[House Hearing, 107 Congress]
[From the U.S. Government Publishing Office]




                   PROMOTION OF CAPITAL AVAILABILITY
                         TO AMERICAN BUSINESSES

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

                             JOINT HEARING

                               BEFORE THE

                            SUBCOMMITTEE ON
                    CAPITAL MARKETS, INSURANCE, AND 
                    GOVERNMENT SPONSORED ENTERPRISES

                                AND THE

                            SUBCOMMITTEE ON
                       FINANCIAL INSTITUTIONS AND
                            CONSUMER CREDIT

                                 OF THE

                              COMMITTEE ON
                           FINANCIAL SERVICES

                     U.S. HOUSE OF REPRESENTATIVES

                      ONE HUNDRED SEVENTH CONGRESS

                             FIRST SESSION

                               __________

                             APRIL 4, 2001

                               __________

       Printed for the use of the Committee on Financial Services

                            Serial No. 107-9

                               __________

                    U.S. GOVERNMENT PRINTING OFFICE
71-863                     WASHINGTON : 2001


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                 HOUSE COMMITTEE ON FINANCIAL SERVICES

                    MICHAEL G. OXLEY, Ohio, Chairman

JAMES A. LEACH, Iowa                 JOHN J. LaFALCE, New York
MARGE ROUKEMA, New Jersey, Vice      BARNEY FRANK, Massachusetts
    Chair                            PAUL E. KANJORSKI, Pennsylvania
DOUG BEREUTER, Nebraska              MAXINE WATERS, California
RICHARD H. BAKER, Louisiana          CAROLYN B. MALONEY, New York
SPENCER BACHUS, Alabama              LUIS V. GUTIERREZ, Illinois
MICHAEL N. CASTLE, Delaware          NYDIA M. VELAZQUEZ, New York
PETER T. KING, New York              MELVIN L. WATT, North Carolina
EDWARD R. ROYCE, California          GARY L. ACKERMAN, New York
FRANK D. LUCAS, Oklahoma             KEN BENTSEN, Texas
ROBERT W. NEY, Ohio                  JAMES H. MALONEY, Connecticut
BOB BARR, Georgia                    DARLENE HOOLEY, Oregon
SUE W. KELLY, New York               JULIA CARSON, Indiana
RON PAUL, Texas                      BRAD SHERMAN, California
PAUL E. GILLMOR, Ohio                MAX SANDLIN, Texas
CHRISTOPHER COX, California          GREGORY W. MEEKS, New York
DAVE WELDON, Florida                 BARBARA LEE, California
JIM RYUN, Kansas                     FRANK MASCARA, Pennsylvania
BOB RILEY, Alabama                   JAY INSLEE, Washington
STEVEN C. LaTOURETTE, Ohio           JANICE D. SCHAKOWSKY, Illinois
DONALD A. MANZULLO, Illinois         DENNIS MOORE, Kansas
WALTER B. JONES, North Carolina      CHARLES A. GONZALEZ, Texas
DOUG OSE, California                 STEPHANIE TUBBS JONES, Ohio
JUDY BIGGERT, Illinois               MICHAEL E. CAPUANO, Massachusetts
MARK GREEN, Wisconsin                HAROLD E. FORD, Jr., Tennessee
PATRICK J. TOOMEY, Pennsylvania      RUBEN HINOJOSA, Texas
CHRISTOPHER SHAYS, Connecticut       KEN LUCAS, Kentucky
JOHN B. SHADEGG, Arizona             RONNIE SHOWS, Mississippi
VITO FOSELLA, New York               JOSEPH CROWLEY, New York
GARY G. MILLER, California           WILLIAM LACY CLAY, Missiouri
ERIC CANTOR, Virginia                STEVE ISRAEL, New York
FELIX J. GRUCCI, Jr., New York       MIKE ROSS, Arizona
MELISSA A. HART, Pennsylvania         
SHELLEY MOORE CAPITO, West Virginia  BERNARD SANDERS, Vermont
MIKE FERGUSON, New Jersey
MIKE ROGERS, Michigan
PATRICK J. TIBERI, Ohio

             Terry Haines, Chief Counsel and Staff Director
            Subcommittee on Capital Markets, Insurance, and 
                    Government Sponsored Enterprises

                 RICHARD H. BAKER, Louisiana, Chairman

ROBERT W. NEY, Ohio, Vice Chairman   PAUL E. KANJORSKI, Pennsylvania
CHRISTOPHER SHAYS, Connecticut       GARY L. ACKERMAN, New York
CHRISTOPHER COX, California          NYDIA M. VELAZQUEZ, New York
PAUL E. GILLMOR, Ohio                KEN BENTSEN, Texas
RON PAUL, Texas                      MAX SANDLIN, Texas
SPENCER BACHUS, Alabama              JAMES H. MALONEY, Connecticut
MICHAEL N. CASTLE, Delaware          DARLENE HOOLEY, Oregon
EDWARD R. ROYCE, California          FRANK MASCARA, Pennsylvania
FRANK D. LUCAS, Oklahoma             STEPHANIE TUBBS JONES, Ohio
BOB BARR, Georgia                    MICHAEL E. CAPUANO, Massachusetts
WALTER B. JONES, North Carolina      BRAD SHERMAN, California
STEVEN C. LaTOURETTE, Ohio           GREGORY W. MEEKS, New York
JOHN B. SHADEGG, Arizona             JAY INSLEE, Washington
DAVE WELDON, Florida                 DENNIS MOORE, Kansas
JIM RYUN, Kansas                     CHARLES A. GONZALEZ, Texas
BOB RILEY, Alabama                   HAROLD E. FORD, Jr., Tennessee
VITO FOSSELLA, New York              RUBEN HINOJOSA, Texas
JUDY BIGGERT, Illinois               KEN LUCAS, Kentucky
GARY G. MILLER, California           RONNIE SHOWS, Mississippi
DOUG OSE, California                 JOSEPH CROWLEY, New York
PATRICK J. TOOMEY, Pennsylvania      STEVE ISRAEL, New York
MIKE FERGUSON, New Jersey            MIKE ROSS, Arizona
MELISSA A. HART, Pennsylvania
MIKE ROGERS, Michigan
                              ----------                              

       Subcommittee on Financial Institutions and Consumer Credit

                   SPENCER BACHUS, Alabama, Chairman

DAVE WELDON, Florida, Vice Chairman  MAXINE WATERS, California
MARGE ROUKEMA, New Jersey            CAROLYN B. MALONEY, New York
DOUG BEREUTER, Nebraska              MELVIN L. WATT, North Carolina
RICHARD H. BAKER, Louisiana          GARY L. ACKERMAN, New York
MICHAEL N. CASTLE, Delaware          KEN BENTSEN, Texas
EDWARD R. ROYCE, California          BRAD SHERMAN, California
FRANK D. LUCAS, Oklahoma             MAX SANDLIN, Texas
BOB BARR, Georgia                    GREGORY W. MEEKS, New York
SUE W. KELLY, New York               LUIS V. GUTIERREZ, Illinois
PAUL E. GILLMOR, Ohio                FRANK MASCARA, Pennsylvania
JIM RYUN, Kansas                     DENNIS MOORE, Kansas
BOB RILEY, Alabama                   CHARLES A. GONZALEZ, Texas
STEVEN C. LaTOURETTE, Ohio           PAUL E. KANJORSKI, Pennsylvania
DONALD A. MANZULLO, Illinois         JAMES H. MALONEY, Connecticut
WALTER B. JONES, North Carolina      DARLENE HOOLEY, Oregon
JUDY BIGGERT, Illinois               JULIA CARSON, Indiana
PATRICK J. TOOMEY, Pennsylvania      BARBARA LEE, California
ERIC CANTOR, Virginia                HAROLD E. FORD, Jr., Tennessee
FELIX J. GRUCCI, Jr, New York        RUBEN HINOJOSA, Texas
MELISSA A. HART, Pennsylvania        KEN LUCAS, Kentucky
SHELLEY MOORE CAPITO, West Virginia  RONNIE SHOWS, Mississippi
MIKE FERGUSON, New Jersey            JOSEPH CROWLEY, New York
MIKE ROGERS, Michigan
PATRICK J. TIBERI, Ohio


                            C O N T E N T S

                              ----------                              
                                                                   Page
Hearing held on:
    April 4, 2001................................................     1
Appendix:
    April 4, 2001................................................    49

                               WITNESSES
                        Wednesday, April 4, 2001

Grauer, Peter A., Managing Director, Leveraged Corporate Private 
  Equity Group, on behalf of Credit Suisse First Boston Private 
  Equity, the Securities Industry Association and the Financial 
  Services Roundtable............................................    35
Hawke, Hon. John D., Jr., Comptroller of the Currency, Department 
  of the Treasury................................................    10
Kabel, Robert J., Partner, Manatt, Phelps and Phillips, LLP, on 
  behalf of the Bank Private Equity Coalition....................    30
Meyer, Hon. Laurence H., Member, Board of Governors, Federal 
  Reserve System.................................................     7
Whaley, John P., Partner, Norwest Equity Partners and Norwest 
  Venture Partners, on behalf of the American Bankers Association 
  Securities 
  Association....................................................    33

                                APPENDIX

Prepared statements:
    Baker, Hon. Richard H........................................    50
    Bachus, Hon. Spencer.........................................    52
    Oxley, Hon. Michael G........................................    57
    Kanjorski, Hon. Paul E.......................................    54
    Kelly, Hon. Sue W............................................    56
    Waters, Hon. Maxine..........................................    58
    Grauer, Peter A..............................................   137
    Hawke, Hon. John D., Jr......................................   101
    Kabel, Robert J..............................................   115
    Meyer, Hon. Laurence H.......................................    60
    Whaley, John P...............................................   120

              Additional Material Submitted for the Record

Hawke, Hon. John D., Jr.:
    Written response to questions from Representatives Bachus, 
      Baker and Kelly............................................   113
Meyer, Hon. Laurence H.:
    Written response to questions from Representatives Bachus, 
      Baker and Kelly............................................    79
The Securities Industry Association, prepared statement..........   153

