon and clarify a federal policy that 
has been in place for over 200 years that States have virtually 
exclusive regulatory control over the insurance industry. Indeed, up 
until 1944, it was universally understood by everyone (including 
Congress) that Congress has no constitutional authority to regulate the 
business of insurance. This changed with a single Supreme Court 
decision issued that year. Congress responded immediately by enacting 
the McCarran-Ferguson Act, which ``restore[d] the supremacy of the 
States in the realm of insurance regulation.'' 4
---------------------------------------------------------------------------
    \4\ United States Dep't of Treasury v. Fabe, 113 S. Ct. 2202, 2207 
(1993).
---------------------------------------------------------------------------
    McCarran's statement of federal policy could not be more clear: 
``The business of insurance, and every person engaged therein, shall be 
subject to the laws of the several States which relate to the 
regulation or taxation of such business.'' 5 Given the 
States' historical expertise in the realm of insurance regulation and 
the absence of any such expertise at the federal level, there does not 
appear to be any compelling reason for abandoning this traditional 
policy approach.
---------------------------------------------------------------------------
    \5\ 15 U.S.C. Sec. 1012(a).
---------------------------------------------------------------------------
    At a time when Congress is seriously considering empowering States 
in a myriad of areas, Congress should not strip the States of their 
authority to regulate in a business arena that has been within their 
virtually exclusive domain throughout this country's fruitful history.
    The States are the only logical choice for comprehensive regulation 
of insurance. Although there are uniform national concerns in this 
industry as in many others, in uncountable ways, insurance involves 
concerns of an intensely local nature. The concerns in Ohio, for 
example, with its multiple urban centers, lakefront communities and 
manufacturing concerns, are quite different than the insurance issues 
raised in Iowa with its thousands of farmers and few large urban areas.
    The public has a substantial interest in the continued functional 
regulation of insurance by the States, regardless of who is conducting 
the activities. Because of the social need for insurance and its 
importance to the public, the underwriting and sale of insurance has 
become one of the most highly regulated professions today. By their 
regulation, the States ensure that those who engage in the business of 
insurance are qualified to do so, remain appropriately qualified, offer 
sound insurance products, and comply with reasonable safeguards for the 
protection of consumers. This entire body of State insurance statutes 
and regulations is frequently revised and updated to address evolving 
regulatory issues and to ensure comprehensive consumer protection. 
Preservation of the applicability of these State regulations is 
essential because, at least at the current time, no comparable 
regulations exist at the federal level and no federal regulator has 
expertise in this arena.
III. What Is At Stake
    In March 1996, the Supreme Court issued its decision in Barnett. 
The Supreme Court's central holding was that Section 92 preempts State 
laws that prohibit national banks from selling insurance, pursuant to 
their Section 92 authority. In the course of rendering this decision, 
however, the Supreme Court also acknowledged that ``[t]o say this''--to 
say that Section 92 preempts State laws that would otherwise prohibit 
small-town national banks from selling insurance--``is not to deprive 
States of their power to regulate national banks, where (unlike here) 
doing so does not prevent or significantly interfere with the national 
bank's exercise of its powers.'' 6 The OCC has ceased upon 
this standard as a potential mechanism for disrupting and potentially 
eliminating state efforts to regulate national bank sales of insurance 
products.
---------------------------------------------------------------------------
    \6\ Barnett, 116 S. Ct. at 1109.
---------------------------------------------------------------------------
    A request for comments issued by the OCC on January 14, 1997 
dramatically illustrates this.7 The question at the heart of 
the OCC's consideration is whether any provisions of the State of Rhode 
Island's ``Financial Institution Insurance Sales Act'' (``Rhode Island 
Act'') 8 which governs the insurance activities of financial 
institutions should be deemed preempted by Section 92. An anonymous 
Requestor that asked the OCC to consider this issue contends that five 
of the provisions included in the Rhode Island Act ``discriminate'' 
against national banks and significantly interfere with the exercise of 
their Section 92 powers.9
---------------------------------------------------------------------------
    \7\ See 62 Fed. Reg. 1950 (Jan. 14, 1997).
    \8\ See R.I. Gen. Laws Sec. Sec. 27-58-1 et seq.
    \9\ 62 Fed. Reg. at 1951.
---------------------------------------------------------------------------
    The Rhode Island Act was supported by a bipartisan group of state 
legislators. Indeed, it was agreed to by a significant portion of the 
State's banking industry. As reflected in the Rhode Island Governor's 
statement upon signing, the Act is designed to level the playing field. 
None of the provisions at issue actually or constructively preclude 
national banks from engaging in the business of insurance in any way, 
and none of the challenged provisions impose different requirements on 
national banks than those imposed on any other financial institution 
engaging in the sale of, or in the solicitation for the purchase of, 
insurance products.10
---------------------------------------------------------------------------
    \10\ The challenged provisions generally prohibit the tying of 
banking and insurance; generally require that a financial institution's 
loan and insurance businesses be physically segregated; generally 
prohibit financial institution employees with loan or deposit-taking 
responsibilities from soliciting and selling insurance; require that 
loan and insurance transactions be completed independently and through 
separate documents; and prohibit usage of nonpublic customer 
information without the written consent of the customer. See id.
---------------------------------------------------------------------------
    The OCC, however, apparently believes that these provisions may 
``significantly interfere'' with a national bank's exercise of its 
Section 92 powers, although the agency has not articulated the standard 
by which any such significant interference will be 
measured.11 Indeed, based on the OCC's supplemental request 
for comments on the issue, it appears that the OCC is prepared to 
impose its own views of how best to legislate on the States. Not only 
is the OCC inquiring whether the Rhode Island provisions prevent or 
significantly interfere with national banks' insurance sales 
activities, the OCC is asking whether there are ``better'' means that 
the State might have chosen to effectuate its policy goals. This is 
clearly beyond the OCC's legitimate role as banking regulator. It is 
the role of legislators--and in this context, State legislators--to 
determine how best to effectuate public policy, not the OCC.
---------------------------------------------------------------------------
    \11\ Remarkably, the OCC first sought comments on the preemption of 
the Rhode Island Act before the State Insurance Department had 
finalized regulations that would implement the statute. We, among 
others, pointed out the prematurity of the OCC's request. Apparently 
recognizing its error, the OCC recently reopened the comment period to 
permit consideration of the finalized regulations. It is only in light 
of those regulations that the meaning of the statute can be 
ascertained.
---------------------------------------------------------------------------
    During the first round of comments, numerous members of Congress 
expressed their belief that it was inappropriate for the OCC to attempt 
to preempt any State insurance laws. No member voiced the opposite 
view. Nevertheless, the OCC labors on, possibly prepared to opine that 
these state law provisions--enacted on a bipartisan basis by state 
legislators with the agreement of significant representatives of the 
banking industry in the State--should not be applied to national banks. 
Interestingly, the Rhode Island law has been in force now for over two 
and a half years and all players seem to be functioning remarkably 
well.
    The question whether any of the provisions of the Rhode Island Act 
may be preempted is not an isolated one. Sixteen other States have 
enacted laws that seek to regulate bank involvement in insurance sales 
activities,12 another seven have acted by 
regulation,13 and at least six other States are now 
considering legislation to regulate bank sales of insurance. And, in 
the meantime, the OCC is meeting with State insurance regulators 
intimating that it is prepared to preempt any laws or regulations that 
it views as going too far. There is thus an intense need to clarify the 
States' regulatory supremacy in this area. The financial services 
proposal currently before you, however, fails to adequately ensure that 
state regulators will remain empowered to insurance activities in 
general and, more specifically, the unique consumer protection concerns 
that arise when federally insured depository institutions engage in 
insurance sales.
---------------------------------------------------------------------------
    \12\ Arkansas (House Bill 2070 (1997)); Colorado (House Bill 97-
1175 (Colorado Rev. Stat. Sec. Sec. 10-2-601 et seq.)); Connecticut 
(Public Act No. 97-317 (Connecticut Gen. Stat. Sec. 36a-775)); Illinois 
(House Bill 586 (1997) (The Illinois Insurance Code Article XLIV)); 
Indiana (House Enrolled Act No. 1241 (1997) (Indiana Code Sec. Sec. 27-
1-15.5-8 et seq.)); Kentucky (Kentucky Laws Ch. 312 (H.B. 429) (1998) 
(Ky. Rev. Stat. Sec. 304)); Louisiana (House Bill No. 2509 (1997) (La. 
Rev. Stat. 22:3051-3065)); Maine (S.P. 439-L.D. 1385 ((9-A Maine Rev. 
Stat. Ann. Sec. Sec. 4-401 et seq.)); Massachusetts (Senate 1948, Bill 
No. MA97RSB (May 15, 1998)); Michigan (House Bill No. 5281 (1993) 
(Mich. Compiled Laws Sec. 500.1243)); New Hampshire (House Bill 799 
(1997) (N.H. Rev. Stat. Ann. Sec. Sec. 406-C et seq.)); New Mexico 
(House Bill 238 (43rd Legislature, 1st Sess.) (New Mexico Stat. Ann. 
Sec. Sec. 59A-12-10 et seq.)); New York (Bill No. 5717-B (July 18, 
1997) (New York Banking Law Sec. 14-g; New York Insurance Law 
Sec. Sec. 2123 and 2502) (sunsets July 18, 2000)); Pennsylvania (House 
Bill 1055 amending the Act of May 17, 1921 (P.L. 789, No. 285), 
Printer's No. 1985 (June 9, 1997), 40 Penn. Stat.); Texas (House Bill 
No. 3391 (1997) (Texas Insurance Code Article 21)); and West Virginia 
(H.B. 2198 (March 14, 1997) (W.V. Code Chapter 33)).
    \13\ Florida (Dept. of Insurance Rules 4-224.001-4-224.014); 
Georgia (Rules and Regulations of the Office of the Commissioner of 
Insurance Chapter 120-2-76 (adopted February 17, 1997)); Maryland 
(Advisory Letter Issued by the Insurance Commissioner and the 
Commissioner of Financial Regulation on October 31, 1996); Mississippi 
(Executive Memorandum issued by the Commissioner of Banking and 
Consumer Finance on May 13, 1997); Ohio (Department of Insurance Rule 
3901-5-08); Vermont (Insurance Division Bulletin 117 (June 13, 1997)); 
and Wyoming (Chapter 16 of the Rules of the Division of Banking).
