[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.
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\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.
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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.
---------------------------------------------------------------------------
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.
---------------------------------------------------------------------------
\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.
---------------------------------------------------------------------------
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
---------------------------------------------------------------------------
\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).
---------------------------------------------------------------------------
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
---------------------------------------------------------------------------
\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).
---------------------------------------------------------------------------
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.
---------------------------------------------------------------------------
\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).
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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
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\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
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\4\ United States Dep't of Treasury v. Fabe, 113 S. Ct. 2202, 2207
(1993).
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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).
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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
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\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
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\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.
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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.
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\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
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\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
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\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.
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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.
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\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).
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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
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\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.
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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
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\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.