 
                   PROMOTION OF CAPITAL AVAILABILITY
                         TO AMERICAN BUSINESSES

                              ----------                              


                        WEDNESDAY, APRIL 4, 2001

             U.S. House of Representatives,
        Subcommittee on Capital Markets, Insurance 
              and Government Sponsored Enterprises,
                                            Joint with the 
                    Subcommittee on Financial Institutions 
                                       and Consumer Credit,
                           Committee on Financial Services,
                                                    Washington, DC.
    The subcommittees met, pursuant to call, at 10:04 a.m., in 
room 2128, Rayburn House Office Building, Hon. Richard H. 
Baker, [chairman of the Subcommittee on Capital Markets, 
Insurance and Government Sponsored Enterprises], presiding.
    Present for the Subcommittee on Capital Markets, Insurance, 
and Government Sponsored Enterprises: Chairman Baker; 
Representatives Bachus, Biggert, Ose, Toomey, Ferguson, Ryun, 
Bentsen, J. Maloney of Connecticut, Mascara, Inslee, Ford, 
Hinojosa, Lucas, Shows and Ross.
    Present for the Subcommittee on Financial Institutions and 
Consumer Credit: Representatives Bachus, Roukema, Baker, Kelly, 
Ryun, Biggert, Toomey, Grucci, Ferguson, Tiberi, Waters, C. 
Maloney of New York, Bentsen, Mascara, Moore, Kanjorski, J. 
Maloney of Connecticut, Ford, Hinojosa, Lucas, and Shows.
    Also Present: Representatives LaFalce and Oxley.
    Chairman Baker. Good morning. I would like to call this 
joint hearing of the House Subcommittee on Capital Markets and 
the House Subcommittee on Financial Institutions of the House 
Financial Services Committee to order.
    This morning Chairman Bachus and myself have joined 
together for the purpose of again reviewing the rules proposed 
pursuant to the enactment of Gramm-Leach-Bliley with regard to 
merchants' banking activities. Chairman Bachus and I both, 
along with Ranking Member Kanjorski, realize the significance 
of these proposals and do appreciate the modifications made 
from the earlier proposals submitted last summer to the status 
of the proposals currently. Certainly all Members perceive 
Gramm-Leach-Bliley to be a significant step toward unleashing 
the power of markets to facilitate economic development, 
utilize new technologies and create market opportunity 
heretofore not possible.
    It would appear to me and I am perhaps aware that others 
still have remaining concerns with regard to certain aspects of 
the implementation of the proposed regulations. Certainly we 
should not preclude activities which are currently authorized 
by law under the name of modernization and make managerial and 
cross-marketing decisions more difficult which are customarily 
utilized in the marketplace today.
    In the course of the hearing today we will hear not only 
from regulators, but from market participants, and I am advised 
that there are a series of competitive meetings ongoing so our 
membership here today, gentlemen, will be continually changing 
I am told. But it does not in any way lessen the committee's 
interest in this matter, nor our attention to your testimony 
here today.
    At this time, I would like to recognize Ranking Member 
Kanjorski, then come back for opening statements.
    [The prepared statement of Hon. Richard H. Baker can be 
found on page 50 in the appendix.]
    Mr. Kanjorski. Thank you, Mr. Chairman, for the opportunity 
to speak before we begin today's hearing on the promotion of 
capital availability to American business.
    As the Ranking Democratic Member on the Capital Markets 
Subcommittee, I want to maintain the competitiveness of our 
Nation's capital markets. These resources help American 
businesses compete in the international marketplace. They also 
strengthen our domestic economy by helping our Nation to remain 
productive, providing better jobs at higher wages for American 
workers, and improving the quality of life for American 
families.
    It is therefore appropriate and constructive for us to hold 
hearings at this time on the revised merchant banking rules 
issued by our Nation's financial regulators earlier this year. 
These proceedings will help us determine whether these 
regulations run counter to the purposes of the Gramm-Leach-
Bliley Act or whether they capture the essence of the law's 
intent.
    During the debate over the modernization law, one of the 
most highly contentious issues debated was the extent to which 
we should break down the legal barriers separating banking and 
commerce. In Japan, the intermingling of these sectors via cozy 
kieretsu combinations probably contributed to the great 
inefficiencies that first produced the economic disorder in 
their banking system in the 1990's and which continues today. 
Ultimately, Congress learned from these concerns and we enacted 
a law maintaining a firewall between banking and commerce.
    A closely related issue examined in the overhaul of the 
financial services industry concerned merchant banking. This 
term refers to equity investments by commercial banks in non-
financial firms. In our deliberations, we recognized the 
importance of merchant banking in providing equity capital to 
the private sector, but decided that for at least 5 years only 
units of financial holding companies could engage in such 
activities. Consequently, the law permits these units to 
acquire equity investments in non-financial companies and to 
sponsor equity funds, providing that they limit their ownership 
positions and do not retain day-to-day management control of 
these investments.
    In March of 2000, the Federal Reserve and the Treasury 
Department issued interim and proposed regulations to implement 
the merchant banking provisions of the modernization act. These 
proposals generated considerable debate among affected parties 
and in the press. Of particular concern to me, along with many 
of my Democratic colleagues, was their effect on small business 
investment companies, which bring important capital resources 
to small businesses in the communities in which they operate.
    Because commercial banks represent the largest source of 
the SBIC program's private funding, concerns arose that 
provisions contained in the merchant banking rulemaking, such 
as the proposed 50 percent capital charge on all equity 
investments, would have constricted the availability of 
financial resources for small businesses. During our 
subcommittee's prior hearing on the interim rules, I expressed 
concerns about the effect of the proposal on SBICs, and urged 
the regulators to create a limited carve-out under their 
merchant banking rules for such investments. To their credit, 
the regulators responded to many of my concerns when issuing 
their revised capital proposal for non-financial equity 
investments in January, 2001.
    As I noted earlier, in passing the Gramm-Leach-Bliley Act, 
we maintained the firewalls preventing the indiscriminate 
mixing of banking and commerce. From my perspective, it remains 
very important that our Federal financial regulators strike an 
appropriate balance between allowing financial holding 
companies to engage in merchant banking activities and 
insulating commercial banks, which carry Federal deposit 
insurance, from the associated risks.
    In closing, Mr. Chairman, my colleague in the other body, 
Senator Paul Sarbanes of Maryland, perhaps said it best when he 
noted that the financial modernization law gave the Federal 
Reserve and the Treasury the ability to jointly develop 
implementing regulations on merchant banking activities ``to 
define relevant terms and impose such limitations as they deem 
appropriate to ensure the new authority does not foster 
conflicts of interest or undermine the safety and soundness of 
depository institutions or the act's general prohibitions on 
the mixing of banking and commerce.'' Although I generally 
agree with his assessments, I believe it equally important to 
learn more about the views of the parties testifying before us 
today and, if necessary, to further refine and improve merchant 
banking regulations in the future.
    Thank you Mr. Chairman.
    [The prepared statement of Hon. Paul E. Kanjorski can be 
found on page 54 in the appendix.]
    Chairman Baker. Thank you.
    Chairman Bachus.
    Mr. Bachus. Thank you, Chairman Baker, for your leadership 
on this issue and for convening this joint hearing.
    One of the committee's chief central responsibilities in 
this Congress will be overseeing the implementation of the 
historic Gramm-Leach-Bliley financial modernization 
legislation. Among the issues that need to be addressed are the 
far-reaching financial privacy regulations scheduled to go into 
effect July 1 and a more recent regulatory proposal that would 
permit banks, through financial holding companies and financial 
subsidiaries, to engage in real estate brokerage and management 
activities.
    Though the privacy and the real estate rules are of greater 
interest to individual American consumers, the merchant banking 
rules first proposed in March of last year have enormous 
consequences for the financial services industry and for 
capital formation processes that help fuel our economy. Private 
equity placements and venture capital investments provide 
critical seed money for American entrepreneurs whose creativity 
and energy have helped make the U.S. economy the envy of the 
world.
    I was one of the Members that felt that, as originally 
proposed by the regulators last March, the merchant banking 
rules were deficient in important respects. Particularly 
troublesome was the requirement that financial holding 
companies hold 50 cents in capital for every dollar of equity 
investment in non-financial companies. By setting the capital 
threshold so high, the original capital rule served as a huge 
disincentive for any investment banking firm thinking of 
partnering with a depository institution under the financial 
holding structure established by Gramm-Leach-Bliley.
    To their credit, the regulators took the criticism of the 
original proposal to heart and have come back this year with 
rules that clearly move in the right direction. Most 
importantly, the revised proposal replaces the rigid 50 percent 
capital requirement with a more flexible sliding scale, an 
approach that increases or decreases the capital charge imposed 
on merchant banking investments in direct proportion to the 
concentration of such investment in an institution's portfolio.
    But acknowledging that a bad proposal has been made better 
is not the same thing as concluding that the proposal was a 
good idea in the first place. In my mind the Federal Reserve 
and the Treasury have simply not met their burden of proof in 
demonstrating that additional requirements are needed in the 
merchant banking arena. Banking organizations have been making 
private equity investments pursuant to other statutory 
authorities since well before Gramm-Leach-Bliley was enacted, 
and have done so profitably and seemingly without loss to 
individual institutions, depositors or the system as a whole. 
This track record strongly suggests that bank regulators 
already have the legal tools needed to effectively supervise 
merchant banking activities of financial holding companies and 
bank holding companies without these new rules.
    With the welcome improvements made by the regulators, the 
revised merchant banking rules still place financial holding 
companies at a decided competitive disadvantage in relation to 
firms that choose to operate outside of that structure. Such a 
result cannot be squared with the congressional intent 
evidenced by Gramm-Leach-Bliley, which was to encourage, not 
actively impede, affiliations between securities firms and 
banks. This regulatory initiative before us greatly concerns 
me.
    I yield back the balance of my time.
    [The prepared statement of Hon. Spencer Bachus can be found 
on page 52 in the appendix.]
    Chairman Baker. Thank you Mr. Bachus.
    Ms. Waters, do you have a statement?
    Ms. Waters. Yes, I do, thank you. Thank you very much.
    Good morning, Mr. Chairman. I am pleased to have the 
opportunity to speak about the promotion of capital 
availability to American businesses.
    As the Ranking Member of the Financial Institutions 
Subcommittee, I believe we have a duty to oversee the 
regulations implementing the merchant banking provisions of the 
financial modernization legislation that became law last 
Congress. I also believe that it is important for us to monitor 
the expansion of merchant banking activities themselves, to 
ensure that the regulations are important, to carry out the 
intent of the Gramm-Leach-Bliley Act.
    I understand that the final revised rules address a number 
of industry concerns that were voiced about their original 
interim rules. I am pleased that the provisions governing the 
small business investment companies will ensure the continued 
ability of banks to invest in SBICs, benefiting small business 
as well as the communities they serve.
    Regarding the larger issue of merchant banking in general, 
there must be sufficient oversight of these activities. We have 
a responsibility to limit the risk inherent in merchant banking 
and not sacrifice safety and soundness in the haste to expand 
these activities too rapidly. This intent is crystal clear in 
the statutory language of the Gramm-Leach-Bliley Act.
    The legislation did permit financial holding companies to 
engage in merchant banking activities. Moreover, the bill 
imposed a series of prudential restrictions on the conduct of 
the merchant banking activity. It required that the merchant 
banking activity be conducted in an affiliate of the depository 
institution rather than in the depositary institution itself or 
a subsidiary of a depository institution.
    It also required that merchant banking investments be held 
only for a period of time long enough to enable the sale or 
deposition of each investment on a reasonable basis. 
Furthermore, the legislation restricts the ability of financial 
holding companies to routinely manage or operate companies held 
under the merchant banking authority.
    Finally, the legislation specifically granted the Federal 
Reserve and the Treasury Board authority to issue joint 
regulations implementing the merchant banking activities. 
Merchant banking was singled out, appears the only one of nine 
activities listed in the legislation as financial in nature to 
receive an explicit grant of authority to the regulators to 
issue regulations. Moreover, the Federal Reserve retains this 
authority under the Bank Holding Company Act to set capital 
standards for bank holding companies which include financial 
holding companies.
    The legislation also explicitly prohibited cross marketing 
between the depository institution and merchant banking 
portfolio companies acquired under the new authority. I 
understand that there are some members of the industry that 
would want this provision changed, but the law is clear on this 
point and should not be undermined through additional changes 
in the regulations.
    While I understand that the industry is concerned about the 
ability of American banks to compete in the global marketplace, 
we certainly do not want to model our banking policy after the 
Japanese system, which serves an example to all of what can 
happen when the separation between banking and commerce is 
breached.
    I believe these regulations will not prove to be 
unreasonably burdensome and will fullfil the congressional 
intent to ensure adequate oversight of merchant banking 
activities.
    During the consideration of the financial modernization 
legislation, Federal Reserve Board Chairman Alan Greenspan 
testified that, of the nine banking activities permitted in 
various versions of H.R. 10, merchant banking should be viewed 
as the most risky of those activities. With that in mind, I 
look forward to hearing the views of the witnesses and thank 
you in advance for your testimony.
    [The prepared statement of Hon. Maxine Waters can be found 
on page 58 in the appendix.]
    Chairman Baker. Thank you, Ms. Waters.
    Are there additional opening statements?
    Mrs. Kelly.
    Mrs. Kelly. Thank you, Mr. Chairman. I want to thank both 
you and Mr. Bachus for agreeing to hold the hearing on the 
promotion of capital availability to American businesses.
    The issue revolves around a large source of capital to many 
businesses; and, as we know, capital is the lifeblood of 
industry. As the Chairman of the Oversight and Investigations 
Subcommittee, the issue is very high on my list of priorities; 
and I am very pleased that we all share this interest.
    As we are aware, in March of 2000 the Federal Reserve and 
Treasury issued two rules for financial holding companies which 
contain provisions that run contrary to the language Congress 
agreed to as part of the Gramm-Leach-Bliley law. In particular, 
I was concerned about the 50 percent capital charge on all 
merchant banking activities and I believe that the cross 
marketing restrictions were too severe. I feared that the 
capital charge would force divestment from some banks of sound 
investments which could, in turn, have negative effects on the 
economy.
    I was pleased to see that the final rule issued in January 
of 2001 eliminated the hard dollar cap, removed some of the 
automatic penalty associated with holding investments over the 
time limits set by the rules and relieved some of the cross-
marketing restrictions. While it was a good step in the right 
direction, I believe the Federal Reserve should go farther.
    The rule seems to neglect to take into account the 
sophisticated internal risk modeling mechanisms banks employ to 
accept the risks inherent in merchant banking activities and 
the new and existing powers for bank examiners analyzing 
merchant banking activities. While I strongly believe we must 
ensure safety and soundness, we must also ensure the law as we 
wrote it in Gramm-Leach-Bliley is implemented as we intended.
    I want to thank the witnesses for joining us here today to 
share their considerable knowledge on these issues, and I look 
forward to the testimony and discussing the issues with them.
    I thank you again for holding this hearing, and I yield 
back the balance of my time.
    [The prepared statement of Hon. Sue W. Kelly can be found 
on page 56 in the appendix.]
    Chairman Baker. Thank you, Mrs. Kelly.
    Does any Member wish to give an opening statement?
    If not, I would suggest that we are just under 8 minutes or 
so on the matter pending on the floor, that we would recess 
momentarily, come immediately back, keep you about 10 minutes, 
and we will reconvene our hearing at that time.
    [Recess.]
    Chairman Baker. I would like to reconvene the hearing.
    Members are on their way, returning from the vote. I am 
told we will have about an hour before we are interrupted 
again, so at this time I would like to proceed with recognition 
of our first panel of witnesses.
    The Honorable Laurence Meyer, Governor, Board of Governors 
of the Federal Reserve, we welcome you here and look forward to 
your testimony. Your comments will be made part of record, as 
well as that of Mr. Hawke. Please proceed.