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IV. Ensuring That The Bill Does Not Undermine Functional Regulation
    Put simply, enactment of the current H.R. 10 draft would 
dramatically undermine the ability of state insurance regulators to 
regulate and it would jeopardize many of the consumer protections 
already in place in many states that are designed to ensure that 
consumers are well-informed and free to choose to purchase insurance 
products adequate to address their insurance needs. Although the bill 
pays lip service to functional regulation in certain respects, it 
ultimately fails to adequately protect it. It is for this reason that 
we support the amendments sought by the NAIC to improve the bill's 
preemption provisions. In the insurance sales context, we be-

lieve three core sets of changes supported by the NAIC would improve 
the proposed legislation: (1) clarify that state insurance regulators 
are entitled to receive consideration of their views in court when 
disputes arise between regulators; (2) amend the so-called ``non-
discrimination'' provision to appropriately clarify the scope of the 
standard; and (3) strengthen and clarify the safe harbor consumer 
protection provisions. It is worth noting that all of these 
``improvements'' that we are now seeking were included in the bill that 
you shepherded through the House last term, Mr. Chairman.
    Clarify That The Opinions of State Insurance Regulators Are 
Entitled To Consideration In Court Reviews of State Insurance Laws. The 
viability of regulatory provisions already in force in many States 
would be put into jeopardy because of the implication created in the 
bill that the OCC is entitled to exclusive consideration when a court 
confronts the question whether a challenged provision should be 
preempted because it ``significantly interferes'' with a national 
bank's exercise of its insurance sales powers. Although Section 306 
creates a special procedure for the challenge of state insurance 
regulations and dictates that the state insurance regulator and the OCC 
are entitled to equal consideration during that review, Section 
104(b)(2)(C) exempts laws in existence prior to September, 1998 from 
the ``no unequal deference'' standard. The OCC, however, simply has no 
expertise in the regulation of the business of insurance. Moreover, the 
OCC has repeatedly demonstrated that the expansion of national bank 
powers is at the forefront of its concerns. This preoccupation has led 
the OCC to interpret a small exception to the general prohibition on 
national bank sales of insurance that authorizes national banks located 
and doing business in places with populations not exceeding 5,000 
inhabitants as allowing national bank agents to sell from anywhere so 
long as they are headquartered in a small-town bank office and to sell 
to customers located anywhere without any geographic restriction 
whatsoever. For these reasons, we believe that OCC interference with 
State regulation of the business of insurance--and exclusive 
consideration of OCC opinions regarding such regulation--is 
inappropriate. The Courts are well qualified to determine whether State 
regulations prevent or significantly interfere with a national bank's 
exercise of its insurance sales authority and requiring or implying 
that the OCC is entitled to special deference over and above that 
accorded state insurance regulators on such questions is therefore 
unacceptable.
    Amend the ``Non-Discrimination'' Provision. Section 104(c) 
completely prohibits States from distinguishing in any way between 
financial institutions and other entities--and from enacting provisions 
that may have a greater effect on financial institutions than on other 
entities (even if inadvertent)--in regulating the sale of insurance 
products. As over 25 States and the OCC itself have previously 
recognized, however, the sale of insurance products by financial 
institutions creates unique problems that require consumer protections 
tailored for the financial institution context. These laws are not 
``anti-competitive.'' Indeed, they expressly recognize that banks are 
in the business to stay. But they attempt to create a level playing 
field between bank and non-bank insurance agents and brokers, and to 
protect consumers from potential abuse. Banks' access to cheap funds, 
FDIC-insured status, and control over credit, puts them in a position 
not held by others in the insurance industry. For this reason, many 
States believe provisions regulating bank sales of insurance are 
necessary to prevent coercion and confusion and to protect customer 
privacy.
    Indeed, as the OCC itself recognized when it published an advisory 
letter to provide guidance to national banks on insurance and annuity 
sales activities, 14 there are many instances in which 
``discriminatory'' regulation (in the sense of treating banks 
differently than non-banks) is appropriate and necessary. Consequently, 
there is no basis on which to argue that the type of ``discrimination'' 
present in consumer protection provisions such as those contained in 
the Rhode Island Act are per se illegitimate.15
---------------------------------------------------------------------------
    \14\ See OCC Advisor Letter AL 96-8 (October 8, 1996).
    \15\ Absolutely nothing in the Barnett decision, or its precedents, 
supports the argument that a State cannot regulate national banks in a 
manner that distinguishes them from non-banks.
---------------------------------------------------------------------------
    In working on these laws at the state level, agents have negotiated 
with all interested parties--banks, insurance companies, securities 
firms. Michigan's law, enacted almost six full years ago, is the 
product of negotiations between the banks and the agents. West 
Virginia's law, enacted two years ago, is the product of negotiations 
that included not just the banks and the agents, but insurance 
companies as well. The process has been no different in the other 
twenty-two States.
    Although the safe harbor provisions are an effort to capture many 
of the substantive regulatory controls that currently are imposed, they 
are both under inclusive of the current universe of regulatory 
requirements designed to address bank-specific consumer protection 
issues and they cannot possibly take into consideration the wide array 
of issues that may in the future require bank-specific regulatory 
solutions.
    We believe that, as long as the legislation makes clear that States 
may not prohibit the exercise of authorized insurance sales powers, 
there should be no need to bar state legislatures and governors from 
implementing bank-specific solutions designed to address consumer 
protection concerns that may arise when such powers are exercised. This 
would mandate the complete elimination of the ``non-discrimination'' 
provision. At a minimum, however, we believe that the standard must be 
clarified in two ways. First, the prohibition on the enactment of 
provisions that facially differentiate between insured depository 
institutions and other entities must be amended to clarify that such 
provisions are impermissible only if they treat insured depository 
institutions differently based on their federally-insured status 
because it is only regulation of that facet of their insurance-related 
activities that should be limited in any way to the regulatory 
requirements dictated by the legislation or protected by the safe 
harbor provisions. Second, the ``indirect discrimination'' provision--
104(c)(2)--must be completely eliminated. It is unfair and unreasonable 
to prohibit the application of broad regulatory requirements simply 
because they may happen to have an indirect disparate impact on 
financial institutions.
    Strengthening The Safe Harbor Provisions. Finally, we believe that 
the current list of safe harbors must be strengthened. Section 
104(d)(2)(B) establishes 13 separate ``safe harbor'' provisions. These 
``safe harbors'' essentially permit a State to promulgate consumer 
protection laws and regulations that are substantially the same as but 
no more burdensome or restrictive than the requirements included in 
each provision. Any state law that falls within a safe harbor cannot be 
preempted. The ``safe harbors'' apply to laws already in place as well 
as those that may be enacted in the future. The ``safe harbor'' 
provisions included in the bill, however, are inadequate.
    Consumer protection provisions that are at the heart of the 
regulation of banks sales of insurance in many states--requiring 
separation of banking and insurance activities within the bank, for 
example--have been excluded from the list of consumer protections that 
are automatically deemed to be permissible. That exclusion jeopardizes 
the application of many such provisions and may undermine the 
regulatory scheme of as many as 30 States that have been designed to 
address many of the unique issues that arise when banks--in their 
unique position controlling federally insured credit capital--also 
engage in the business of insurance.
    Specifically, we believe four of the current safe harbor provisions 
should be clarified and two provisions should be added:
1. Discrimination Against Non-Affiliated Agents (Safe Harbor ii)
 The current version of the safe harbor permits a state to 
        prohibit an insured depository institution from imposing a fee 
        related to insurance required in connection with a loan when 
        the insurance is purchased from an agent not affiliated with 
        the bank that is not imposed if the insurance is purchased from 
        an affiliated agent.
 This provision must be amended to clarify that an insured 
        depository institution cannot impose any other condition 
        related to insurance required in connection with a loan that is 
        purchased from an unaffiliated agent that is not imposed when 
        the insurance is purchased from an affiliated agent.
2. Referral Fees (Safe Harbor v)
 The current version of this safe harbor permits a state to 
        prohibit an insured depository institution from paying a 
        referral fee to an unlicensed person if that fee is based on 
        the subsequent purchase of insurance.
 The provision should be amended to also permit a state to 
        require that any referral fee paid to an unlicensed person can 
        be no more than a nominal fee as many states have implemented 
        such a requirement.
 The nominal fee requirement also is imposed through the 
        federal consumer protection requirements that would be 
        promulgated by the federal banking agencies under Section 176 
        of the bill.
3. Anti-Tying (Safe Harbor viii)
 The current version of this safe harbor creates an exception 
        to the general rule by allowing insured depository institutions 
        to engage in any practice that the Fed has determined is 
        permissible under the Bank Holding Company Act anit-tying 
        rules.
 This may allow insured depository institutions to offer 
        product packages that would violate state anti-rebating rules 
        applicable to all other agents.
 The provision should be amended to delete that exception.
4. Disclosures (Safe Harbor x)
 The current version of this safe harbor permits states to 
        require insured depository institutions to disclose that 
        insurance products are not insured by the FDIC or guaranteed by 
        the state or federal government.
 The wording of the safe harbor permits states to require such 
        a ``disclosure, in writing, where practicable''.
 That language creates an ambiguity regarding whether the 
        disclosure need be in writing only where practicable or whether 
        the disclosure itself need be given only where practicable.
 The comma between the words writing and where should be 
        deleted to clarify that the disclosure need be in writing only 
        where practicable.
5. Disclosure Acknowledgment
 A new safe harbor should be included that would allow a state 
        to require the collection of an acknowledgment whenever a 
        required disclosure is given. Many states currently require the 
        collection of such an acknowledgment.
 An acknowledgment requirement in connection with disclosures 
        also is imposed through the federal consumer protection 
        requirements that would be promulgated by the federal banking 
        agencies under Section 176 of the bill.
6. Activities Separation
 A second new safe harbor should be included that would permit 
        a state to require insured depository institutions to separate 
        their insurance sales activities from their deposit-taking and 
        lending activities within the bank. Many states currently 
        maintain such separation requirements.
 A separation of insurance and deposit-taking activities also 
        is imposed through the federal consumer protection requirements 
        that would be promulgated by the federal banking agencies under 
        Section 176 of the bill.
                               conclusion
    The financial services mechanism H.R. 10 seeks to establish must 
function in the real world. That can only be accomplished if there is 
true functional regulation. We believe that virtually everyone in 
Congress supports such functional regulation. The task is to implement 
it effectively. The affiliations contemplated by H.R. 10 are exciting 
and probably necessary. But there must be a level playing field for 
everyone in the industries involved. Small business concerns cannot be 
swept away by the resulting mergers of the bigger players. And, most 
importantly, the interests of consumers that state insurance regulators 
have been exclusively charged with protecting for decades must remain 
at the forefront.
    It is clear that the absence of sufficient regulatory authority 
over national banks--or any other entity--that is active in the 
insurance arena is a problem. Neither the Comptroller nor any other 
federal regulator possesses the necessary expertise to regulate the 
vast intricacies of the insurance business or of financial 
institutions' participation in that business. For this reason, and for 
the reasons delineated at length above, IIAA, NALU and PIA urge this 
Committee to recommend enactment of legislation that clarifies that all 
entities that engage in the business of insurance--including national 
banks and any other entity in a new financial services holding 
company--are bound by state law regulating those activities and 
incorporating the suggestions we have offered in an effort to improve 
the ability of the states to satisfy this regulatory obligation. This 
would maintain the status quo by ensuring that the States remain the 
paramount regulatory authority for the insurance industry. Without 
enactment of such legislation, the emerging regulatory void in portions 
of this industry will continue to fester. The primary victims if such a 
bill is not enacted will inevitably be the consumers who are confronted 
by the unregulated participants in the essential but highly complicated 
business of insurance.
    Mr. Chairman, we look forward to working with you to pass financial 
services reform.

    Mr. Oxley. Thank you.
    Let me begin with some questions.
    Mr. Sinder, you referred to the court decision not by name 
I don't think, but the Independent Insurance Agents versus 
Hawke?
    Mr. Sinder. Yes, sir.
    Mr. Oxley. Would you give the committee a little bit of 
background on that case and how that should, if indeed it 
should, affect our consideration of H.R. 10?
    Mr. Sinder. Sure. That case was filed by the Independent 
Insurance Agents of America, NALU and PIA, the three clients 
who I am testifying on behalf of.
    Mr. Oxley. Did you litigate that case?
    Mr. Sinder. Yes, sir. It has made it through the District 
of Columbia District Court. The case involves the OCC's grant 
of authority for national banks to sell crop insurance. They 
granted this authority under section 247 of the National 
Banking Act, which is the general powers provision of the 
National Banking Act. There is a separate provision, as you 
know, called section 92 which authorizes small-town national 
banks to engage in insurance sales activities.
    The Comptroller argued that it was permissible for all 
banks to engage in crop insurance sales because it was credit-
related insurance. There is a decision that was issued by the 
D.C. circuit several years ago that said that credit-related 
insurance products that are limited to the amount of the loan 
and for the terms of the loan are permissible for bank sales.
    We argued that that is a very specific exemption and that 
crop insurance is a general insurance product, like any other 
PNC product, and that if you allow banks to sell crop insurance 
as a credit-related activity, you completely eviscerate the 
very small exception that is left by the small-town sales 
provision. The court agreed with us. The court said that 
section 247 does not authorize general insurance sales like 
crop insurance because of the existence of section 92, which 
limits those activities to small towns.
    Mr. Oxley. Thank you. That appears to be, that one and a 
similar one appear to be a different outcome than had been the 
case over the last several years, was it not? In other words, 
there were a number of decisions based on OCC decisions that 
went pretty much with the OCC, and then these two appeared to 
be going in the opposite direction.
    Mr. Sinder. We believe the tide is turning.
    The other decision in some ways might be more important for 
this committee's deliberation. It is a case that was issued by 
the 11th circuit and it involves the ability of national banks 
to underwrite annuity-based products. The 11th circuit held 
that the Comptroller had authorized this activity of section 
247 under the National Banking Act, again as a general banking 
power. It involves a unique product called a retirement CD that 
is an annuity with a deposit component. The 11th circuit said 
that there is no underwriting authority that exists under 
section 247. The Comptroller had issued various statements 
saying that he believed that there was such authority. This is 
the first time that a court has had the opportunity to review 
the underwriting issue and they went against the OCC.
    Mr. Oxley. Thank you. Mr. Zimpher, what effect on 
Nationwide, what would be the effect on Nationwide if you were 
unable to form a mutual holding company? How would it affect 
your ability to raise capital and indeed be competitive in the 
marketplace?
    Mr. Zimpher. Well, fortunately, Mr. Chairman, fortunately 
right now I don't know that it is necessary for us to consider 
that for current purposes to capitalize ourselves. Our life 
company, Nationwide Financial Services, is a publicly traded 
company. Our mutual company owns 80 percent of that company.
    If this bill were to be in effect, though, I think the net 
effect would be we would have to form a mutual holding company. 
I don't think we would have to demutualize necessarily, but we 
would have to form a mutual holding company in which to engage 
in other affiliated activities. Otherwise, simply to avoid dual 
regulation or double regulation of all of the various products.
    Mr. Oxley. Thank you.
    Let me ask Mr. Schultz, why aren't the provisions that H.R. 
10 has included to require for a deduction from regulatory 
capital of a bank's investment and its operating subsidiaries 
sufficient to address these concerns?
    Mr. Schultz. I think many reasonable people in the past 
have indicated that, and I think you are addressing firewalls, 
I assume.
    Mr. Oxley. Yes.
    Mr. Schultz. Firewalls can evaporate pretty quickly at 
times, and it appears to me that the op-sub is just closer to 
the core bank than if it were in a separate holding company 
structure.
    Mr. Oxley. Have you had discussions with other bankers from 
Iowa on this provision, and is there a consensus on this issue?
    Mr. Schultz. I haven't had that many discussions on this 
specific topic recently, but I think most community bankers 
would support the affiliate approach.
    Mr. Oxley. Thank you.
    The Chair's time has expired.
    The gentleman from New York, Mr. Towns.
    Mr. Towns. Thank you very much, Mr. Chairman. If we simply 
pass the House banking version of H.R. 10 without any changes 
whatsoever, would your industry have a level playing field--I 
will sort of go down the line with this question--competing 
against one another? The banking market, if we pass it as is, 
if the Commerce Committee says okay, we like it, we smile and 
we send it on its way without doing anything to it--let's start 
with you, Mr. Schultz and then go down.
    Mr. Schultz. Again, the question is, am I going to smile 
and like it?
    Mr. Towns. No, no. I am saying if we smile and say we like 
the bill and we send it on, the question is if we do that, 
would your industries have a level playing field for competing 
against one another? That is the question.
    Mr. Schultz. Possibly leveler, but I am not so sure 
completely level.
    Mr. Towns. What should we do then to make it level?
    Mr. Schultz. I would have to think about that for a moment.
    Mr. Towns. All right. We will go to Mr. Sutton.
    Mr. Sutton. From the standpoint of the securities industry 
I think it would go a long way toward leveling the playing 
field, particularly toward the areas that I pointed out in my 
testimony, us competing against banks, and us being able to 
purchase banks, which today we can't purchase; on the other 
hand they can purchase us. So I think it would make substantial 
progress toward leveling the playing field for us.
    Mr. Zimpher. Mr. Towns, that is a very good question. I 
would have to say from our perspective, it does level the 
playing field. You heard some earlier testimony from Mr. 
Nichols expressing some concern about a couple of provisions as 
they relate to functional regulation of products in the 
insurance industry issued by banks or securities firms. With 
the assurance that functional regulation is secured for all 
products, I think it would level the playing field.
    As you well know, H.R. 10, as reported by the Banking 
Committee, while it provides for an affiliate structure or an 
operating subsidiary structure in underwriting securities, it 
does not provide for such an underwriting insurance, and we are 
satisfied with that and would strongly encourage the committee 
to certainly at least retain that feature of the Banking 
Committee report.
    Mr. Towns. Thank you.
    Mr. Sinder. In the insurance sales context, we would not 
believe it would create a level playing field, but an unlevel 
one. The primary reason is that State insurance regulators 
would be tremendously inhibited in their ability to regulate 
bank insurance sales activities where they have an unfettered 
right to regulate all insurance activities of other agents.
    In our written testimony we have suggested three specific 
areas that we believe need to be addressed to help level this 
playing field. One is to treat the opinions of State insurance 
regulators equally with those of Federal banking regulators 
when an insurance sales requirement is challenged by a bank. 
The second is to alter, amend, the nondiscrimination 
provisions.
    Right now, those provisions did not allow you to take into 
account in any way the special situation of a bank when it 
engages in sales activities, including inadvertent impact on a 
bank even when the legislation is not directed on a bank. We 
believe that the inadvertent impact section should be deleted 
and that the core nondiscrimination provisions should be 
modified to indicate that it is only when you treat a bank 
differently because of its insured financial status that the 
law is prohibited.
    The last thing we have suggested is that six changes be 
made to improve the safe harbor provisions that protect State 
insurance laws that do specifically address bank sales of 
insurance activities, and those specific changes are outlined 
in our testimony.
    Mr. Towns. Thank you.
    Some of my colleagues are saying that we should expand the 
provisions of the CRA to cover industries other than the 
banking institutions. What do you say to that?
    Mr. Schultz. Sometimes as a community bank I wonder why we 
are subject to CRA, because if we don't invest----
    Mr. Towns. I didn't hear you.
    Mr. Schultz. I said sometimes we wonder as a community bank 
whether we should be subject to CRA, why we should be when 
maybe our credit union friends are not, you see. I am not sure 
that extending regulatory burden wider is really the solution 
in many cases, even though from a competitive standpoint it 
certainly raises some question. I make loans to customers and 
so on, and we also sell insurance. And getting back to the 
question you raised a little while ago, in my State, banks have 
been allowed to sell insurance for a long time. Our people are 
licensed agents, are subject to State insurance regulations and 
have had no problems. So I think the concern in the banking 
industry in some areas might be in the States where this hasn't 
been the practice as to whether it will be easy enough for 
banks to enter the insurance business because of the safe 
harbors that are in the proposed legislation.
    Again, getting back to the question about CRA and other 
types of regulation, you know, we are regulated as a bank and 
so on. As it relates to how we invest in our community and 
other consumer regulations, I am not sure who regulates Bob 
Spear, my American Family agent friend, when he makes a car 
loan, or makes a house loan, or the State Farm agent who is a 
friend of mine also who does the same thing.
    Mr. Towns. My time has expired, so please respond briefly.
    Mr. Sutton. CRA is really not something I can comment on 
because it is not something we have been involved in.
    Mr. Zimpher. I think you raise an interesting question. I 
don't believe the insurance industry should be subject to the 
CRA. I think the nature of investments, the nature of the use 
of capital within my industry as opposed to the banking 
industry, insuring properties and lending mortgage capital and 
lending practices are two very distinct business functions, and 
I think that I would seriously question whether CRA should be 
applied to the insurance industry. We make investments now, 
obviously, through our investment subsidiaries and any other 
urban projects or redevelopment projects. So there is money 
being used in an investment capacity, in a capital flow 
capacity and in hundreds of cities around this country.
    Mr. Sinder. This is an issue on which the insurance agents 
have not focused and have no direct interest. We are 
comfortable with the provisions as they are in the bill, but we 
have no official position at all.
    Mr. Towns. Thank you very much.
    Mr. Gillmor [presiding]. The gentleman from Illinois, Mr. 
Shimkus.
    Mr. Shimkus. Thank you, Mr. Chairman. Two quick questions 
for you all. It is one that I asked Secretary Rubin and a lot 
of you were in the room.