    STATEMENT OF HON. LAURENCE H. MEYER, GOVERNOR, BOARD OF 
               GOVERNORS, FEDERAL RESERVE SYSTEM

    Mr. Meyer. Thank you, Chairman Baker, Chairman Bachus and 
subcommittee Members.
    When I last appeared here to address the topic of merchant 
banking, the Board and the Department of the Treasury were 
considering comments on rules we had proposed only recently 
before the testimony. As I indicated at that time, our 
experience has been that public comments generally provide us 
with valuable insights and information.
    That is, in fact, what happened in this case. The Board and 
the Treasury received a significant amount of useful 
information that led us to revise our rules that implement the 
merchant banking powers in the Gramm-Leach-Bliley Act. We have 
also consulted with our fellow banking agencies regarding the 
appropriate capital treatment for equity banking activities. As 
a result, we have significantly revised and again sought public 
comment on a proposed capital approach.
    Let me provide some background that I hope will put both 
what we did and what we have proposed in context.
    The Bank Holding Company Act reflects a long-held concern 
of Congress that mixing banking and commerce could result in an 
adverse effect that may reduce the availability of credit to 
unaffiliated companies and create a greater risk to deposit 
insurance funds and, ultimately, the taxpayer.
    As part of the consideration of the GLB Act, Congress 
considered and rejected the idea of allowing banking 
organizations to affiliate broadly with commercial firms. At 
the same time, Congress recognized that merchant banking 
represents a form of ownership of commercial firms by banking 
organizations that is functionally equivalent of financing for 
small businesses.
    To distinguish merchant banking from the more general 
mixing of banking and commerce, the GLB Act requires that 
merchant banking investments be held only for a period of time 
to enable the resale of the investment and prohibits the 
investing financial holding company from routinely managing or 
operating a commercial firm except as necessary or required to 
obtain a reasonable return on resale of the investment.
    The final rule adopted in late January of this year focuses 
on defining these important restrictions. Generally, the rule 
permits a 10-year holding period for direct investments and a 
15-year holding period for investments in private equity funds. 
Many commenters acknowledged that merchant banking investments 
are rarely held beyond these periods.
    The final rule also contains several safe harbors and 
examples of routine management. For example, the final rule 
allows representatives of a financial holding company to serve 
on the board of directors of a portfolio company. In addition, 
a financial holding company may enter into agreements that 
restrict extraordinary actions of the portfolio company. On the 
other hand, a financial holding company would be considered to 
be routinely managing a company if an officer or employee of 
the financial holding company is also an executive officer of 
the portfolio company or if the financial holding company 
restricts decisions made in the ordinary course of business of 
the portfolio company.
    In response to commenters, the final rule provides a 
mechanism for allowing specific employee and junior officer 
interlock in the limited situation where the interlock does not 
rise to the level of routine management of the portfolio 
company.
    The GLB Act allows an investing financial holding company 
to routinely manage a portfolio company in special 
circumstances. The final rule adopts statutory language in this 
area.
    The final rule also contains several provisions that are 
designed to encourage the safe and sound conduct of merchant 
banking activities. The Board recently issued supervisory 
guidance that outlines some of the best practices employed by 
merchant bankers for managing the risks of equity investment 
activities. That guidance has been well received by the 
industry as useful and flexible.
    In addition, the interim rule contained two thresholds that 
triggered agency review of the financial holding companies that 
devote significant amounts of capital to merchant banking 
activities. The final rule eliminates the absolute dollar 
threshold and contains a sunset provision that automatically 
eliminates the entire threshold review process once the banking 
agencies have implemented final banking rules governing 
merchant banking activities.
    I should note that the thresholds may be exceeded with 
Board approval, and one experienced investment firm has already 
received Board approval to exceed the thresholds.
    The GLB Act contains provisions that prohibits cross-
marketing activities and restricts credit and other funding 
transactions between a depository institution and a portfolio 
company controlled by the same financial holding condition. 
Both are contained in the GLB Act to reinforce the separation 
between banking and commerce and are mirrored in the final 
rule.
    An integral part of our original merchant banking proposal 
involved the regulatory capital that would be required to 
support merchant banking activities. This proposal attracted 
quite a bit of comment, and it is an example of an area where 
we learned from the public comments.
    Together with the other agencies we have developed a new, 
revised capital proposal. In developing this new capital 
proposal, the banking agencies were guided by several 
principles. First, equity investment activities in non-
financial companies generally involve greater risks than 
traditional bank and financial activities. I have explained in 
much greater detail our analysis of the risk associated with 
equity investment activities in my testimony last June. If 
anything, the activity in equity markets since last June has 
confirmed this analysis; and few of the commenters on that 
original capital proposal disagreed with the substance of that 
analysis or our conclusion.
    A second and related principle is that financial risks to 
an organization engaged in equity investment activities 
increase as the level of investment accounts for a larger 
portion of the organization's capital, earnings and activities. 
The grant by the GLB Act of merchant banking authority to 
financial holding companies with its promise of increased 
equity investment activities was an appropriate time to 
reevaluate whether existing capital charges were adequate to 
account for this risk.
    A third principle guiding the agencies' efforts is that the 
risk of loss associated with a particular equity investment is 
likely to be the same regardless of the legal authority used to 
make the investment or whether the investment is held in the 
bank holding company or in the bank. In fact, the agencies' 
supervisory experience is that banking organizations are 
increasingly making investment decisions and managing 
investment risks as a single business line across legal 
entities.
    In light of these principles, the Board and the other 
agencies issued a revised proposal that would apply 
symmetrically to equity investment activities of bank holding 
companies and banks.
    The revised proposal would apply a series of marginal 
capital charges that begin with an 8 percent capital charge and 
increase to a 25 percent charge as the level of the banking 
organization's overall exposure to equity investment activities 
increases relative to the institution's Tier 1 capital. These 
charges are regulatory minima, and financial holding companies 
are expected to hold capital based on their assessment of the 
nature and risk of their investment activities.
    Commenters, including a number of Members of the 
subcommittee, strongly urged the agencies not to impose a 
higher capital charge on investments made through a small 
business investment company. These commenters argued that SBICs 
serve the important public purpose of encouraging investment in 
small businesses, are already subject to investment limitations 
imposed by the Congress and the Small Business Administration, 
and have generally been profitable to date.
    Commenters made similar arguments in support of an 
exception for investments made by State banks under the special 
grandfathering authority preserved by Section 24 of the Federal 
Deposit Insurance Act. These investments also have been 
reviewed and limited by Congress and are subject to further 
review and limitation by the FDIC.
    The agencies recognized substantial merit in these 
arguments. Accordingly, we revised the capital proposal so that 
it does not generally impose a higher capital charge on 
investments made through SBICs.
    The proposal also includes an exception for investments 
held by State banks under the special grandfather rights in 
Section 24 of the FDI act.
    One of the comments made most often in response to our 
original proposal was that internal risk-based models for 
assessing capital adequacy better reflect the individual risk 
profile of individual organizations than the more general 
formulas that currently underlie the agencies' regulatory 
capital requirements. We have been working with the Basel 
Capital Committee on a proposal, recently published for public 
comment, that would focus regulatory capital requirements at 
least at large banking organizations on internal risk models 
developed by the organization and verified by the regulatory 
agencies.
    But neither the banking agencies nor most banking 
organizations are at the stage where we can rely on these 
models as a replacement for regulatory minimum capital 
requirements. We view our revised capital proposal for equity 
investment activities as a bridge to a robust internal model 
approach.
    The invitation for public comments on the revised capital 
proposal will remain open until April 16. We will carefully 
review all of the comments that we receive so that we may 
develop a final rule that will be workable and, importantly, 
will enhance safety and soundness.
    [The prepared statement of Hon. Laurence H. Meyer can be 
found on page 60 in the appendix.]
    Chairman Baker. I thank you, Governor Meyer.
    Our next witness is the Honorable John Hawke--no stranger 
to the committee as well--Comptroller of the Currency. Welcome, 
sir.