    The major players in the debate obviously is Chairman 
Greenspan and the administration, whether it be Levitt or Rubin 
or the chair of the FDIC. If safety, soundness and stability is 
a principle that our financial institutions need to be based 
on, which I believe, and the political winds blow in different 
directions at different times, for the sake of talking to the 
average investor, who do you feel best is the least political 
of the players? Let's just go from Mr. Schultz down.
    Mr. Schultz. Of those two players?
    Mr. Shimkus. Of the two sides of this debate, Chairman 
Greenspan or really Secretary Rubin.
    Mr. Schultz. I think the public would probably feel that 
Chairman Greenspan would be the less political.
    Mr. Shimkus. Who do you feel?
    Mr. Schultz. And I would too.
    Mr. Shimkus. You would agree, okay. Mr. Sutton?
    Mr. Sutton. I am not so sure that I know all of the views 
that have been expressed by all of the parties that you just 
discussed. I would say that I think from what I understand, the 
various issues surrounding regulatory----
    Mr. Shimkus. Well, the question is, to the consumer, if 
they want to make sure we are not playing politics and we want 
safety and soundness and really a nonpartisan overview of 
financial services, who would they trust?
    Mr. Sutton. I think they would trust safety and soundness 
to the bank regulators and investor interest to the SEC, which 
I think is what you have been hearing about probably all day 
long.
    Mr. Shimkus. Well, I want to know what you would feel, but 
that is fine.
    Mr. Zimpher.
    Mr. Zimpher. Mr. Chairman and Mr. Shimkus, I have no idea 
who the public might--how they may perceive it. I have the 
utmost respect for both of those gentlemen. I think this 
country has been well-served by two very public-spirited 
gentlemen. I have read both of their testimony, studied their 
positions. I tend to support Mr. Greenspan. Whether the public 
would support that predominantly, I have no idea.
    Mr. Shimkus. Well, I think the public understands that one 
is a politically appointed position and one is not.
    Mr. Sinder. The insurance agents have the utmost respect 
for both Federal regulators, but the most important concern for 
us between the debate for subs and affiliates is not where 
insurance activities are performed, but it is who gets to 
regulate them. For us, we don't believe any Federal regulators 
should regulate them, because no Federal regulator has ever 
regulated insurance activities or other activities. Those 
should be left to be functionally regulated by the States.
    Mr. Shimkus. Okay. The last question is: Is there a larger 
risk to the FDIC and the taxpayer if the operating subsidiary 
version of H.R. 10 becomes law over if the holding company 
version of H.R. 10; and I will just go down the line again. Mr. 
Schultz.
    Mr. Schultz. I think consistent with my testimony, it would 
be that there is less risk that is pushed out into a separate 
affiliate of the holding company, and after hearing this debate 
and reading the testimony, I do not know which one you are 
going to hear last. Both of them present very sound arguments, 
but I think the less risk is the holding company.
    Mr. Shimkus. Mr. Sutton.
    Mr. Sutton. We are not currently involved in any banking 
activities----
    Mr. Shimkus. But you might be.
    Mr. Sutton. So if we were, I would assume that from the 
issue of risk, that the holding company would probably be less 
risk.
    Mr. Shimkus. Thank you.
    Mr. Zimpher. I would probably agree with that, Mr. Shimkus, 
but that is an unfounded opinion. That is an uninformed----
    Mr. Shimkus. You could be a Member of Congress, then. I 
mean it would work out.
    Mr. Zimpher. I have thought about it.
    Mr. Sinder. I hate to sound like a broken record, but 
again, we believe the most important focus is on who regulates 
the activities, not where the activities take place, and as 
long as whatever bill is enacted----
    Mr. Shimkus. Now, that is a cop-out, because the issue in 
this debate is the holding company versus the operating 
subsidiary, and if insurance sales goes under the operating 
subsidiary, people are going to make the claim that the 
insurance is subsidizing some of that risk.
    Mr. Sinder. I don't think from a sales perspective you have 
the same subsidization concerns as you do from an underwriting 
perspective. If we had to choose, we would choose to put it in 
the affiliate, but like Chairman Levitt, we believe that the 
most important----
    Mr. Shimkus. We are the politicians here. We are asking for 
gut responses based upon your industry.
    Thank you, Mr. Chairman. I yield back.
    Mr. Sutton. Mr. Gillmor, could I excuse myself?
    Mr. Gillmor. Mr. Sutton, yes, go ahead. Thank you for being 
here with us.
    The gentleman from Michigan, the ranking member of the 
committee, Mr. Dingell.
    Mr. Dingell. Mr. Zimpher, you expressed concern that the 
Comptroller's op-sub rulemakes it clear that he is willing to 
allow the banks to do any nonbank activity, including 
underwriting. I share that concern. The Comptroller also told 
me that today, there are 19 national banks or subsidiaries of 
national banks underwriting insurance in the United States, and 
that there are 22 subsidiaries of banks engaged in reinsurance 
activities. Is there a risk to depositors when banks that don't 
have experience in the insurance industry get involved in such 
activities as underwriting and reinsurance?
    Mr. Zimpher. I believe there very well potentially could 
be, sir; yes, sir.
    Mr. Dingell. As I note, the Comptroller indicates that 12 
of the 22 banks that are engaged in reinsurance use managing 
general agents or independent contractors to perform at least 
part of these insurance activities. Doesn't that tell you that 
the banks who do this really don't know very much about the 
business, and are simply relying on others to do the job for 
them?
    Mr. Zimpher. One could reach that conclusion, Mr. Dingell. 
I am not familiar with the specific examples you cite, but from 
your presentation, one could reach that conclusion, yes.
    Mr. Dingell. Now, doesn't it also make it clear that banks 
and its depositors are especially vulnerable to fraud and 
mismanagement by these contractors?
    Mr. Zimpher. That is also a distinct possibility and 
potential, yes.
    Mr. Dingell. And that would be particularly true in view of 
the facts that banks would not be subject to State regulation 
and that there would be no substitute Federal regulation which 
would be put in place; isn't that right?
    Mr. Zimpher. That follows along the reasoning of your 
earlier questioning of the prior panel, Mr. Dingell. Absent 
State regulation that particularly would relate to fraud or 
sales practices, there would be a void, and policyholders, 
other investors could very seriously suffer.
    Mr. Dingell. Indeed, the insurance pools that protect 
people in the event of collapse of an insurance company would 
no longer be present; isn't that right?
    Mr. Zimpher. That's right. If the banking laws don't apply, 
that's right. They are not going to be assessed; they will not 
participate in their guarantee funds, so the holders of those 
policies are again----
    Mr. Dingell. The insurance commissioners have suggested 
amendments to this. Do you support the amendments that the 
insurance commissioners have suggested to protect against the 
abuses that you and I have been discussing?
    Mr. Zimpher. Mr. Chairman and Mr. Dingell, we support any 
effort to strengthen and assure functional regulation.
    Mr. Dingell. It is my understanding--this one to Mr. 
Sinder, please. It is my understanding that 18 different states 
have laws that require separation of banks' loan making and 
insurance sales activity. If H.R. 10 in its present form were 
to become law, would the physical separation laws of these 18 
states be preempted?
    Mr. Sinder. Possibly.
    Mr. Dingell. Can you say they would not?
    Mr. Sinder. You could not say they would not.
    Mr. Dingell. As a matter of fact, it is almost certain they 
would, isn't it?
    Mr. Sinder. I believe that they would.
    Mr. Dingell. Very well. The Michigan State house has passed 
a resolution calling on the Michigan State delegation, our two 
Senators, and the Congress at large to enact legislation that 
affirms, not preempts, State insurance laws including 
Michigan's physical separation law. This resolution was 
supported not only by the Michigan Association of Insurance 
Agents, but also by the Michigan Bankers' Association and the 
Michigan Credit Union League.
    Is it your view that H.R. 10 as reported by the banking 
committee fails to protect Michigan State insurance laws as 
this resolution suggests?
    Mr. Sinder. Yes.
    Mr. Dingell. Now, why is it possible for the Michigan 
Bankers' Association to support Michigan's physical separation 
law, but the National Bankers' Association opposes the same law 
at the Federal level?
    Mr. Sinder. I wish I knew the answer to the question.
    Mr. Dingell. It is a good question, isn't it? Now, your 
written statement says as follows: ``Although the bill pays lip 
service to functional regulation in certain respects, it 
ultimately fails to protect it.'' That is a strong statement. 
Must the functional regulation provisions of the bill be 
strengthened if the insurance agents are to support financial 
services legislation?
    Mr. Sinder. Yes.
    Mr. Dingell. Now, if the functional regulation provisions 
of the bill are not improved, would it be fair to say that the 
agents are no better off with the banking committee's bill than 
with the current law?
    Mr. Sinder. That's essentially correct in my view.
    Mr. Dingell. Now, there have been some recent court rulings 
that have called into question the decisions of the Comptroller 
to permit banks to engage in insurance activities.
    Are these rulings evidence that the courts thinks that the 
Comptroller has gone too far in improving insurance powers for 
banks? Is it possible that with the tide turning against the 
Comptroller that the courts' agents might be better off with 
the current law and fighting it out in the courts, rather than 
with the enactment into law of the banking committee's bill?
    Mr. Sinder. Possibly. We are very much in favor of the 
decisions. They do point to specific areas where the 
Comptroller has overstepped his bounds, but there are certain 
advantages to the current bill if it is enacted.
    Mr. Dingell. Thank you. Thank you, Mr. Chairman.
    Mr. Gillmor. Thank you, Mr. Dingell. A question for Mr. 
Sinder and also if the other members would like to jump in, on 
the issue of title insurance. The banking version generally 
permits national banks to sell insurance with the exception of 
title insurance.
    From your experience, is there any justification for 
treating title insurance different, or do you think they should 
be all forms of insurance?
    Mr. Sinder. There is some justification for treating title 
insurance differently. It is a product that is a one-time sale. 
It primarily protects the bank's interests and not the 
consumer's interests in the underlying loan and protecting the 
underlying loan. There is some conflict of interest in a bank 
that is seeking to get the loan and will too readily approve a 
title insurance sale in order to secure the loan.
    Mr. Gillmor. Why wouldn't the same arguments apply to any 
other type of insurance that the bank was selling to a 
borrower?
    Mr. Sinder. We believe there are issues involved in other 
sales to borrowers. But those products do not protect the 
interests of the bank. They do protect the first beneficiary of 
such products.
    Mr. Gillmor. How about credit life?
    Mr. Sinder. Credit life has a long and tortured history.
    Mr. Gillmor. The fact is it protects the bank.
    Mr. Sinder. If we had our druthers, the banks would not be 
permitted to sell credit life directly, but we have lost that 
fight.
    Mr. Gillmor. Basically, you would prefer that the bank not 
sell insurance, credit life, title, whatever?
    Mr. Sinder. Under the bill, the bank can sell title 
insurance through an affiliate, it just cannot do it through a 
subsidiary. The title insurance product is very complicated 
because the agent takes on some of the underwriting risk.
    When you sell any other type of insurance product, the 
underwriting and the sale are completely separate. So if the 
bank acts as the agent, or if the bank subsidiary acts as the 
agent in the sale of the product, a different company, which 
under the bill would have to be an affiliate, assumes all of 
the underwriting risk.
    When you sell a title product, the agent him or herself 
also assumes some of the underwriting risk. So in effect if you 
don't treat title differently, you are allowing the bank to 
engage in some underwriting activities, whereas it can't for 
any other insurance product.
    Mr. Gillmor. Any other comments on that issue, Mr. Schultz? 
Mr. Zimpher?
    Mr. Zimpher. I would not, no.
    Mr. Gillmor. Mr. Zimpher, is the banking committee bill's 
provisions regarding the separation of financial and commercial 
activities creating problems for insurance companies since 
insurance companies take money from policyholders and invest 
for those policyholders?
    Mr. Zimpher. Mr. Chairman, you are right that insurance 
companies must invest the funds that they receive from 
policyholders. Those investments are strictly limited and 
regulated by State investment statutes and laws across the 
country.
    Section 6 of H.R. 10, as it is reported by the banking 
committee, would permit insurance companies to retain some 
shares of interest in investment operations on behalf of 
policyholders. We happen to believe that that perhaps should be 
expanded, particularly on behalf of our policyholders whose 
funds it is we are investing; that insurance companies should 
continue to have some management supervisory role and 
responsibility in those operations.
    Mr. Gillmor. If I may go back to you, Mr. Sinder, we were 
told earlier by the Treasury Secretary that financial 
activities and operating subs would be regulated in the same 
manner as affiliates.
    My question is what has been the real-life experience of 
insurance agents in respect to insurance sales through banks 
and bank operating subsidiaries? Is there a feeling on the part 
of an agent that there has been any loss of consumer 
protection?
    Mr. Sinder. This is an area that the Comptroller of the 
Currency has tread somewhat lightly because of the pendency of 
the H.R. 10 bills. The history of this is that there was a real 
question about whether section 92, the small town sales 
authorization, overrode State laws that prohibited bank sales 
of insurance. That issue was not resolved until 1996.
    In March 1996, the Supreme Court issued a decision. They 
said section 92 preempts. In the wake of that, 25 States 
enacted bank sale of insurance consumer protection provisions 
to regulate the manner in which small town banks sell 
insurance.
    The first State to do so after the Barnett decision was 
Rhode Island. Within 6 months before the Department of 
Insurance could even issue its implementing regulations, the 
Comptroller of the Currency issued a request for comments in 
the Federal register asking whether certain provisions included 
in the Rhode Island bill should be preempted. That was in 
February 1997. It has been over 2 years.
    The Comptroller has not issued any opinion on this. We 
believe that it is because the office fears congressional 
response if it oversteps its bounds in doing so. As soon as 
this issue is resolved, we also fear that the Comptroller will 
then step up and give his view on whether these laws should be 
allowed to exist. In the past, the Comptroller has made 
statements that licensing provisions shouldn't apply to 
national banks, and anything else that interferes in a way that 
the Comptroller feels is bad with the banks' insurance sales 
function should not be allowed to exist.
    So today, is the real practical experience that banks are 
complying with these provisions? Yes. Do they want to challenge 
them? Yes.
    Mr. Gillmor. Mr. Schultz, are you a national bank or a 
State-chartered?
    Mr. Schultz. National bank. We have a holding company that 
also owns a State-chartered bank.
    Mr. Gillmor. You have been selling insurance for how long?
    Mr. Schultz. Many, many years, 30 years.
    Mr. Gillmor. Including title insurance?
    Mr. Schultz. No. I don't pretend to know much about title 
insurance. Iowa was one of the few States that doesn't allow, 
maybe the only State that doesn't allow title insurance.
    Mr. Gillmor. Doesn't allow title insurance? I used to 
practice real estate law. I'm glad I was in Ohio.
    In any event, Mr. Towns, do you have any further questions? 
If not, I want to thank the panelists for being here. We 
appreciate it very much. Stand adjourned.
    [Whereupon, at 3:10 p.m., the subcommittee was adjourned.]
    [Additional material submitted for the record follows:]
Prepared Statement of Hon. Kenneth E. Bentsen, Jr., a Representative in 
                    Congress from the State of Texas
    Mr. Chairman, I appreciate the opportunity to provide my views on 
financial modernization legislation before the House Commerce 
Committee. I would like to focus on one aspect of this legislation that 
directly relates to the safety and soundness of our financial system 
and competitive equity between foreign and national banks. This issue 
is about the corporate structure that this legislation will provide for 
our nation's banks.
    I am a strong proponent of providing more than one option of 
operational structure to our nation's banks. I believe that decisions 
about corporate governance should be made by the bank's officers, not 
the federal government. Later this month, your Committee will be voting 
on H.R. 10, financial modernization legislation. I would urge you to 
keep those provisions included in the House Banking Committee version 
of this bill that would preserve flexibility for our nation's banks and 
would permit them to create operating subsidiaries or bank holding 
company affiliates to offer new services to their customers.
    I believe that there is no safety and soundness associated with the 
inclusion of the operating subsidiary structure in financial 
modernization legislation. During testimony presented to the House 
Banking Committee in May 1997, I asked Federal Reserve Chairman Alan 
Greenspan whether there was any safety and soundness concern or risk 
with an operating subsidiary structure. Let me quote his response:
        ``My concerns are not safety and soundness. It is an issue of 
        creating subsidies for individual institutions which their 
        competitors do not have. It is a level playing field issue. 
        Non-bank holding companies and other institutions do not have 
        access to that subsidy, and it creates an unlevel playing 
        field. It is not a safety and soundness issue.''
His response clearly indicates that safety and soundness is not a 
concern, assuming appropriate firewalls are in place, just as they are 
with a holding company-affiliate model and as provided by the House 
Banking Committee's legislation. In fact, Chairman Greenspan argued 
that a bank receives a subsidy form its parent bank, not its operating 
subsidiary. Further, Chairman Greenspan acknowledged that banks can 
also receive a subsidy through its holding company affiliate as well.
    I believe that our capital markets today are very efficient and 
transparent and would be able to discount such subsidies if they do 
exist. In recent hearings, I asked several federal bank regulators 
about this issue and they all agree that there is no difference in 
capital costs for banks who wish to set up either an operating 
subsidiary or bank holding company affiliate. In addition, the House 
Banking Committee approved bill imposes strict firewalls and a 
requirement for the bank to be well-capitalized before it can opt to 
set up an operating subsidiary. Banks will benefit from this added 
flexibility by choosing whichever structure is better for their 
individual company. Finally, I would argue that the operating 
subsidiary structure will ensure that all assets of banks, including 
its operating subsidiary, are subject to Community Reinvestment Act 
(CRA) regulations.
    As you may know, the current and three previous Chairs of the 
Federal Deposit Insurance Corporation (FDIC) have emphatically stated 
that restricting the organizational flexibility of banking organization 
will have a negative impact on the safety and soundness of our 
financial system. If banks are required to provide new activities 
through holding company affiliates, but not in operating subsidiaries, 
the revenues earned by these new activities will flow directly to the 
holding company shareholders, and not to the bank. If the bank runs 
into trouble, the FDIC will not be able to reach these holding company 
assets, which rightly should be used to protect the bank and the FDIC 
funds.
    Further, I do not believe that there is any compelling evidence 
that the federal government should be interfering with private business 
decisions regarding organizational structure. Each business in this 
country should be free to organize its activities in the most efficient 
manner for that organization. For some banks, an operating subsidiary 
may be more cost-effective, while other banks may choose to use holding 
company affiliates to offer new services to their customers. For 
instance, it might be cheaper to organize an operating subsidiary 
because they do not require a multiple set of books and board of 
directors or legal requirements. Other banks, however, may elect to 
create a holding company structure because of tax consequences, 
compensation schemes, multibranding, risk management, and geographic 
location. Banks should be free to make business decision for themselves 
without unnecessary government mandates.
    I would also encourage you to consider how these options will 
affect our nation's smaller, community banks. Because smaller 
institutions have a smaller revenue base, they may not be able to 
afford to absorb increase organizational and regulatory costs of 
operating a holding company. For these smaller banks, the operating 
subsidiary option may be the best and most economically feasible option 
for these banks to offer their customers a full range of financial 
products in the most cost-efficient manner.
    We need to enact legislation that provides for adequate supervision 
to ensure that expanded financial activities are conducted safely and 
soundly in a subsidiary or an affiliate. The solution is not to favor 
one structure over another but rather to pass legislation that provides 
that the regulators can adequately supervise the effect on the bank of 
the expanded activities and bank's relationship with its subsidiaries 
or affiliates. This supervision along with adequate internal controls 
by the banks is the critical element to conducting in activities in a 
safe and sound manner rather than a mandated corporate structure.
    Another argument that has been made in opposition to operating 
subsidiaries is that the banks are more protected from corporate veil 
piercing under a holding company structure. This is wrong. Bank 
subsidiaries, in the same manner as bank affiliates, are legally 
separate from the insured bank. In those extremely rare instances when 
a court ignores this legal separation and permits the corporate veil to 
be pierced, an exhaustive empirical study conducted by Cornell Law 
Review shows that affiliates, not parent organizations, have been found 
financially liable in the greater number of instances. Piercing the 
corporate veil depends on how entities conduct their operations and not 
on how the operations are structured within an organizational chart.
    Opponents to the subsidiary option also assert that banks have a 
subsidy from the Federal safety net through the deposit insurance 
program, the access to the discount window and the payments system. 
These opponents argue that banks funding operations through 
subsidiaries have an unfair competitive advantage over non-bank owned 
competitors. I would disagree with this argument, because I believe 
banks are among the most heavily regulated private institutions in 
American society. After factoring in the costs of regulations and what 
banks' pay for the services in the federal safety net, I believe it is 
difficult to argue that any net subsidy exists. Even assuming for 
argument's sake that a net subsidy exits, there is no evidence that a 
holding company affiliate structure would be more effective than the 
operating subsidiary in containing the net subsidy because equivalent 
safeguard may be put in place. The subsidy could be passed through in 
the form of dividends to the holding company. And, in repeated 
questioning neither Chairman Greenspan nor the Federal Reserve has 
provided any quantitative evidence of such a subsidy nor any 
quantitative analysis determining a differential in such subsidy 
between an operating subsidiary and a holding company affiliate.