   STATEMENT OF HON. JOHN D. HAWKE, JR., COMPTROLLER OF THE 
              CURRENCY, DEPARTMENT OF THE TREASURY

    Mr. Hawke. Thank you, Mr. Chairman.
    Chairman Baker, Chairman Bachus, Chairman Oxley and Members 
of the subcommittees, thank you for inviting the Office of the 
Comptroller of the Currency to participate in this hearing on 
the new and proposed rules relating to the merchant banking 
investment activities of banking organizations.
    Our written testimony focuses principally on the 
performance of national bank equity investments made through 
small business investment corporations--SBICs--and the OCC's 
involvement in the February 2001, capital proposal, which 
addresses the regulatory capital requirements for those 
investments. Because the OCC was not a party to the final rule 
adopted jointly by the Federal Reserve Board and the Treasury 
Department specifying the conditions under which the newly 
authorized merchant banking activities can be conducted, we do 
not address issues relating to that regulation.
    Merchant banking is a term with no fixed definition that is 
generally used to describe a range of financial activities, 
many of which have long been permissible for national banks. 
For example, national banks for many years have engaged in the 
business of buying and selling securities for the accounts of 
customers, they have advised customers on mergers and 
acquisitions, and they have represented customers in connection 
with the private placement of securities--all of which might be 
considered part of traditional ``merchant banking'' activities. 
The Gramm-Leach-Bliley Act--GLBA--did not affect the ability of 
national banks to engage in any of those activities.
    The rules we are discussing today address only one aspect 
of the business referred to as merchant banking, namely, the 
making of private equity investments in non-financial firms, in 
particular, equity investments having a venture capital 
character. In this regard, as well, it is important to 
recognize that banks and bank holding companies have long had 
the authority to make such investments through SBICs and 
through explicit permission granted under the Bank Holding 
Company Act.
    Prior to the enactment of GLBA, no significant public 
policy or safety and soundness concerns were raised by bank 
regulators concerning the ability of either bank holding 
companies or banks to make private equity investments under 
existing investment authorities. In fact, the clear intent of 
Congress in that far-reaching new law was to expand the ability 
of banking organizations to make such investments in excess of 
the limits contained in prior law, even where such investments 
might constitute control of the company in which they were 
made.
    As part of a compromise negotiated in the final stages of 
the GLBA legislative process, this new merchant banking 
authority was limited to bank holding companies for a period of 
5 years. Given the experience of banks in a broad range of 
merchant banking activities and the safety and soundness 
protections included in GLBA for financial subsidiaries of 
banks, we did not believe it was necessary to so limit the new 
authority. Prudent bank supervision has been emphasizing the 
need to diversify the revenue streams of banks so as to reduce 
the dependence of banks on net interest margins. Non-interest 
income has become an increasingly important component of bank 
earnings, and permitting banks to provide expanded venture 
capital financing to customers, within prudent limits, would 
serve to lessen the concentration of bank earnings in 
traditional loan income. The OCC believes that the elimination 
of the disparate treatment for banks and bank holding companies 
in this area is appropriate certainly no later than the end of 
the GLBA-imposed moratorium.
    The OCC's primary objective in the development of 
regulatory capital rules for merchant banking activities was to 
protect the existing capital and regulatory infrastructure 
surrounding SBICs, which reflects the long-standing 
congressional preference for these entities. Many commenters 
did not believe that the original Federal Reserve Board capital 
proposal was consistent with that objective. That proposal 
would have assessed, at the holding company level, a 50 percent 
Tier 1 capital charge on the carrying value of private equity 
investments in non-financial companies held directly or 
indirectly by a holding company, and would have applied this 
capital charge to a variety of existing investment authorities 
for banks and bank holding companies beyond the new GLBA 
banking merchant authority.
    One of the OCC's principal concerns about the proposal was 
that any consolidated holding company capital requirement that 
would apply a charge to assets held by or under a bank that was 
more stringent than the charge that was fixed by the primary 
regulator of the bank would undermine the congressional mandate 
that bank capital requirements be set by the primary Federal 
bank regulator. Since the primary purpose of holding company 
capital is to protect the subsidiary bank, the OCC saw no basis 
for the judgments of the primary bank regulator to be 
supplanted through the establishment of more strict 
consolidated holding company capital requirements.
    I am pleased to say that the revised capital proposal is a 
significant improvement over the original proposal in several 
respects. First, the scope of the proposal is much narrower 
than the earlier version. It limits the scope of the regulation 
to specified equity investment activities of a character 
similar to those that might be engaged in by financial holding 
companies under Gramm-Leach-Bliley.
    Second, the new capital proposal is more consistent with 
the experience that national banks have had with regard to SBIC 
investment activities for over 40 years, during which there 
have been no safety and soundness concerns. In view of this 
record of performance, the safeguards placed on these 
activities, and the important public purpose of encouraging the 
development and funding of small businesses, the recent 
proposal accords SBIC investments preferential treatment.
    The banking agencies have recognized, however, in light of 
the substantial growth in SBIC investments in recent years, 
that significant concentrations of private equity investments 
could potentially result in safety and soundness concerns, just 
as with any heavy concentration of assets. The OCC favors the 
approach adopted in the recent proposal, that is, requiring 
stepped-up capital charges when aggregate equity investment 
levels exceed specified concentration thresholds. Thus, we 
believe that the revised capital proposal promotes the 
continued conduct of private equity investments, while 
maintaining safety and soundness principles and preserving the 
intent of Congress to promote bank investments in small 
businesses through SBICs.
    I would be pleased to respond to any questions.
    [The prepared statement of Hon. John D. Hawke Jr. can be 
found on page 101 in the appendix.]
    Chairman Baker. Thank you very much, Mr. Hawke.
    I would like to start our questions with you, Governor 
Meyer.
    Oh, excuse me, I would be reminded Chairman Oxley has 
joined our committee, and I would like to at this time 
recognize the Chairman for any opening statement he may wish to 
make.
    Mr. Oxley. Thank you, Mr. Chairman; and I will submit my 
formal statement for the record.
    Let me just welcome our witnesses, Mr. Meyer from the Fed 
and Mr. Hawke from the Comptroller's Office. We have had a 
number of opportunities to work together over the years, 
particularly on the Gramm-Leach-Bliley bill.
    I would say to both you, Chairman Baker, and to Chairman 
Bachus I thank you for having this hearing. I think we need to 
explore some of these merchant banking issues, particularly in 
light of the recent changes that were made in the regs; and I 
guess the old admonition about doing no harm from the 
Hippocratic oath probably has some reference here as well.
    We look for a modern financial marketplace based on the 
tenets of the Gramm-Leach-Bliley Act, and to a large extent all 
of us are working our way through this major change that was 
made in the statute from almost 70 years ago. It is important 
to have this kind of hearings so that the members can get our 
arms around these kinds of issues that in many cases were just 
simply not issues before the passage of Gramm-Leach-Bliley. The 
merchant banking issue is clearly one of them, and how the 
regulators and how the Congress deals with this will have a 
great deal to do with how successful we are in moving toward 
that modern financial services marketplace. So, again, Mr. 
Chairman, thank you for these instructive hearings. I yield 
back, and I ask unanimous consent that my statement be made 
part of the record.
    Chairman Baker. Certainly, without objection. Thank you, 
Mr. Chairman, for your interest and your participation here 
this morning.
    [The prepared statement of Hon. Michael G. Oxley can be 
found on page 57 in the appendix.]
    Chairman Baker. Governor Meyer, under current law, the 
Credit Suisse First Boston now manages, on behalf of Louisiana 
State Teachers Pension Fund, approximately a half a billion 
dollars at the Teachers Pension Fund direction and from time to 
time will make minority investments in firms and as a condition 
of that investment establish a restrictive covenant which would 
allow Credit Suisse First Boston, for example, but not 
exclusively, to make managerial changes they deem in the best 
interest and in accordance with their fiduciary area 
responsibility to the pension plan.
    As I am understanding the rule as now promulgated, they 
would no longer have the unconditioned right to do--they could 
do it, but it would come only in consultation with the Fed's 
approval. Is that correct?
    Mr. Meyer. No, I don't think that is correct. The final 
rule makes clear that the financial holding companies can 
engage in what would be considered routine management in 
exceptional circumstances, and you gave one example. When it 
comes to changing senior management, for example, because of a 
change in the strategic direction of the firm or performance of 
the firm, the final rule recognizes that explicitly as one of 
the situations in which it would be appropriate to have that 
involvement.
    Chairman Baker. Let's explore further what constitutes 
exceptional circumstances. That is the trigger then that would 
allow the third party to make strategic changes. Is there a 
blueprint that you can go down and say here's what we can do 
under certain circumstances?
    Mr. Meyer. We have tried to provide a list of examples, 
although we do not claim it is exhaustive, because you can't in 
advance think of all the situations that would be relevant, but 
to reduce uncertainties and give guidance. So we have talked 
about situations where there was a change in management, where 
there was a sale of some business line or where there was a 
significant acquisition, where there were significant losses 
that had to be remedied. It was a long list, but I think it is 
a very good list of the circumstances in which it is important 
to give the financial holding company the opportunity to 
intervene to protect its investment.
    Chairman Baker. Well, my point is that this appears, at 
least from an outside reading of the regulation, to restrict 
conduct which prior to the January promulgation may have been 
in the course of ordinary business an acceptable practice which 
now, at the very least, may be subject to a second look before 
you proceed to determine if the Fed's approval may be 
necessary. Is there anything in market practice from your view 
that warrants this divisional level of concern?
    My view is that the modernization proposal was to enable 
more relationships with less regulatory oversight to occur to 
facilitate economic growth. It would appear that this, at the 
very least, if I agree with your view that there is a list of 
things that you are allowed to do as illustrative but not 
exclusive, that there may be things that you can't do now that 
you could do previously without Fed's approval, is that a 
correct summation?
    Mr. Meyer. Let me try to work on that.
    First of all, the examples that we gave in the 
modifications we made in the revised rule reflected careful 
discussions with commenters; and we put into the final rule 
examples that they gave us that reflected what is considered to 
be best practice in the industry.
    Before we even wrote our interim rules we sat down and we 
interviewed large security firms and large banks that were 
heavily involved in merchant banking to get an idea of what 
industry practice was, and we thought of ourselves as codifying 
best practice in these areas. Where we found we had overstepped 
and hadn't gotten it right, we tried to do a better job in the 
final rule.
    Now, let's see, I have lost----
    Chairman Baker. Principal point was, are there things which 
historically you could engage in which pursuant to the 
promulgation you may not?
    Mr. Meyer. I think the other point that you were making is 
a very, very important one. It goes to the tension between 
Gramm-Leach-Bliley, making a determination that shouldn't be a 
broader mixing of banking and commerce and then on the other 
hand providing authority for merchant banking activities. And 
the key point in the legislation, mirrored in the regulation, 
is that there are certain restrictions on merchant banking so 
that it is not the same as the broad mixing of banking and 
commercial.
    We did not put into the legislation such things as holding 
periods and prohibitions on routine management. You have put 
them in there. But I presume the Majority put them in there 
because they wanted to assure that this won't become a broader 
mixing of banking and commerce. So we are simply mirroring what 
you did.
    Chairman Baker. Let me, before I recognize Mr. Bentsen, 
make one declarative statement. I wouldn't have done it, but 
some Members did it on the direction of expert financial advice 
from somewhere.
    Mr. Bentsen.
    Mr. Bentsen. Thank you, Mr. Chairman.
    I apologize for having to step out during both of your 
testimonies. And, Mr. Hawke, I don't want you to think I missed 
your testimony altogether, that that is any indication of where 
I think you might be or not be.
    Chairman Baker. Mr. Bentsen, can you pull your mike up, 
please?
    Mr. Bentsen. Looking at the proposed capital requirements, 
which I guess was the most controversial aspect of the proposed 
rule, how did the Board and the Treasury come up with this new 
sort of sliding scale? Is that modeled after anything or was 
that just something you all came up with internally?
    Mr. Meyer. Well, after the comments came in, we thought 
that they justified a total reassessment of our approach to the 
capital rule. We began with the proposition that equity 
investments are riskier than traditional banking activities and 
required some additional capital treatment.
    As we worked further on that, we determined that the risk 
to the banking institution from the equity investments depended 
very critically on how large those equity investments were 
relative to the total organization. So, for example, if you 
have an SBIC that is 5 percent of the Tier 1 capital, that 
doesn't impose much risk on the banking organization because it 
is so small relative to the total. So we decided that what that 
would justify would be a sliding scale, where the capital 
charge would be quite low for low concentrations of merchant 
banking activity but get progressively larger as the 
concentrations rose. This came out of very careful analytical 
thinking.
    The staff member who led the effort is sitting behind me, 
and we think it was a major contribution to an improved capital 
rule.
    Mr. Bentsen. I don't know if you want to comment on that or 
not.
    Mr. Hawke. Just briefly, Congressman Bentsen. During the 
discussions that we had with the Federal Reserve, we made our 
position very strongly known that we wanted a preference for 
SBICs, and that was our overwhelming concern about the capital 
reg. The Fed staff expressed the view that they were concerned 
about concentrations, and we recognized that at some point 
concentrations could become important. But the stair-step 
formulation that appears in the final regulation protects SBIC 
investments up to a level that matched the outermost limits of 
the experience that we had had with our banks in terms of SBIC 
investments. A bank can only invest up to 5 percent of its 
capital in an SBIC, so anything over 5 percent of total capital 
has to come from appreciation in the investments.
    Mr. Bentsen. Let me ask you also, because my time is 
running out. The way I read this, on top of the scale the Board 
and the Comptroller have the authority to subsequently go back 
in and look at financial holding companies' equity investment 
in their merchant banking operation and apply other criteria. 
Am I reading that correct? Is that only after you exceed a 
certain threshold or is that in any case?
    Mr. Meyer. Well, in general, the capital rule is about a 
regulatory minimum. Banks are expected to hold economic capital 
in excess of that regulatory minimum. So in general you would 
be expecting to see banks hold more than that amount of 
capital, and we would be assessing their economic capital 
allocation through the supervisory process.
    Second, once their concentration got up to a level of 50 
percent of Tier 1 capital, then we have indicated that their 
merchant banking activities would come under more intensified 
scrutiny. Since we are already up to the highest marginal 
capital charge of 25 percent, when they get up to 25 percent of 
Tier 1 capital, when it gets up to 50, we would intensify our 
supervisory review; and depending upon the risk management and 
the nature of the equity investments, we could ask for 
additional capital.
    Mr. Bentsen. You state in your testimony with respect to 
internal risk models that you all are reviewing that, but at 
this point in time--if I understand that, that means whether or 
not the internal risk models of the institution itself, not the 
Fed or the Comptroller, but at this time you all intend to 
still rely on your own risk molding, risk assessment.
    Mr. Meyer. We intend to rely on this capital charge for the 
purpose now. But, as we have indicated, we do think it is a 
bridge ultimately to the use of internal risk models by banking 
organizations overseen by their regulators.
    Mr. Bentsen. With the Chairman's indulgence, you referenced 
the Basel reviews are ongoing discussions about this. With 
respect to internal risk models, would the idea be that there 
would be some standard, some international standard that 
regulators would use for what is a qualified risk model versus 
what anybody comes up with?
    Mr. Meyer. Yes. What the Basel approach is now working with 
in the new proposed rule is an approach whereby the banks could 
use their internal systems for their banking books, for 
example, to determine the appropriate capital charge in 
relationship to risk. But that would be overseen and validated 
by their supervisors.
    I should note that banks are much more advanced in their 
measurement and management of risk in the banking book than 
they are in their equity investments in their merchant banking 
portfolios. Very frankly, I don't know of a single bank at this 
point that has a model sophisticated enough to put it before us 
and have any hope that it would be appropriate for determining 
their capital charges.
    Chairman Baker. Mr. Bentsen, your time is expired.
    Mr. Bachus.
    Mr. Bachus. Thank you.
    First of all, the committee has prepared about 15 
questions, some of which may not be covered today in oral 
questions. We would like to submit those to you, those that are 
not answered today.
    My first question is about process; and, Governor Meyer, I 
am going to direct this to you. You had an interim rule in 
March, and then 9 days before the change in Administration you 
issued a final rule. Didn't that preclude the new 
Administration from weighing in on these rules?
    Mr. Meyer. When the law was passed, first of all, we needed 
to move quickly to reduce uncertainty in the industry. So 
within a day or two after the powers became effective we put 
out an interim rule. We certainly wouldn't have wanted to wait 
longer to reduce that uncertainty. There were a lot of comments 
about that rule and we wanted to move as quickly as we could to 
make revisions in that rule, again to reduce uncertainty and to 
improve it.
    Now, you will undoubtedly recall that one of the reasons 
that this law was passed was because the Federal Reserve and 
the Treasury had worked together to bridge their differences 
and to reach agreements to allow it to go through, and we were 