    I would also like to point out that the Federal Reserve has not 
expressed the same concerns about transfer of the subsidy in connection 
with foreign bank operations in the United States. In this decade 
alone, the Federal Reserve Board has issued approvals for almost 20 
foreign banks to own directly so-called Section 20 subsidi-

aries that engage in securities underwriting activities in the United 
States. While foreign banks are not supported by the United States 
federal safety net, they do have full access similar safety net 
benefits in their home country. Yet, these foreign banks are permitted 
to conduct non-banking activities directly through a subsidiary 
structure in the United States. In its first order permitting foreign 
banks to conduct securities underwriting through a Section 20 
subsidiary, the Board states that any potential advantages of allowing 
foreign banks to operate through the subsidiary structure rather than 
the bank holding company structure is not significant in light of the 
firewalls imposed. These firewalls are similar to those including in 
H.R. 10 as reported by the House Banking Committee.
    It simply does not make sense to permit foreign banks to enjoy the 
benefits of organization freedoms when acting in the United States but 
to deny these same benefits to United States banks. I believe in the 
principle of national treatment, which means foreign banks are treated 
in the same way as national banks. However, I do not believe that we 
should be providing flexibility to foreign banks that are denied to 
domestic institutions.
    Further, I would like to inform the Committee that I believe that 
these operating subsidiaries would ensure functional regulation for 
products sold from them. This would ensure that the Securities and 
Exchange Commission and states' securities regulators would have 
primary regulatory jurisdiction of operations. I believe that 
functional regulation is the most appropriate manner to ensure that 
consumers will understand what they are buying.
    Therefore, I urge this Committee to follow the approach of the 
Banking Committee by giving our banks the organizational choice that 
will be available to foreign banks under this legislation.
                                 ______
                                 
 Prepared Statement of The National Association of Independent Insurers
     The National Association of Independent Insurers ( NAII) is the 
nation's largest full service property-casualty trade association with 
619 members in the United States. NAII members include insurance 
companies of every size and type--stock, mutual, reciprocal and Lloyds. 
NAII members write almost $81.3 billion in annual premiums representing 
every type of property-casualty coverage, including automobile, 
homeowners, business insurance, workers' compensation and surplus 
lines.
    NAII and its members applaud the work of this committee and 
Congress in moving the Financial Services Act of 1999 toward 
finalization. The current version represents long hours of work at 
modernizing the financial services sector of the United States economy, 
while attempting to retain the best of existing regulatory structure in 
each of the respective areas of financial services. In addition to the 
public policy discussion at the congressional level, interested parties 
have worked behind the scenes to voice their concerns. A variety of 
regulators at the federal level--including the Chairman of the Federal 
Reserve, the Secretary of the Treasury, and the heads of the Office of 
Thrift Supervision and the Securities and Exchange Commission--have 
given their input. Likewise, state insurance regulators, through their 
organization, the National Association of Insurance Commissioners 
(``NAIC''), have commented on H.R. 10. In addition, trade associations 
comprised of insurers, insurance agents, thrifts, and banks, to name a 
few, have suggested language in an attempt to draft a bill which 
recognizes the needs of all the interested parties under such a unified 
financial services package.
    The authors of H.R. 10 have made great strides toward this 
objective by seeking to establish clear delineation of regulatory 
authority based on functional regulation. NAII and others believe that 
with modification, H.R. 10 can set out a bright line of functional 
regulation which will minimize needless costs of regulatory overlap and 
regulatory challenges, not only between the regulator and the 
regulated, but between the different kinds of regulators. NAII supports 
H.R. 10 and the concepts behind it. However, NAII believes that in 
order to achieve true functional regulation and a smooth running 
financial services sector of the economy, H.R. 10 must be modified to 
clearly delineate functional regulation and thus ensure that no element 
of the financial services sector receives an unfair advantage.
Section 104(c)(2)
    Of paramount concern to NAII members is the language in Section 
104(c)(2). Summarizing Section 104(c)(2), no state may pass a law or 
regulate insurance activities where such law or regulation, as 
interpreted or applied, will have an impact on a bank that is 
substantially more adverse than on non-bank entities. On its face, this 
sounds rather innocuous, indeed laudable, as no law or regulation 
should be permissible if that law or regulation is intended to be more 
adverse to a bank than other similarly situated entities. 
Unfortunately, this provision is not intent-based. It is based on the 
effect a law has on a particular party. Therein lies our concern. 
Section 104(c)(2), because it is effect based, provides a loophole 
which will permit banks to challenge state insurance laws even where 
there was no intention by the state of treating banks differently than 
insurance companies. We believe this is a path that will destroy the 
concept of functional regulation that the authors of H.R. 10 have tried 
hard to preserve.
    Under H.R. 10 as currently drafted, the advantage is given to the 
banks. Banks gain because state laws are preempted simply because they 
are banks. Such preemption is not a two-way street, as insurers are not 
positioned to have banking laws preempted where a banking law would 
have an adverse impact on an insurer.
    A concrete example of where a bank could have an unfair advantage 
in relation to the business of insurance involves accounting practices. 
Currently, under what are called Statutory Accounting Principles (SAP), 
insurers are required to report their financial results under what tend 
to be more conservative accounting rules than Generally Accepted 
Accounting Principles (GAAP). Banks follow GAAP accounting. Would an 
insurer affiliated with a bank not be held to SAP, and not be as 
strictly regulated as an insurer without bank affiliation, since the 
imposition of differing accounting principles is an additional cost to 
the bank?
    The problem with Section104(c)(2) is that it is not directly tied 
to the intent of the state to adversely impact a bank. Section 
104(c)(2) operates regardless of the state's intent. The only test of 
Section104(c)(2) is if the impact on a bank is different because it is 
a bank. If that impact exists, then any such state law or regulation is 
preempted. This is not preemption based on a state passing a law 
intentionally to affect a bank in the context of insurance business. It 
is preemption by hindsight, as the state's action will be viewed in 
relation to what happens, potentially years down the line, to a bank. 
It will not matter that the state had absolutely no intention of 
adversely impacting a bank. It will not matter that the state law was 
reasonably related to proper governmental objectives. What will matter 
is that a bank need not comply with such a law. That is an unfair 
advantage to the bank.
    Nor is it true functional regulation to give a bank this advantage, 
for by granting the advantage, there is an area where the function of 
the business of insurance is not regulated by the states. It is likely, 
too, that under Section104(c)(2), costly litigation will arise, for the 
bright line of functional regulation will become blurred as banks 
attempt to show that the effect, not the intent, of a state law 
adversely impacts the bank. In the context of these likely squabbles 
between banks and their regulators, and insurers and their regulators, 
under current Section 104(c)(2), financial services modernization would 
not be controlled by functional regulation, but rather plagued by 
dysfunctional regulation.
NAIC Amendments
    The National Association of Insurance Commissioners recently 
submitted to the Committee a package of amendments which include a call 
for deletion of 104(c)(2). NAII supports this and other NAIC 
amendments, and strongly encourages members of the House Commerce 
Committee to seriously consider their adoption. Please note that while 
stating NAII's support for removal of Section104(c)(2) from H.R. 10, 
the NAII strongly opposes any state law which is intended to have an 
adverse impact on a bank or which on its face singles out banks. Many 
NAII members have business relationships with banks, and would find 
affiliations with banks mutually advantageous.
    In addition, NAII strongly supports the proposed NAIC clarification 
to Section 303 stating that all insurance activities, not just sales, 
are to be functionally regulated. This change is consistent with the 
deletion of Section 104(c)(2) in order to achieve with ``bright line'' 
functional regulation.
Operating Subsidiaries
    NAII applauds the language in H.R. 10, Section 304, stating that a 
national bank and the subsidiaries of a national bank may not provide 
insurance as principal. To do otherwise would make functional 
regulation virtually impossible. However, there are activities which 
are permitted to national banks and bank subsidiaries. These include 
``authorized products'' or other insurance related activities. Because 
these products or activities are insurance related, consistent with 
functional regulation, these should be regulated by the states.
    At this point, it is appropriate to cite an example of an activity 
in which national banks or subsidiaries of national banks are permitted 
to engage but which should be functionally regulated as insurance. 
National banks are authorized to enter into debt cancellation 
agreements providing for the cancellation of the borrower's outstanding 
debt upon the death of the borrower. The Office of the Comptroller of 
the Currency (``OCC'') recently extended that authority to include debt 
cancellation agreements pursuant to which debt is cancelled as a result 
of the borrower's disability or loss of employment. These products 
resemble insurance and should be functionally regulated by the states. 
This is not to prohibit the banks from offering the products, only to 
regulate the product as insurance.
    A similar product is Guaranteed Auto Protection Coverage (``GAP 
Coverage'') whereby coverage is issued for the excess of the 
outstanding loan amount over any recovery from an insurer in the event 
of theft or total loss of a vehicle. For example, an individual may 
have a loan balance outstanding of $5000. The car is in an accident and 
totaled, but the appropriate payment by the insurance company is 
determined to be $4000. GAP coverage would pay $1000. National banks 
are permitted to offer this product. This product should be regulated 
by the state as insurance.
    The effect of a failure to regulate the above products as insurance 
if offered by a bank results in an unfair advantage to the bank in the 
sale of the product. If offered by a bank, these products are not 
subject to state regulation as are the same products if offered by an 
insurer. All of the additional cost of state regulation, and all of the 
additional state consumer protections, do not exist in relation to the 
bank's issuance of these products. These costs do exist if an insurer 
offers the same products. Thus, it is the insurer which is 
disadvantaged.
Affiliations
    Undoubtedly, mergers and acquisitions are a reality of the modern 
corporate world and are a proper subject for financial services 
modernization. It is wholly appropriate for banks and insurers to 
affiliate. Such affiliation, however, must be consistent with 
functional regulation. The current language of H.R. 10 in Section 
104(a)(2) attempts to grant functional regulation of the transaction to 
the states as to the business of insurance, but in reality merely 
enumerates the information a state may require relating to the 
transaction. Indeed, under H.R. 10, a state may require that the 
insurer's capital be restored to a certain level, but that is the 
extent of state authority. There are factors other than capital that 
relate to insurer solvency. Thus, the state effectively does not have 
functional regulatory authority over the affiliation. The NAIC's 
proposed amendment goes far to restore functional regulation as applied 
to affiliations by permitting the states to collect, review, and take 
actions on such applications, provided that the state law does not 
discriminate against the bank. NAII supports this amendment as 
protective of the solvency of insurers in affiliations.
Lee Amendment
    The NAII urges the Committee to delete the so-called Lee Amendment 
in Section 6(b). The Lee Amendment would apply Fair Housing Act 
standards to insurance affiliates of banks and represents a backdoor 
attempt to implement federal regulation of insurance. The Fair Housing 
Act, which was initially enacted in 1968 and amended in 1988, prohibits 
discrimination in housing on the basis of race, color, religion, sex, 
familial status, national origin or handicap. It expressly applies to 
home sales and rentals and the service of home sellers, landlords, 
mortgage lenders and real estate brokers. The Act does not make any 
reference to the separate service of providing property insurance for 
the simple reason that Congress, in enacting the law, recognized that 
insurance is a state regulated business. The Lee Amendment runs counter 
to the McCarran-Ferguson Act of 1945 which mandates the state 
regulation of the business of insurance. Every state and the District 
of Columbia have laws that prohibit insurance redlining. The addition 
of a federal application in this area will, at best, lead to a system 
of dual state and federal regulation of insurance.
Conclusion
    NAII urges the Committee to adopt the NAIC amendments to H.R. 10 as 
consistent with and in furtherance of the concept of functional 
regulation. It is clear that the intent of the drafters of H.R. 10 is 
preserving state regulation of the business of insurance. No better 
tangible evidence of Congressional intent in this area exists than the 
wording of Section 301 of H.R. 10 which states that the intent of 
Congress with reference to the regulation of the business of insurance 
as embodied in the McCarran Ferguson Act remains the law of the United 
States. It is to the benefit of banks as well as insurers that H.R. 10 
draw a ``bright line'' to define insurance and regulate the insurance 
function. With that ``bright line,'' H.R. 10 will indeed be financial 
services modernization, streamlining the financial services sector.
                                 ______
                                 
         Prepared Statement of the Investment Company Institute
I. Introduction
    The Investment Company Institute is the national association of the 
American investment company industry. The Institute's membership 
includes 7,546 open-end investment companies (``mutual funds''), 457 
closed-end investment companies and 8 sponsors of unit investment 
trusts. The Institute's mutual fund members have assets of about $5.730 
trillion, accounting for approximately 95% percent of total industry 
assets, and have over 73 million individual shareholders. The 
Institute's members include mutual funds advised by investment 
counseling firms, broker-dealers, insurance companies, bank holding 
companies, banks, savings associations, and affiliates of commercial 
firms.
    The Institute has been an active participant in the debate on 
financial services reform and has provided testimony to Congress on 
subjects directly related to such reform numerous times over the last 
twenty-three years. The Institute appreciates the opportunity to 
provide the Committee with its views on H.R. 10, the ``Financial 
Services Act of 1999.''
    Initially, we would like to commend the continued leadership of the 
House Commerce Committee in its effort to reform our nation's financial 
services laws. To most observers, it is now abundantly clear that the 
laws that separate mutual funds, banks, broker-dealers, insurance 
companies, and other financial services firms are obsolete in the face 
of technological advances, fierce competition, and dynamic and evolving 
capital and financial markets.
    By permitting affiliations among all types of financial companies, 
H.R. 10 represents a major step forward in the effort to modernize the 
nation's financial laws and to realign the financial services industry 
in a manner that should benefit the economy and the public. It also 
includes one of the most important principles that underlie successful 
financial services reform: the establishment of an oversight system 
based on functional regulation.
    Thus, H.R. 10, like S. 900, the ``Financial Services Modernization 
Act of 1999,'' reflects a sound framework for reform of the financial 
services industry, and we urge Congress to enact it. We are concerned, 
however, that attempts will be made to weaken its commitment to 
functional regulation, to apply the Community Reinvestment Act (CRA) to 
mutual funds, or to affect the ability of mutual fund organizations and 
other service providers to share certain information that is necessary 
to effectively operate a mutual fund. Any of these actions would pose 
serious concerns for mutual funds and their shareholders.
II. Background
    Regulation of the Mutual Fund Industry. Since 1940, when Congress 
enacted the Investment Company Act, the mutual fund industry has grown 
steadily from 68 funds to over 7,000 funds today, and from assets of 
$448 million in 1940 to over $5 trillion today. In our view, the most 
important factor contributing to the mutual fund industry's growth and 
success is that mutual funds are subject to stringent regulation by the 
Securities and Exchange Commission (SEC) under the Investment Company 
Act. The core objectives of the Investment Company Act are to: (1) 
ensure that investors receive adequate, accurate information about 
mutual funds in which they invest; (2) protect the integrity of the 
fund's assets; (3) prohibit abusive forms of self-dealing; (4) restrict 
unfair and unsound capital structures; and (5) ensure the fair 
valuation of investor purchases and redemptions. These requirements--
and the industry's commitment to complying with their letter and 
spirit--have produced widespread public confidence in mutual funds. In 
our judgment, this investor confidence has been, and continues to be, 
the foundation for the success that the industry enjoys.
    Our opinion concerning the efficacy of the mutual fund regulatory 
system has been confirmed by the General Accounting Office. In its 
report on mutual fund regulation twenty-four months ago, the GAO found 
that ``the SEC has responded to the challenges presented by growth in 
the mutual fund industry.'' It also noted that the ``SEC's oversight 
focuses on protecting mutual fund investors by minimizing the risk to 
investors from fraud, mismanagement, conflicts of interest, and 
misleading or incomplete disclosure.'' To carry out its oversight goal, 
the SEC performs on-site inspections, reviews disclosure documents, 
engages in regulatory activities, and takes enforcement actions. The 
SEC is also buttressed by ``industry support for strict compliance with 
securities laws.'' 1
---------------------------------------------------------------------------
    \1\ Mutual Funds: SEC Adjusted its Oversight in Response to Rapid 
Industry Growth (GAO/GGD-97-67, May 28, 1997) at pages 28, 5 & 29, 
respectively.
---------------------------------------------------------------------------
    The mutual fund industry has always spoken out against developments 
that would impair this effective and time-tested regulatory system 
which is what would occur if aspects of banking regulation were imposed 
on the mutual fund industry.
    Differences Between Bank Regulation and Mutual Fund Regulation. 
H.R. 10 recognizes that if financial services reform is to succeed in 
producing more vibrant and competitive financial services companies, it 
must provide a regulatory structure that respects and is carefully 
tailored to the divergent requirements of each of the business sectors 
that comprise the financial services marketplace. The mutual fund 
industry has historically and continues to be subject to extensive SEC 
oversight. And for reasons that continue to make good sense even in 
this era of consolidation and conglomeration, the regulations governing 
the mutual fund business rest on different premises, have different 
public policy objectives, and respond to distinct governmental and 
societal concerns.
    Our securities markets are based on transparency, strict market 
discipline, creativity, and risk-taking. The Investment Company Act and 
federal securities laws reflect the nature of this marketplace and, 
accordingly, do not seek to limit risk-taking nor do they extend any 
governmental guarantee. Rather, the securities laws require full and 
fair disclosure of all material information, focus on protecting 
investors and maintaining fair and orderly markets, and prohibit 
fraudulent and deceptive practices. Securities regulators strictly 
enforce the securities laws by bringing enforcement actions, and 
imposing substantial penalties in a process that by design is fully 
disclosed to the markets and the American public.
    Banks, by contrast, are supported by federal deposit insurance, 
access to the discount window and the payments system, and the overall 
federal safety net. For these reasons, banking regulation imposes 
significant restraints and requirements on the operation of banks.
    It may well be that this regulatory approach is prudent and 
appropriate when it comes to the government's interest in overseeing 
banks. But it would be fundamentally inconsistent with the very nature 
of the securities markets to impose bank-like regulation on mutual fund 
companies and other securities firms. To do so could profoundly impair 
the ability of mutual funds and securities firms to serve their 
customers and compete effectively. More worrisome, it could compromise 
the continued successful operation of the existing securities 
regulatory system.
    Finally, and perhaps most importantly, imposing bank-like 
regulation on an industry for which it was not designed could even 
jeopardize the functioning of our broad capital markets. This would 
risk the loss of a priceless and valuable national asset. As SEC 
Chairman Arthur Levitt has stated, ``[o]ur capital markets must remain 
among our nation's most spectacular achievements . . . Those markets, 
and investors' confidence in them, are rich legacies we have inherited, 
but do not own. They are a national asset we hold in trust for our 
children, and for generations of Americans to come.'' 2 
Thus, this Committee is wise to ensure that otherwise well-intended 
efforts to modernize financial services law and regulation do not 
compromise our capital formation system.
---------------------------------------------------------------------------
    \2\ ``A Declaration of (Accounting) Independence,'' Remarks by 
Arthur Levitt, Chairman, U.S. Securities and Exchange Commission, 
before The Conference Board, New York, New York (Oct.--8, 1997).
---------------------------------------------------------------------------
III. Successful Financial Services Reform Should Not Be Undermined
    Both H.R. 10 and S. 900 establish a new structure for the 
affiliation of financial services companies in the United States. The 
bills do not merely alter the nature of the banking system through 
banking reform, but instead propose a regulatory structure that 
reflects the new economic relationships. But because each of the 
industries in the new holding company is subject to extensive oversight 
under distinct regulatory systems, both bills appropriately adopt the 
concept of functional regulation as the proper regulatory oversight 
system for an integrated financial services industry. This fosters 
regulatory reliance and respect for the jurisdiction of the regulatory 
agencies that supervise these industries. The Institute strongly 
supports this result.
    Importantly, both bills protect the domestic banking and 
international financial system as well as insured depository 
institutions and the deposit insurance funds by providing the banking 
agencies with authority to take appropriate action when necessary. At 
the same time, they prevent the imposition of a banklike regulatory 
approach on the mutual fund industry by avoiding conflicting and 
duplicative regulation. This is accomplished without creating any 
regulatory gaps in the structure.3
---------------------------------------------------------------------------
    \3\ For these reasons, the Federal Reserve Board (FRB) has 
indicated that this functional regulation oversight system would 
maintain the safety and soundness of our financial system in general 
and the banking system in particular. See generally Hearings before the 
Senate Committee on Banking, Housing and Urban Affairs on H.R. 10, the 
Financial Services Act of 1998, Written Statement of Alan Greenspan, 
Chairman of the Board of Governors of the Federal Reserve System on 
H.R. 10 at 5 & 13-15.
---------------------------------------------------------------------------
    We would like to take this opportunity to urge the Committee to 
oppose amendments that would (1) change the provisions in the bill that 
carefully proscribe the authority of bank regulators with respect to 
mutual funds and securities firms; (2) seek to apply aspects of the 
Community Reinvestment Act to mutual funds; and (3) limit, by statute, 
the ability of mutual fund organizations and other service providers to 
share certain information regarding fund investors that is necessary to 
effectively operate a mutual fund.
    In addition, we recommend three changes to H.R. 10: (1) 
clarification of the supervisory authority of the OTS and OCC over 
regulated nonbank entities to strengthen functional regulation; (2)--
allowing companies to engage in limited commercial activities; and (3) 
extending the ``grandfather date'' for companies with commercial 
activities to control a thrift.
    Each of these points is discussed below.
IV. No Weakening of Functional Regulation Oversight 4
---------------------------------------------------------------------------
    \4\ This section addresses the socalled ``Fed Lite'' oversight 
provisions in Subtitle B of Title 1 of H.R. 10 that relate to the 
functional regulation of mutual funds, securities firms and insurance 
companies in a holding company system.