partners in that process. It seemed only natural that these 
partners worked together to do the regulations, which we did.
    Now if we had waited, for example, for the new 
Administration, we would not have yet had our first meeting. 
The Under Secretary for Domestic Finance has not been 
officially nominated, to my understanding; and we would still 
be waiting for our first meeting with the new Administration on 
this topic. I don't think that would have been a prudent thing 
to do.
    Having said that, I expect to have as exceptional a 
relationship with the new Treasury as we did with the previous 
Treasury; and I look forward to sitting down with the Under 
Secretary for Domestic Finance at the earliest convenience and 
reviewing all of the implementation we have done with Gramm-
Leach-Bliley and getting feedback on that.
    Mr. Bachus. Thank you. I hope that you will do that.
    I have several concerns, and I noted this is what you said 
in response to Congressman Bentsen: Equity investments are more 
risky than traditional activities. Now a lot of what you have 
done here is premised on that fact. But, in fact, is that true? 
I mean, a lot of your merchant banking activities historically 
have been high profit, maybe some would argue not as risky as 
commercial lending. So did you all make a determination that 
this premise was, in fact, correct?
    Mr. Meyer. We have indeed studied it very carefully. And, 
frankly, when we had meetings with trade associations, and so 
forth, to give us feedback on the original capital proposal, 
oftentimes the very first thing they would say is, these are no 
riskier than traditional banking assets. But when I confronted 
them and we had a full discussion on it, few held on to that 
position very long. Very frankly, few of the commenters made 
that point. Most agreed that equity investments are riskier.
    Mr. Bachus. We are talking about a percentage. Say they 
invest five times and two of them go flat but three of them are 
highly profitable. What I am talking about is an average here.
    Mr. Meyer. Absolutely. There is an iron law of economics 
that when a particular activity or instrument has very high 
risk, it has to offer higher expected returns to get people to 
hold it. It is very fundamental.
    Merchant banking activity is a very good example of an 
activity that has a very high expected rate of return, and it 
must be high because of the risk that it holds. We did a study 
of 25 years of experience with venture capital firms, and we 
found that, for example, one-third to one-quarter of individual 
investments suffered losses and that 20 percent of these firms 
went out of business.
    Mr. Bachus. Are these bank holding companies and financial 
holding companies?
    Mr. Meyer. No, these are firms that had 100 percent capital 
backing them, no leverage. Why no leverage? Because these 
activities were viewed as so risky to begin with that they 
backed them 100 percent with capital. Leverage is a way to 
increase your expected return by taking on more risk. But these 
investments were already very risky to begin with. So I really 
do not think that this is a reasonable concern or an issue.
    Let me say one more thing. If you have a list of banking 
organizations that have told you that they can't tell the 
difference between the riskiness of their merchant banking 
investments and their loan portfolio I would like their names.
    Mr. Bachus. One more thing. You have put--the merchant 
banks often have minority investments in their portfolio 
companies and then they require restrictive covenants to make 
those investments safer, but in fact, if a final rule prohibits 
or restricts their ability to make these restrictive covenants, 
doesn't it, in fact, have the perverse effect of making that 
investment more risky? And what do you say to the critics who 
say that the final rule restricts their ability to manage and 
protect their minority rights in the companies they invest in?
    Mr. Meyer. Well, as I indicated earlier, in the final rule 
we have made revisions and clarified the terms under which 
financial holding companies can engage in routine management in 
those exceptional circumstances. I think what we have done has 
mirrored what is industry practice.
    One has to make a distinction between routine management on 
a day-to-day basis and interventions in those special 
circumstances when the threat to the investment is there, such 
things as losses being taken by the firm, when there has to be 
a change in management, when there is an important sale of 
another company or when you might be selling off a line of 
business. So these are precisely those critical junctures when 
intervention and routine management is allowed, and I think we 
have clarified that we have done something which is consistent 
with the best practice in the industry.
    Mr. Bachus. Let me simply close by saying I would think 
that any restrictions that you allow the merchant banking 
company to have would be a good thing as far as protecting 
their own interest and the more management they do would be the 
best. So I would hope these rules do not limit them in any way.
    Mr. Meyer. I appreciate that point. I think what we are 
trying to do is that delicate balancing act, making those 
distinctions between merchant banking and the broader mixing of 
banking and commerce; and, quite frankly, we are hearing from 
some Members of this committee that they would prefer that 
there was a broader mixing of banking and commerce. We are 
restricted by what you did in the bill.
    Mr. Bachus. Remember, as a regulator, your duty is to 
protect the bank, not to protect the company that is being 
invested in.
    Mr. Meyer. We certainly understand that. But also 
understand that when you put something into the legislation, 
expect it to show up in the regulation. Don't expect a 
regulation to undo what the Majority did in their legislation.
    Mr. Bachus. If you could identify those areas, it would be 
helpful.
    Chairman Baker. Thank you, Mr. Bachus.
    Mr. Hinojosa.
    Mr. Hinojosa. Thank you, Mr. Chairman. I am going to pass 
and come back with some questions.
    Chairman Baker. Certainly.
    Mr. Lucas.
    Mr. Lucas. Pass.
    Chairman Baker. Mr. Ford.
    Mr. Ford. Since I just walked in, I am definitely going to 
pass.
    Chairman Baker. That is OK.
    Mrs. Roukema.
    Mrs. Roukema. Mr. Chairman, I didn't think I had a 
question, but I do want to make a statement, and then I guess I 
will ask a question.
    I am one of those that was very concerned in Gramm-Leach-
Bliley regarding the safety and soundness and the mixing of 
banking and commerce. And I believe we did the right thing. I 
have no regrets about that. And I am deeply concerned as to 
whether or not you are following through consistent with the 
law.
    But you have both made the case that what you are doing is 
enforcing the law. Now, your statement--I am going to go over 
them--but it sounds to me you have hit the proper balance here 
consistent with Gramm-Leach-Bliley.
    But I do want to ask a question, and maybe it is obvious, 
but it may be a good example of how you are translating through 
regulation the meaning of Gramm-Leach-Bliley. And I am not sure 
but why you have indicated that the FHCs have to wait, as I 
understand it, ``for an extraordinary corporate event prior to 
being permitted to intercede in the management of the portfolio 
company.''
    Now this is evidently a good example of how you have to 
translate the legislation into your regulation. I don't quite 
understand it. How do you do that? Wouldn't it be better to 
serve the interests of safety and soundness if there were 
action before the fact rather than after the fact? And I am not 
quite sure how you would address it after the fact, after there 
is significant evidence. Could you use that as an example of 
how you translate the legislation and your regulations into 
practical action?
    Mr. Meyer. Well, I think you made the point very well. The 
issue here is balance, and it is a difficult balance to strike. 
I think I would agree with that.
    The question here is, how do you carry out the statute's 
prohibition on routine management? And simply by saying that 
you can intervene any time you want with no restrictions would 
seem to go against the spirit of the prohibition of routine 
management. So we had to find a way to balance that, and so 
what we did was to say that, no, in the ordinary course of 
business you can't have covenants which restrict the ordinary 
course of business, day-to-day routine management, but you 
could in these critical cases. And we laid out a series of 
examples, as I noted before.
    We don't mean that that list is exhaustive, and we will 
gain more experience with this regulation over time. But I 
think that is the only way we could do it that on the one hand 
would be consistent with the prohibition on routine management 
and on the other hand would allow opportunities for 
intervention at critical junctures when it is necessary to 
protect the investment.
    Mrs. Roukema. What is an example, however, of the 
extraordinary corporate events?
    Mr. Meyer. Change in senior management, a significant loss 
that the firm was incurring, a purchase of a new business, sale 
of an existing business line. There are many, many other 
examples.
    Mrs. Roukema. You would automatically take that under 
review.
    Mr. Meyer. We have given guidance so there would be no 
uncertainty. If a financial holding company found a portfolio 
company in one of those circumstances, it doesn't have to come 
back to us and ask permission. They have the authority to 
intervene. Now it has to be temporary.
    Mrs. Roukema. I am sorry?
    Mr. Meyer. They can't do it forever.
    Mrs. Roukema. Temporary?
    Mr. Meyer. Temporary.
    Mrs. Roukema. All right. Well, I hope this is working well.
    Mr. Meyer. Well, we will find out.
    Mrs. Roukema. Thank you.
    Thank you, Mr. Chairman.
    Chairman Baker. Thank you, Mrs. Roukema.
    Mrs. Maloney.
    Mrs. Maloney. I would like to, first of all, welcome you. 
Good to see you. Thank you for having this hearing.
    First of all, I would like to ask the Honorable John Hawke 
and Governor Meyer, how does the proposed merchant banking 
capital rule compare with the new proposed Basel capital 
standards? How do they compare?
    Mr. Hawke. Mrs. Maloney, the Basel proposal is very much a 
work in progress right now and----
    Mrs. Maloney. They came out with preliminary guidelines, 
did they not?
    Mr. Hawke. The Basel proposal is out for comment--similar 
to a proposed rule.
    To try to simplify a very complicated process, the Basel 
proposal is divided into two parts. One is the standardized 
approach, which is very simple. The other is a complicated 
approach.
    In the simple standardized approach, the current proposal 
is that equity investments of this sort would have 150 percent 
risk weighting, which I think works out to be something not 
terribly different from what the Federal Reserve proposal is. 
As far as the more complicated proposal, that is still up in 
the air. There hasn't been a specific proposal yet for the 
treatment of equity in the more complicated part of the 
proposal.
    Mrs. Maloney. But if the committee completes its work and 
the United States signs on for uniform global capital 
standards, wouldn't any additional merchant banking capital 
charges and changes be repealed? I mean, would the Basel 
Committee, if we sign on, would that then become the capital 
standard that we are going to use in this country and in 
foreign countries?
    Mr. Hawke. I think that is a very good, very pertinent 
question; and it applies to a number of aspects of the Basel 
proposal. I would certainly hope that when the dust all settles 
our domestic capital requirement would be consistent with what 
Basel comes out with. But we are still quite a ways from the 
end of the line on that.
    Mrs. Maloney. When do you expect them to complete their 
work?
    Mr. Hawke. The Basel Committee is hoping to have a final 
proposal out by the end of the year, and it would not 
essentially take effect until 2004.
    Mrs. Maloney. Now, are the capital standards basically the 
same for domestic operations as for foreign loans? Is there any 
difference now?
    Mr. Hawke. In the Basel proposal?
    Mrs. Maloney. Not in the Basel. I am just talking about now 
in the United States.
    Mr. Hawke. At present, the existing Basel Accord applies to 
internationally active banks, but the existing accord is much 
simpler in its contours than the proposed accord will be. So, 
essentially, it has been applied up and down the line 
domestically.
    Mrs. Maloney. But are the capital standards higher for 
loans domestically or for foreign or are they the same?
    Mr. Hawke. For individual loans, they are the same.
    Mrs. Maloney. The Fed is, as I understand, heading the 
Basel Committee. Do you have any comments on it?
    Mr. Meyer. The Federal Reserve does not head the Basel 
Committee. The president of the Federal Reserve Bank of New 
York is chairman of the Basel Committee. But the Federal 
Reserve participates, as the OCC does, as a member of the Basel 
Committee.
    Mrs. Maloney. So do you have any further comment on it? Do 
you see it, likewise, that what they are proposing is basically 
what you are proposing? Is it basically the same, and once it 
becomes complete then that will be the standard? Is that how 
you see it, too?
    Mr. Meyer. I see it working the following way: First of 
all, right now the treatment of equity is really one of gaps 
that hasn't been completely worked through at Basel. We are in 
discussions about what that will be, particularly for the more 
advanced approaches; and we are hopeful that the final Basel 
rule will be flexible enough that it will be consistent with 
our rule. We will be trying to move it in that direction, but 
we can't guarantee that.
    Whatever happens at Basel will require us then to review 
our capital proposals in light of the Basel treatment. It 
should be understood, however, that national authorities always 
have the opportunity and the authority to impose higher, more 
conservative capital requirements than Basel. They just can't 
be more liberal than what Basel comes out with. So we will have 
to look over the Basel rule, we will have to look over the 
nature of the equity investments that are typical in merchant 
banking investments in the U.S. compared with equity 
investments that are undertaken abroad and reach a final 
determination at that time.
    Mrs. Maloney. So, in other words, you see a higher capital 
standard for our domestic----
    Mr. Meyer. Not necessarily.
    Mrs. Maloney. I find it interesting there is more default 
on our foreign loans than on our domestic loans, and I read a 
report on that from some of our private banks. Why do you 
believe that is?
    Mr. Meyer. Well, I would presume that if one took a poll 
and one asks about the default rate as the loans were given 
further and further away from where that banking organization 
was located that the default rates would go up. That is fairly 
typical. It reflects the greater knowledge that banks have with 
respect to domestic conditions and laws, and so forth, then 
what is going on in other countries. So I don't find that 
particularly surprising.
    Mrs. Maloney. But then, because of the outcome, should we 
have higher standards for foreign loans or capital requirements 
possibly so that we would not have such a great default?
    Mr. Meyer. Under the new Basel approach the capital 
requirements against individual loans would depend upon the 
risk assessment by the bank. That couldn't take into account 
all of these kinds of considerations, so I think it is 
perfectly consistent.
    Chairman Baker. Mrs. Maloney, your time is expired.
    Mrs. Kelly.
    Mrs. Kelly. Thank you, Mr. Chairman.
    Gramm-Leach-Bliley prohibits the depository institution 
controlled by a financial holding company from cross-marketing 
any product or services with or through any company in which 
the financial holding company or a bank holding company hold an 
equity interest through the merchant banking authority. 
However, a depository institution generally may cross-market 
the product or services of non-financial companies held by 
insurance affiliates of the financial holding companies through 
statement stuffers, internet sites, portals, things like that. 
Would the Fed support an amendment to Gramm-Leach-Bliley that 
would correct that kind of inequity and allow the same kind of 
cross-marketing abilities to be extended to products or 
services of portfolio companies that are held under the 
merchant banking authority?
    Mr. Meyer. The Board hasn't taken a position on this.
    As you well know, this asymmetry in Gramm-Leach-Bliley is 
probably not one of its greatest virtues, and we would agree 
with that. However, in correcting it, one has to make a 
decision as one makes it more symmetrical whether one wants to 
have the same restrictions on cross-marketing everyplace or 
reduce those restrictions everyplace.
    Again, clearly the restrictions on cross-marketing were one 
of the vehicles that the Congress used to make the distinction 
between merchant banking activities and the broader mixing of 
banking and commerce. That is an issue you may want to 
reconsider, but we haven't taken a position on it.
    Mrs. Kelly. I want to jump to the committee statement that 
talks about the fact that depository institutions should be 
able to compete on an equal basis with Section VI(C)(3)(h) of 
the Gramm-Leach-Bliley Act. Do you think that the joint rules, 
even in their current form, given their numerous restrictions, 
satisfy the congressional intent which talks about the fact--
and I can read it for you. It says, ``the Board shall take into 
account that investment banking firms affiliated with 
depository institutions should be able to compete on an equal 
basis for principal investments with firms unaffiliated with 
any depository institutions so the effectiveness of these 
organizations and their investment banking activities is not 
compromised.''
    Do you believe that the joint rules, even in their current 
form, satisfy the Congressional intent?
    Mr. Meyer. We do believe so. Remember that what we did, as 
I indicated earlier, is that we sat down with large securities 
firms and large banks to try to determine how they conduct 
their merchant banking activities and to put in our regulations 
what constituted best practice. In that way we thought we would 
ensure that the two-way street which is so important in the 
Gramm-Leach-Bliley Act remained open.
    If you take a look, for example, at capital treatment, we 
did find out that the large securities firms tend to hold more 
capital relative to their merchant banking investments than 
banking organizations did. So we don't really think that the 
capital rules are going to provide an obstacle for securities 
firms to affiliate with banks.
    I will also note that a very large number of the major 
securities firms are already affiliated with banks, and we have 
had two others that have become affiliated with banks, with 
foreign banking organizations, and another sizable securities 
firm with merchant banking activities has recently elected to 
become a financial holding company. So I don't see this as an 
obstacle, and we tried very hard in our rules to keep that two-
way street open.
    Mrs. Kelly. Mr. Chairman, I am going to run out of time 
here, but I would like to ask one more question. What is the 
statutory authorization for the aggregate cap on merchant 
banking investments?
    Mr. Meyer. For the caps?
    Mrs. Kelly. Yes.
    Mr. Meyer. I think the authority that we would use would be 
the authority for overall safety and soundness that comes from 
the Bank Holding Company Act for bank holding companies. After 
all, what it is is not a strict cap, but it is a threshold that 
requires us to do a careful review of the safety and soundness 
and risk management of those financial holding companies that 
have devoted a very high amount of their capital to these 
activities.
    Mrs. Kelly. So there is no statutory authorization as far 
as you know.
    Mr. Meyer. No. Just as we are given the authority for 
capital in general, in order to protect safety and soundness, 
it is that authority that we are using in this case.
    Mrs. Kelly. Thank you. Thank you, Mr. Chairman.
    Chairman Baker. Thank you, Mrs. Kelly.
    Mr. Grucci.
    Mr. Grucci. Thank you, Mr. Chairman. I have no questions at 
this time and yield back my time.
    Chairman Baker. Mrs. Biggert.
    Ms. Biggert. Thank you, Mr. Chairman. I have no questions 
either.
    Chairman Baker. Mr. Hinojosa, if you do not have a question 
at this time, we will start the second round at this point.
    Mr. Hinojosa. Go ahead.
    Chairman Baker. Governor Meyer, I want to return to the 
presumption on which much of this has been constructed, 
something subsequent to the line Mrs. Kelly was pursuing. The 
explanation for many of the determinations is based on the 
predicate that Congress acted; therefore, the regulator 
implemented. But the law did not require a 50 percent capital 
offset, nor did it require a 20 percent offset, nor did it 
require a sliding scale. Those were all determinations made 
under the broad directive, as I understood your answer to Mrs. 
Kelly, that you have the responsibility to provide for capital 
adequacy, that is correct.
    Second, with regard to the modifications made since the 
earlier addition, we now have the--and this is a summary. I 
don't believe this to be the rule. I didn't get that clarified.
    With regard to managerial relationships, the final rule was 
modified to clarify that the holding company may be considered 
routinely managing if they provide investment advisory services 
and management consulting services to the portfolio company so 
long as the holding company does not exercise managerial 
discretion of decisionmaking authority. To me, that reads, I 
can sit in a room and say we think you might ought to look at 
this, but I cannot say I recommend that you do this. What is 
the distinction? I see a differing view behind you there.
    Mr. Meyer. The final rule does indicate that you can 
provide consulting services and give advice, and that does mean 
giving recommendations.
    Chairman Baker. How does that--is distinguished from making 
a managerial----
    Mr. Meyer. It is not a decision. It is advice. There is a 
difference between advice and a dictate that says, this is what 
you are going to do in the ordinary course of business. Do it 
because we are the financial holding company and we own a share 
of this firm. You can't do that.
    Chairman Baker. But clearly the law didn't make a provision 
as to doing either A or B. That is a recommendation of the 
regulation.
    Mr. Meyer. We are trying to strike the balance.
    Chairman Baker. I understand.
    Mr. Meyer. There is no precise way of doing it. So these 
questions are all reasonable ones, but we had to try to strike 
a balance between the Majority in Congress' view that we should 
do something to prohibit routine management. That was a 
difficult task. We have done our best to try to draw that 
balance.
    Chairman Baker. I am not questioning the credibility of 
your decisionmaking acumen. I am merely pointing out that much 
of the earlier explanations to questions was that Congress 
dictated certain courses of action to which you responded, and 
in my view there was a broad discretionary grant of authority 
given in which the Fed found it appropriate to act.
    My view is that I have some philosophic disagreements with 
the exercise of the discretion as provided by the final rule. 
But if wasn't clearly marked, it wasn't I-66 that you are on--
this is more David Copperfield--first you see it, then you 
don't--and somebody has got to make a decision about what the 
final illusion looks like. Were it to be our judgment, and I am 
speaking a little in advance with final agreement with Mr. 
Bachus, and I may wish to speak to this later, to provide more 
clarification in the formulation of these rules by way of 
further congressional deliberations.
    I noted in your comment that Gramm-Leach-Bliley was not 
symmetrical in its market consequence. To the extent you could 
help us provide for symmetry I would very much appreciate your 
direction in order to better understand where those inequities 
exist. The underlying philosophy that I think many members of 
this committee have adopted is whatever A can do in the 
marketplace to B, B ought to be able to do in the marketplace 
to A. And from what I am getting from much of the presentation 
this morning and the questions, that does not appear to be the 
current circumstance. Do you agree with that observation?
    Mr. Meyer. Mr. Chairman, I was responding to the asymmetry 
that was introduced at the last minute into Gramm-Leach-Bliley 
with the special preference for insurance affiliates with 
respect to cross-marketing activities. So that was a very good 
example of a place in which the law became asymmetrical at the 
last minute, and I could understand why there might be some 
questions about that. But, again, the rule mirrored that. As I 
say, we have not taken a position on that, on how that should 
be corrected.
    Chairman Baker. That is my point. If there are identifiable 
areas of market distortion, we very much are interested in not 
wanting to provide arbitrage or preference or anything else. 
One might choose to try it, but I want to make sure if we 
provide in that manner we are correcting it and not making it 
worse.
    Mr. Meyer. We would look forward to working with you in 
those areas.
    Chairman Baker. Thank you very much.
    Mr. Bentsen, you would be recognized for a second round, if 
you would like.
    Mr. Bentsen. Thank you, Mr. Chairman. I keep trying to read 
the rule. Every time, you are interrupting me. But I do have a 
question.
    Chairman Baker. At least I am not waking you up.
    Mr. Bentsen. No, no, it is really fascinating. But I do 
have a couple of questions.
    Mr. Hawke, and this may be more of an agency or political 
question, but in reading this, as I now recall some of the 
details of Gramm-Leach-Bliley that I have forgotten, national 
bank subsidiaries are precluded for 5 years from engaging in 
merchant banking above the current 5 percent rule or the civic 
rule, is that right.
    Mr. Hawke. As I said in my direct testimony, merchant 
banking is a very broad term. What banks were not given was 
authority parallel to what holding companies got to make 
private equity investments beyond what they can already do, 
say, with respect to SBICs.
    Mr. Bentsen. Until?
    Mr. Hawke. Until 5 years.
    Mr. Bentsen. Four years or five years, I guess.
    Would it be the position of the Comptroller's office that 
what is being proposed right now--the capital standards that 
are being proposed right now--would apply to national bank 
subsidiaries as it does to holding companies? And I would ask 
the same question of the Fed as well, or is that too 
prospective in nature?
    Mr. Hawke. You mean, would it apply 5 years out?
    Mr. Bentsen. Right.
    Mr. Hawke. We would hope that if 5 years out the Fed and 
the Treasury see fit to extend the new merchant banking 
authority to financial subsidiaries of banking organizations, 
we would have an opportunity to examine then what the 
appropriate capital requirements were under those 
circumstances. There is certainly going to be some momentum 
behind the existing rule that the Treasury and the Fed adopted 
in this area. I would think that it would likely become a 
standard for what banks might be able to do 5 years out.
    Mr. Bentsen. Governor Meyer, would that--I mean, again, 
obviously, this is some ways down the road and you would have 
to take into consideration civic investments and other issues, 
but would it be fair to assume that if these standards go 
through and the Fed find them to be workable and prudent, that 
if and when a petition is made to open up merchant banking 
activity for national banks, which I would bet would probably 
be made, that the Fed would view these rules as being 
commensurate for a national bank subsidiary.
    Mr. Meyer. Congressman, I would not like to see you lose 
money, so I would just say this. There is no presumption one 
way or another. That is a decision that would be made within 
the 5-year time. There is no presumption one way or another 
which way it will go at this point as to whether or not this 
will be extended.
    Second, I think the important principle in the capital rule 
which I hope would be preserved would be one of symmetry. That 
is, the capital treatment of merchant banking investments 
should be independent of whether they are held in the bank 
holding company or in the bank; and I hope that principle would 
be one which would continue if the new merchant banking 
authority were then extended to banks.
    Mr. Hawke. We would certainly support the symmetrical 
extension of new authority to national banks.
    Mr. Bentsen. I appreciate that.
    If I could ask one or one more question on symmetry. If I 
read this correctly, Mr. Hawke, in your testimony, the ongoing 
Basel proposal would apply a risk weight standard of 150 
percent for venture and equity, and I think you all are looking 
at it using a factor of 100 percent. But you perceive there is 
symmetry because, I think, of what Governor Meyer said. You are 
trying to establish minimums, and you have regulatory 
discretion which would allow you to go higher. Is that a 
correct interpretation?
    Mr. Hawke. The Basel proposal is awfully complicated, but 
under the simplified Basel approach there would be a 150 
percent risk weighting that could be applied at the regulator's 
discretion to equity investments. They did not particularly 
characterize the type of equity investment, whether it is 
speculative or venture capital, but equity investment 
generally.
    I should say that is a very controversial issue within the 
Basel Committee, because there are banks in the home countries 
of many members of the committee that have long had the ability 
to be invested in equity.
    Mr. Bentsen. Thank you.
    Chairman Baker. Mr. Bachus.
    Mr. Bachus. Thank you.
    Governor Meyer, why should a financial holding company have 
to wait for what we have called extraordinary corporate events 
prior to being permitted to intervene or intercede in the 
management of one of their portfolio companies?
    Mr. Meyer. I would answer as I have before. Because you 
have, the Congress, put into the bill a prohibition.
    Mr. Bachus. Under risk management.
    Mr. Meyer. That is the higher reason.
    Mr. Bachus. So if we amended that----
    Mr. Meyer. Absolutely. If you eliminated the restrictions 
on the mixing of banking and commerce, of course, a lot of 
other things would be possible, too.
    Mr. Bachus. We are talking about the risk management 
provision.
    Mr. Meyer. OK.
    Mr. Bachus. As the routine management----
    Mr. Meyer. If you eliminated the routine management, that 
is one of the protections that make merchant banking different 
from the mixing of banking and commerce, but obviously you 
could change that.
    Mr. Bachus. Don't you agree that we would all be better 
served if these companies that have expertise were allowed to 
intercede before, say, their investment got in trouble.
    Mr. Meyer. You are perhaps not talking to a sympathetic 
party here, because I do support the provisions and the spirit 
of Gramm-Leach-Bliley that at this point we shouldn't move 
ahead to a broader mixing of banking and commerce, and I 
appreciate the restrictions that were put into the law to make 
that effective.
    Mr. Bachus. But to me, anytime you allow one to assist in 
the management of something they have invested in, it would 
obviously improve the safety and soundness of their investment.
    Mr. Meyer. I appreciate that point, and it is a valid one. 
But you understand as well the balance that we are trying to 
strike here.
    Mr. Bachus. I think our main concern is safety and 
soundness of the investment. And if these companies have 
expertise and management I would think we would want to 
encourage----
    Mr. Meyer. In terms of risk management, that is always 
something that a financial holding company can intervene in, in 
terms of the process of risk management but not the day-to-day 
activity. Risk management is a process, and that process 
definitely comes under the review and intervention of the 
financial holding company. It has to be satisfied with the risk 
management.
    Mr. Bachus. I am thinking about Warren Buffett, for 
example, going down and firing the CEO, which he does and is 
very successful.
    Mr. Hawke. Mr. Bachus, if I could add a note to that. It is 
very traditional for banks that have extended loans to a 
company to exercise some involvement in the affairs of the 
company when the loan gets into trouble. I would hope that the 
rule that the Fed and the Treasury have adopted would not 
interfere in any way with the ability of a bank, whether it is 
in a holding company that made a merchant banking investment or 
not, to exercise the normal rights and authorities of a bank to 
take remedial steps with respect to a company it has made a 
loan to.
    Mr. Bachus. Otherwise, if they do it in a commercial loan 
then they will start----
    Mr. Meyer. But it is perfectly appropriate to do that, and 
I think there is considerable effort to do just that, prepare 
for a financial holding company to intervene to protect its 
investment.
    Mr. Bachus. I would just say I think they ought to be free 
to assist management any way they see proper.
    But let me ask you another question. Why is a carrying 
value of merchant banking investment used to determine the 
aggregate merchant banking investments instead of the actual 
cost of the investment? The reason I ask that, it seems the 
more successful the investment the more they are penalized.
    Mr. Meyer. As the carrying value goes up, the capital to 
the firm goes up. As the carrying value goes down, the capital 
of the firm goes down. So that is the real exposure to the firm 
from that merchant banking investment. When the firm reports 
its balance sheet and its financial statements, its merchant 
banking activities, it is going to report its carrying value.
    Mr. Bachus. Because of that, the more successful a 
financial holding company's investments are, the less ability 
they have to make other investments.
    Mr. Meyer. Not at all. The more successful they are, the 
more they can make investments. But they have to hold capital 
against their carrying value, because that carrying value 
reflect the exposure of that organization to the risks.
    OK, if you have a 10 percent or a 20 percent or a 50 
percent decline in the value of the firm, the risk depends upon 
the current carrying value.
    Mr. Bachus. Mr. Hawke.
    Mr. Hawke. Mr. Bachus, I think a great many investments, 
particularly made by SBICs, are carried at historical cost, and 
they are not written up. This is particularly true of 
investments in privately held venture capital--in companies 
that don't have a public trading market. Any assets held in the 
available-for-sale account of an institution will be carried at 
what may be a higher value, but the unrealized appreciation 
will not count toward Tier 1 capital. So the big difference is 
whether the increase in value that is unrealized can be counted 
toward Tier 1 capital.
    Mr. Bachus. All right. I have got 47 seconds, right.
    Chairman Baker. No, you are 47 seconds over, but I am not 
counting.
    Mr. Bachus. I will ask a real short one.
    Chairman Baker. Good.
    Mr. Bachus. Has the Fed considered excluding investments 
from the rules once a portfolio company has gone public?
    Mr. Meyer. No. Once a portfolio company goes public those 
now publicly traded equities are held under the merchant 
banking authorities and are subject to the same rules. We have 
made no distinction between the private equity investments and 
the publicly traded ones. That is something that, over time--
for example, if banks develop internal risk models that are 
more sophisticated and can make that distinction--we would 
certainly be willing to consider.
    Mr. Bachus. Thank you.
    And I just want to make a comment. Oftentimes--you talked 
about market volatility and what the market has done since you 
came out with these rules. But I think you might agree that 
since you have shown the merchant banking investments are more 
stable than some of your publicly traded equity which have 
really gone down in value.
    Mr. Meyer. Well, the difference between publicly traded 
equity and private equity investments is that the latter are 
not regularly marked to market, so you wouldn't know right now 
to what degree losses are incurred. If the market stays as it 
is right now, then we will find out over time.
    Chairman Baker. Thank you, Mr. Bachus.
    I just want to make a quick observation. It has always been 
a matter of mystery to me--Mr. Bachus and I used to know the 
citations when we were in the depths of the Gramm-Leach-Bliley 
debate--why a holding company can have up to a 24.9 percent 
interest equity in a domestic corporation non-voting but you 
can have up to a 40 percent position in a foreign corporation. 
And I never have ever had a successful explanation as to why 
that appears to be a less risky position than a 24.9 percent in 
the domestic corporation. So there are a lot of apparent 
inconsistencies, to me at least, in providing opportunity as it 
relates to risk in the markets.
    I think this committee has a lot of work to do, and I look 
forward to working with Mr. Bachus and Mrs. Maloney and others 
on this matter.
    I am informed that we have a series of votes. Do we know 
how many? I am told two, two votes; and I make this 
announcement for the benefit of our next panel. We would 
conclude this panel of witnesses, express our appreciation for 
your courtesy and long participation this morning. It is an 
important matter to the committee. We do look forward to having 
further informational exchanges and follow-up with our written 
questions and look forward to working with the gentlemen.
    Mr. Bachus. Could I?
    Chairman Baker. Sure.
    Mr. Bachus. One thing that we would like you to do, we have 
identified the routine management provision within the Act that 
is problematic. Would you work with us to identify other areas 
in which you might inadvertently work against us?
    Mr. Meyer. I think perhaps we would like to communicate 
with you a little further to clarify the routine management 
aspects.
    Mr. Bachus. Not only that, if there are other provisions 
that you are mandating, some of these regulations, we would 
like to sort of identify it. Because it is sort of my 
understanding that it did not mandate any of these regulations.
    Mr. Meyer. We are looking forward to working with you.
    Chairman Baker. We have a follow-up question.
    Mrs. Maloney. The Chairman raised an important point, and I 
would like to hear from both of you. What is the explanation 
that you can have 40 percent in a foreign company but only 24 
percent here? What is the explanation?
    Mr. Hawke. We pointed out that anomaly a number of times 
during the Gramm-Leach-Bliley.
    Chairman Baker. I think you and I have been doing this for 
a decade.
    Mrs. Maloney. I would like to hear why.
    Mr. Hawke. I would rather not try to justify that.
    Mrs. Maloney. Can you, Mr. Meyer, justify it?
    Mr. Meyer. The only thing I can say is today you can have a 
100 percent ownership in a U.S. firm under the new merchant 
banking authority, but I really can't comment on the previous 
rules. I don't know why they exist as they do.
    Chairman Baker. It is an area where we really do need to do 
some work. We tried unsuccessfully in Gramm-Leach-Bliley to 
address that concern. You can only have up to a 5 percent 
voting interest with a 24.9 percent equity position. To me, it 
seems, along the lines of Mr. Bachus' questioning, if you have 
your financial resources at risk or worse, where you have a 
fiduciary responsibility to the Louisiana Teachers Fund and you 
see something going on, you ought to be able to exercise your 
discretion to improve the operation, safety and soundness of 
that enterprise for the benefit of teachers, much less the 
shareholders of the underlying management.
    Mr. Meyer. Mr. Chairman, if you see something going on that 
is a threat to your investment, you can. It doesn't mean you 
can manage the firm on a day-to-day basis.
    Chairman Baker. I understand that. If you can smell the 
smoke and see the fire, you can grab a fire extinguisher. But 
if you see a guy piling rubbish in the corner with matches in 
his pocket, you can't say a word. I think that is the 
distinction that troubles me.
    With that explanation, I would conclude this panel. We will 
reconvene as quickly as possible. Hopefully, no more than 20 
minutes.
    [Recess.]
    Mr. Bachus. [Presiding.] At this time, we will reconvene 
our hearing with our second panel. They are: Mr. Robert J. 
Kabel, Counsel for the Bank Private Equity Coalition, 
representing Manatt, Phelps and Phillips; Mr. John P. Whaley, 
Partner, Norwest Equity Partners and Norwest Venture Partners, 
on behalf of American Bankers Association Securities 
Association; and Mr. Peter D. Grauer, Managing Director, 
Leveraged Corporate Private Equity Group, representing Credit 
Suisse First Boston Equity, on behalf of the Securities 
Industry Association and the Financial Services Roundtable.
    We welcome you gentlemen to the hearing. Did you all have 
an opportunity to hear the first panel? All right. All of you 
did.
    At this time we will start, and we will go from my left to 
right with opening statements.