---------------------------------------------------------------------------
    To implement this oversight system, the FRB would be assigned 
regulatory responsibility over all holding companies, including any 
financial services organization that owns a bank. Both bills also would 
refine the authority of the Federal Deposit Insurance Corporation 
(FDIC), the Office of the Comptroller of the Currency (OCC) and the 
Office of Thrift Supervision (OTS) in this same manner to ensure that 
they could not assert broader authority than that of the FRB with 
respect to regulated nonbank entities.
    In adopting this approach, both bills recognize that in the process 
of merging banks with various industries, it is necessary to adjust the 
present statutory authority of the banking agencies. This adjustment is 
needed because the statutory schemes applicable to these agencies did 
not envision that a bank might be affiliated with several, significant 
regulated nonbank entities like mutual fund companies and broker-
dealers. These nonbank entities each have regulators with the expertise 
to supervise their operations and these regulators may be relied upon 
to coordinate their supervisory efforts with the banking agencies.
    Thus, H.R. 10 strikes an appropriate balance between preserving the 
authority of the FRB, OCC, FDIC and OTS to protect the safety and 
soundness of the banking, financial, and payments systems, and avoiding 
the potential for supervisory intervention into a regulated nonbank 
entity's day-to-day affairs that are the responsibility of its primary 
supervisor like the SEC for mutual funds.
    In this connection, the Institute suggests that Sections 
115(a)(4)&(5) and 118(b)(2)&(3) of H.R. 10 be deleted as inconsistent 
with this functional regulation framework. These Sections grant the OCC 
and OTS authority beyond that which is granted the FRB. Eliminating 
these provisions would pose no safety and soundness concerns. Such 
action will also reinforce an oversight system that relies on and 
defers to the expertise and supervisory strengths of different 
functional regulators (in the investment company case, the SEC). It 
would also reduce the potential for inconsistent and contradictory 
actions concerning investor protection, for overlap of regulation and 
for conflict among regulators.
    As indicated by the FRB, a proper oversight system for these new 
financial services organizations is enhanced by ``relying on the 
expertise and supervisory strengths of different functional regulators, 
reducing the potential [for] burdensome overlap of regulation, and 
providing for increased coordination and reduced potential for conflict 
among regulators.'' 5
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    \5\ See Hearings before the Subcommittee on Finance and Hazardous 
Materials, Committee on Commerce on H.R. 10 and Financial 
Modernization, Testimony of Alan Greenspan, Chairman of the Board of 
Governors of the Federal Reserve System at 10.
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    Unless the bill is amended, OTS and OCC will be able to assert the 
power to take discretionary supervisory action based on their judgment 
about business risk. This would allow them to claim the authority to 
apply a bank-like regulatory approach and/or impose activity or 
operational restrictions on mutual fund complexes in particular or the 
securities markets generally. This could profoundly impair the 
continued successful operation of the existing securities regulatory 
system and damage our capital markets. This is why we suggest that 
certain changes be made to clarify the role of the OTS and OCC--and to 
grant these agencies no greater authority then that which is granted to 
the FRB. This action will strengthen the strong functional regulation 
oversight system embodied in H.R.10.
V. CRA Should Not Apply to Mutual Funds
    The mutual fund industry is opposed to attempts to extend CRA to 
mutual funds. Such an action would act against the interest of the 
millions of middleincome Americans who invest in mutual funds, would be 
directly at odds with the obligations imposed on fund managers to place 
the interests of the fund shareholders first, and would fundamentally 
misconstrue the nature of CRA and represent a drastic change in its 
purpose.
    First, the effects of imposing CRA-like requirements on mutual 
funds would be largely borne by middle-income Americans. Institutions 
and wealthier individuals are better able to obtain the benefits of 
diversification and professional management of their portfolios through 
direct investments.
    Second, forcing mutual funds to make investments in order to serve 
some general social or political purpose--no matter how well-intended--
would be directly at odds with the entire regulatory and fiduciary 
structure that governs the activities of mutual funds, the purpose of 
which is to place the interests of the funds' investors first. (Unlike 
bank depositors, who receive a rate of return guaranteed by the federal 
government, the return on every investment made by a mutual fund is 
directly passed on to the fund's shareholders.) As the former acting 
Chair of the SEC stated, ``Imposing community reinvestment requirements 
on funds similar to those imposed under the CRA would require fund 
directors and managers to take into account factors other than the 
interests of their shareholders, which would be fundamentally 
incompatible with the requirements of the Investment Company Act.'' 
6
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    \6\ Letter from Mary C. Schapiro, Acting Chairman, U.S. Securities 
and Exchange Commission, to Frank N. Newman, Undersecretary for 
Domestic Finance, Department of the Treasury, dated May 26, 1993.
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    Third, CRA is premised, in large part, on the fact that depository 
institutions are publicly chartered entities that receive significant 
federal subsidies, including deposit insurance and access to the 
discount window and the payments system. These benefits are provided so 
that banks may service the convenience and needs of the communities in 
which they are chartered. CRA is intended to ensure that those services 
are provided. Mutual funds, in contrast, are not publicly chartered and 
do not receive the benefits of those federal subsidies. Also, the types 
of activities contemplated by CRA, such as making loans to small 
businesses and offering housing loans, as well as offering basic 
banking services, are not offered by mutual funds, which are pools of 
liquid securities. Thus, it is difficult to contemplate how mutual 
funds could comply with CRA-like requirements.
    It should be noted that mutual funds play an important role in 
economic development throughout America. Mutual funds are major 
investors in municipal securities, which finance projects such as 
housing, hospitals, schools, and infrastructure. Mutual funds also are 
significant purchasers of mortgage-backed securities; the growth of 
this market has reduced housing costs for millions of Americans. Mutual 
funds also supply capital to new and growing companies, for instance by 
purchasing shares in initial public offerings. Mutual funds are helping 
millions of Americans save for their retirement, in IRAs and employer-
sponsored plans, as well as housing, education and other needs.
    For these reasons, the Institute respectfully urges the Committee 
to reject attempts to extend CRA to mutual funds.
VI. Sharing of Customer Information
    Various proposals have been offered to restrict the ability of 
financial services firms to share customer information. The Institute 
does not favor a broad legislative prescription on the sharing of 
customer information because it will fail to take into account the 
unique structure of mutual funds.
    The structure and operation of a fund is unique because the fund 
itself is essentially a pool of assets under the supervision of a board 
of directors. Typically, a fund has few or no employees of its own. 
Instead, as is shown by the diagram in Appendix A, the fund's 
operations are carried out by various entities, including the fund's 
investment adviser, principal underwriter, transfer agent, and 
custodian. In order to service an investor's account, it is necessary 
for these entities to share customer information with one another.
    Because of the structure of the industry, fund shareholders view 
themselves as customers of a mutual fund organization (or perhaps of 
the broker-dealer or other intermediary through which they made their 
investments), rather than of a particular entity within that 
organization (for example, a transfer agent or custodian). From the 
point of view of the shareholder, the fund operation is seamless, as it 
should be. This is apparent from the popularity of such features as 
exchange privileges among affiliated funds and consolidated account 
statements.
    Thus, the application of a generic rule on the sharing of customer 
information to mutual fund organizations is almost certain to be 
disruptive. If fact, it could potentially make impractical existing 
mutual fund operations. This is true even if the rule contemplates an 
``opt out'' approach (i.e., one in which customers must affirmatively 
act to restrict information sharing); funds would be forced to attempt 
to build extensive systems to track those customers that request to 
block information sharing in this context.
    The Institute is sensitive to the concerns of many regarding their 
financial privacy. In fact, the Institute has been working for several 
months with the National Association of Securities Dealers (NASD) on 
rules governing the sharing of confidential customer information. It is 
our belief that the NASD is best-suited to address the matter, as it 
can adopt rules that are tailored to the structure of the mutual fund 
industry and the securities industry in general.
VII. Nonfinancial Activities
    An important objective of any financial services reform legislation 
is to create competitive equality among banks, mutual funds, broker-
dealers, and insurance companies. Unfortunately, H.R. 10 retains a 
strict separation between ``banking'' and ``commerce,'' although it 
attempts to bridge this gap to a limited degree by permitting financial 
services companies to engage in a small amount of activities deemed 
``complementary'' to financial activities. In general, however, a 
diversified financial services company that becomes a financial holding 
company would be required to divest its nonfinancial activities within 
10-15 years. This approach would introduce a fundamental competitive 
inequity: all bank holding companies could enter the securities and 
insurance businesses, but mutual fund companies, broker-dealers and 
insurance companies with limited nonfinancial activities would be 
forced to alter their operations and structure in order to enter 
commercial banking.
    For long-standing public policy reasons, still valid today, mutual 
fund companies and other nonbanking financial services firms have never 
been subject to activities restrictions like those contained in H.R. 
10. In recognition of this and in order to provide a fair and balanced 
competitive environment, the Institute recommends that H.R. 10 be 
amended to allow a financial holding company to engage to a limited 
degree in nonfinancial activities, for example, at a minimum, the 
amount specified in the version of H.R. 10 that was passed by this 
Committee last year. This would create a financial services holding 
company that reflects the realities of today's marketplace in which 
financial companies often engage in limited commercial activities.
VIII. Grandfathered Unitary Savings and Loan Holding Companies
    Under the Home Owners' Loan Act, in general, any company may 
establish or acquire a single thrift and become a socalled unitary 
savings and loan holding company. Such a company can be engaged in any 
kind of commercial or financial activity if its thrift complies with 
the qualified thrift lender test. H.R. 10 would bar a company engaged 
in any commercial or nonfinancial activities from securing a thrift, 
subject to a grandfather provision. Under the grandfather provision, if 
a company already owned a thrift as of March 4, 1999, or had made an 
application for one, it can retain or secure the thrift.
    As a general matter, the Institute has no view on this new 
prohibition. However, we believe that any company that owns a thrift or 
has made an application for one should be covered by a grandfather 
provision that is available until this activity is actually prohibited 
by law. This approach provides all entities with an equal opportunity 
to take advantage of an existing business opportunity. Moreover, we are 
unaware of any identifiable risk to the banking system from extending 
the date. Accordingly, we support changing the applicable date for the 
grandfather provision to the effective date of H.R. 10.
IX. Conclusion
    The Institute continues to support efforts by Congress to modernize 
the nation's financial laws. H.R. 10 represents a significant 
contribution to that endeavor, in particular, by permitting 
affiliations among all types of financial companies, by establishing a 
system of functional regulation and by raising the issue of whether a 
holding company should be able to engage to a limited degree in 
nonfinancial activities. The Institute's recommendations to the 
Committee are embodied in this statement.
    We thank you for the opportunity to present our views and look 
forward to working with the Committee as this legislation moves 
forward.
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