   STATEMENT OF ROBERT J. KABEL, PARTNER, MANATT, PHELPS AND 
 PHILLIPS, LLP; ON BEHALF OF THE BANK PRIVATE EQUITY COALITION

    Mr. Kabel. Thank you, Chairmen Baker and Bachus, Members of 
the subcommittee.
    I am Robert Kabel and, just to correct the record, I am a 
partner at the law firm at Manatt, Phelps and Phillips, but I 
have been outside counsel to the Bank Private Equity Coalition 
for some years.
    On behalf of BPEC, I want to thank you for your continuing 
interest in the regulatory implementation of the merchant 
banking authority enacted as part of the Gramm-Leach-Bliley 
Act. BPEC appreciates your convening of this important hearing 
and the opportunity to present our views on the implementation 
of the merchant banking provisions of GLBA.
    BPEC was formed in early 1995 by the direct investment 
subsidiaries of several large commercial bank holding companies 
to address various statutory and regulatory issues that 
prevented them from competing effectively with non-bank direct 
investment firms.
    Prior to the enactment of GLBA, BPEC members had been 
involved for many years in direct investment activities. These 
direct investment subsidiaries have many years of direct 
investment experience and excellent earning track records.
    BPEC worked in the 104th Congress with then House Banking 
Committee Chairman Jim Leach on the merchant banking language 
included in the first financial modernization bill he 
introduced early in 1995. Identical merchant banking language 
was included in every subsequent version of financial 
modernization legislation, including the legislation that was 
signed into law in November of 1999. The purpose of the 
merchant banking provision was to expand the existing direct 
investment authority of commercial bank holding company 
subsidiaries so they could compete more effectively with 
securities firms and insurance companies who were not subject 
to Glass-Steagall and Bank Holding Company Act restrictions.
    Prior to the enactment of GLBA, the SBA regulated SBICs, 
and the Federal Reserve regulated all other direct investments 
made through bank holding companies. The regulation of merchant 
banking activities was burdensome and often unpredictable. The 
Federal Reserve examinations varied widely in regard to several 
critical issues. Therefore, BPEC and others in the industry 
advocated the enactment of the merchant banking provisions in 
GLBA as a means by which to streamline the regulation of 
merchant baking activities as well as provide for greater 
competitive equality.
    Since enactment of GLBA, BPEC has worked with the Federal 
financial regulators on implementation issues through a series 
of meetings and comment letters.
    Chairman Baker, we appreciate the attention you and the 
Capital Markets Subcommittee have given to this important issue 
since enactment and look forward to working with both 
subcommittees in the future. BPEC strongly believes that the 
appropriate regulatory implementation of the GLBA merchant 
banking provisions in accordance with congressional intent will 
determine whether with this new statute leads to the 
modernization of our financial industry as Congress had 
intended. Nothing less than that is at stake here. If GLBA is 
not properly implemented, the two-way street concept that 
Congress worked toward for so many years will fail to be 
achieved.
    In view of the intense scrutiny given merchant banking 
issues during the development of GLBA, BPEC was surprised and 
disappointed when the Federal Reserve Board and Treasury issued 
their interim merchant banking regulations on March 17 of last 
year and the Board issued its proposed capital rules.
    The interim rule established an extensive set of complex 
rules for merchant banking which BPEC members, and many other 
members of the financial community, thought to be exceedingly 
restrictive. We are pleased the regulators took into account 
many of the extensive comments submitted regarding the interim 
rule and modified several of its provisions so that the final 
rule provides some greater flexibility and certainty of its 
provisions.
    We remain concerned, however, that the final rule imposes a 
series of restrictions on the financial holding company 
merchant banking operations that our non-FHC merchant banking 
competitors are not required to follow. In particular, BPEC 
remains troubled by the cross-marketing restrictions included 
in the final rule. The GLBA explicitly provides insurance 
companies involved in merchant banking with authority to cross-
market products and services. This apparent disparity is unfair 
and unwarranted and should be changed. If regulatory relief is 
not forthcoming, BPEC recommends amending GLBA to permit 
financial institutions to cross-market products and services.
    BPEC, like almost everyone in the financial services 
industry, also was disappointed by the Federal Reserve's 
original proposed capital rule for merchant banking activities. 
During the several year debate which led to the enactment of 
GLBA, none of the regulators ever publicly suggested that there 
should be the prospect of special capital rules for merchant 
banking activities. Congress rightly did not impose an 
excessive capital requirement because it recognized that 
existing merchant banking firms had a long history of making 
prudent investments and therefore did not require a separate 
capital rule.
    BPEC is pleased that the Federal Reserve carefully reviewed 
the substantial industry comments submitted in regards to the 
proposed capital rule and made significant changes in the 
revised proposal now out for comment. Comments made by this 
committee and others in Congress were very constructive, and we 
appreciate the committee's leadership on this issue.
    While BPEC appreciates the fact that the Federal Reserve 
carefully reviewed and responded to many of the comments 
submitted on the original proposed rule, we continue to object 
to singling out any individual class for discriminatory 
treatment. BPEC believes that the Federal Reserve should 
utilize the internal capital allocation models of those 
financial holding companies with merchant banking operations. 
The Federal Reserve should review those models during the 
normal examination process and impose specific capital 
requirements only if the internal models are deemed inadequate 
to protect against the inherent risk in the institution's 
merchant banking portfolio.
    Again, I want to thank you for this opportunity to present 
the views of the Bank Private Equity Coalition on the final 
merchant banking regulations and the revised proposed merchant 
banking capital rule; and I would be happy to answer any 
questions.
    Mr. Bachus. Thank you.
    Mr. Kabel, before you stop, we are going to correct the 
record to show that you are actually testifying--you are a 
partner in Manatt, Phelps, but you are testifying on behalf of 
the Bank Private Equity Coalition.
    Mr. Kabel. That is correct, Mr. Chairman.
    Mr. Bachus. Also, Mr. Grauer.
    Mr. Grauer. Yes, sir.
    Mr. Bachus. You are also testifying on behalf of Financial 
Services Roundtable as well as the Securities Industry 
Association.
    Mr. Grauer. Correct.
    Mr. Bachus. Thank you.
    [The prepared statement of Robert J. Kabel can be found on 
page 115 in the appendix.]

 STATEMENT OF JOHN P. WHALEY, PARTNER, NORWEST EQUITY PARTNERS 
  AND NORWEST VENTURE PARTNERS, ON BEHALF OF AMERICAN BANKERS 
               ASSOCIATION SECURITIES ASSOCIATION

    Mr. Whaley. Messrs. Chairmen, my name is John Whaley. I am 
a partner of Norwest Equity Partners and Norwest Venture 
Partners.
    I am here today on behalf of the ABA Securities 
Association, or ABASA, and the American Bankers Association. 
Many of ABASA's members regard the merchant banking authority 
as the most important feature of the Gramm-Leach-Bliley Act. We 
want to ensure that we may exercise that authority to the 
fullest extent allowed under the law.
    ABASA strongly opposed the original capital proposal as 
well as the interim rule. Subsequently, both of these were 
revised, and we are pleased that the regulators chose to 
address many of our concerns.
    Today, I will highlight three issues: the proposed special 
capital charge on equity investments, the rules on private 
equity funds and legislative relief from certain cross-
marketing limits.
    Regarding capital charges, bank regulators have proposed a 
three-tier system for assessing capital against equity 
investments made by financial and bank holding companies. 
Specifically, the proposed rule would assess an 8, 12 or 25 
percent capital charge deduction on an organization's Tier 1 
capital as the level of equity investments increase. This 
graduated capital charge is a significant improvement over the 
one-size-fits-all 50 percent capital charge originally 
proposed.
    We remain concerned, however, that any special capital 
charge will exacerbate the inequity between financial holding 
companies, or FHCs, and non-FHCs engaged in merchant banking 
activities, thereby undermining congressional intent that all 
investment banking firms engaged in these activities operate on 
a level playing field.
    The special capital charge, even as reduced under the new 
proposal, would preclude FHCs from engaging in merchant banking 
activities on the same terms and conditions as their non-bank-
affiliated competitors. It also might discourage the securities 
and insurance firms from becoming FHCs because the price may be 
too steep.
    For these reasons, we earlier advocated and continue to 
maintain that a supervisory approach would be the optimum way 
to address this issue. Further, the capital charge would apply 
not only to newly authorized merchant banking equity 
investments but also to the four pre-Gramm-Leach-Bliley types 
of investments which are listed in my written statement.
    Of these four types of investments, only SBICs are given 
special treatment under the proposal. No special capital charge 
is applied to any SBIC investment unless the total amount of 
such investments exceeds 15 percent, and then only the excess 
amount above 15 percent is subject to the capital charge.
    ABASA opposes any special capital charge on equity 
investments authorized prior to Gramm-Leach-Bliley. The banking 
industry has a long history of engaging in such activities, and 
there is simply no evidence that additional capital is 
warranted. At the very least, all investments through SBICs 
should be excluded from the special capital charge.
    If the regulators do not exclude all pre-Gramm-Leach-Bliley 
authorities or at least SBICs from the special capital charge, 
at the very least all equity investment made prior to March 13 
of 2000 should be grandfathered. Without such grandfathering, 
many investments made before March 13 will become uneconomic, 
not because of any change in inherent worth but solely because 
of a change of regulatory treatment.
    With respect to private equity funds, merchant banking 
equity investments may be made through pooled funds or directly 
in portfolio companies. The interim rule properly recognized 
that investments made through a private equity fund in which an 
FHC, by definition, may only be a minority investor should have 
fewer restrictions than investments made directly in portfolio 
companies. Nevertheless, the interim rule needlessly imposed 
many of the same restrictions on portfolio investments made 
through private equity funds that it imposed on direct 
portfolio investments. That is, the rule's restrictions applied 
to the FHC's investment in the private equity fund itself and 
then looked through the equity fund and applied it to the 
portfolio investment made by the fund as well.
    ABASA strongly objected to these look-through provisions. 
The restrictions deterred FHCs from investing private equity 
funds and created a significant disincentive to include FHC 
investors in many private equity funds. We are pleased that the 
final rules on private equity funds have been simplified and 
clarified to address many of ABASAs concerns.
    Regarding the need for relief from cross-marketing limits, 
under the cross-marketing limitation a bank cannot market any 
product or service of a portfolio company in which its FHC has 
made a merchant banking investment; and the portfolio company 
in which the FHC has invested may not market the banks products 
and services. A limited exception is provided, however, for 
banks that are affiliated with insurance companies. That kind 
of bank can market its product through internet websites and 
statement stuffers to a portfolio company in which the 
insurance company has made a merchant banking investment. 
Products and services offered by the portfolio company in which 
the insurance company has invested also may be marketed through 
internet websites and statement stuffers via the insurance 
company's affiliated bank.
    Nearly all of ABASAs members are FHCs that may make 
merchant banking investments because of their affiliation with 
securities firms. Very few own insurance companies. As a 
result, our FHC members cannot take advantage of the website 
statement stuffer exception. There is simply no rationale or 
public policy reason for this competitive inequity.
    The ability to cross-market through internet websites and 
statement stuffers is an important tool. As Representative 
Kelly stated and Governor Meyer confirmed and was mentioned by 
Chairman Baker, there is not a great deal of symmetry in how 
Gramm-Leach-Bliley is applied. Therefore, we urge the 
subcommittees to fix this inequity by expanding the website 
statement stuffer exception to all FHCs engaged in merchant 
banking activities.
    Thank you, and I will be happy to respond to any questions 
you have.
    [The prepared statement of John P. Whaley can be found on 
page 120 in the appendix.]
    Mr. Bachus. Mr. Grauer.

       STATEMENT OF PETER A. GRAUER, MANAGING DIRECTOR, 
 LEVERAGED CORPORATE PRIVATE EQUITY GROUP, ON BEHALF OF CREDIT 
  SUISSE FIRST BOSTON PRIVATE EQUITY, THE SECURITIES INDUSTRY 
       ASSOCIATION AND THE FINANCIAL SERVICES ROUNDTABLE

    Mr. Grauer. Thank you, sir.
    I am Peter Grauer, Managing Director and Senior Partner of 
Credit Suisse First Boston's private equity business, which is 
the largest manager of private equity assets in the world. 
Credit Suisse First Boston as a financial holding company 
commends the Federal Reserve and Treasury for the significant 
improvements that the joint rules reflect from the original 
interim rules put out in March of 2000. We appreciate the 
Federal Reserve and Treasury's willingness to be open-minded 
and work with the industry to improve these rules. In the same 
spirit, we look forward to further refining the rules as the 
agencies gain greater expertise in private equity activities.
    While we recognize how far the agencies have come, we still 
believe that the joint rules present an unnecessarily 
burdensome array of restrictions that are neither mandated by 
safety and soundness concerns, nor in keeping with the language 
or spirit of Gramm-Leach-Bliley. In fact, the changes in our 
view do not correlate with the way successfully run merchant 
banking business have conducted their activities over the last 
15 years. Indeed, we believe that more than any factor the 
merchant banking restrictions have impeded non-bank financial 
firms from becoming financial holding companies.
    In our view, the unwillingness of these firms to elect 
financial holding company status serves to underscore both the 
continuing difficulties that the joint rules raise and that 
financial holding companies are operating at a significant 
disadvantage in the marketplace.
    It is important to start from this premise, entirely borne 
out of our experience in the business, that active merchant 
banking, properly managed, poses no greater risk to financial 
holding companies than any other activities that regulated 
financial institutions are permitted to engage in without 
restrictions.
    Today I would like to highlight three specific problem 
areas under the rule. The first I will address are the 
restrictions on routine management or operation of a portfolio 
company for minority investors. Second, I would like to 
underscore what my colleagues have stated with regard to the 
aggregate limit on merchant banking investments causes 
operational difficulties. And, thirdly, restrictions on a 
maximum holding period for merchant banking investments are not 
customary in the private equity market and will increase the 
risk of those investments without any countervailing benefit.
    In my view, these restrictions significantly diminish an 
important business opportunity for financial holding companies 
and undercut the intent of Congress under Gramm-Leach-Bliley 
without adding in any material way to the regulatory goals 
referred to in the joint rules.
    First, in general, the joint rules' restrictions on routine 
management or operation of a portfolio company appear to 
presume that an investment can be protected from bad or 
improper management through control of a portfolio company's 
board of directors. However, where an investor is a minority 
investor and therefore does not have the ability to control the 
portfolio company's board, the need for additional contractual 
and operational protections become significantly greater than 
in the majority-investment context.
    The joint rules' prohibition on the use of many traditional 
covenants that dictate prudent business practices or controls 
increase the risk associated with a minority investment and 
cause minority investors to lose an important tool to protect 
value.
    Based on our experience at Credit Suisse First Boston 
Private Equity, I would strongly recommend that the Federal 
Reserve and Treasury revise the joint rules to permit financial 
holding companies making minority investments to retain the 
right to use a wide range of restrictive covenants. These 
covenants are intended to ensure prudent management and 
operating practices.
    While we recognize that the joint rules do provide limited 
examples of covenants that, if granted to a financial holding 
company, would not be considered to be routine management or 
operation, the regulatory list is limited and incomplete.
    I believe that the current restrictions on routine 
management or operation of a portfolio company are unnecessary 
and could result in a significant handicap to our business. 
Accordingly, I believe that a far broader range of events and 
business developments should expressly be subject to a private 
equity investor's approval without such approval being deemed 
improper participation in routine management or operations.
    Examples should expressly include: all matters affecting 
the financing of a portfolio company; matters affecting the 
regulatory tax or liability status of a portfolio company; 
approval of capital expenditures and major expense items; 
policies regarding the hiring, firing, or setting or changing 
the compensation of non-executive employees; any transactions 
with affiliates or related persons; negative covenants relating 
to any material operations; and the creation of any subsidiary, 
partnership or joint venture to conduct any part of a portfolio 
company's business.
    These rights are typical of those that private equity funds 
routinely seek in connection with a minority equity investment 
in a portfolio company. Indeed, most of them are little 
different from a covenant that a lender would require. While 
the joint rules have left the door open that these items may be 
acceptable on some type of case-by-case basis, the facts are 
that market circumstances will not wait for regulators to make 
these determinations; and if we are unable to negotiate for 
these types of controls on behalf of our managed funds this 
will undercut our ability to participate most effectively in 
private equity market.
    Another aspect of the way in which the joint rules address 
routine operations or management that we find particularly 
troubling is the prohibition on any officer or employee 
interlock between a financial holding company and a portfolio 
company at the executive officer level. From time to time, it 
has been important for us to provide our direct expertise to a 
portfolio company in a variety of different contexts. Certain 
situations can require full-time senior assistance in building 
or restructuring a management team. Investors count on our 
ability to provide this assistance when choosing to invest in 
our funds. There is no reason in my judgment why flexibility 
should not be brought to bear in respect to appropriate senior 
officer interlocks, and such flexibility would be entirely 
consistent with the way in which non-financial holding company 
merchant banking and private equity operations are currently 
conducted.
    The second area I would like mention briefly is the 
aggregate percent of capital-based investments and related 
capital charges imposed on merchant banking investments. In 
light of the fact that my colleagues next to me have addressed 
this item in substantially more detail than I did, I would like 
to join in their remarks on these important issues.
    My third point, holding periods for private equity 
investments should be eliminated. The recent amendments to the 
joint rules should reduce, but will not eliminate, the fire-
sale mentality by creating these limits. A simple look at the 
market circumstances over the past several weeks demonstrates 
why forced sales and formally limited holding periods could be 
problematic from an investment as well as a safety and 
soundness viewpoint.
    Private equity is the ultimate buy-and-hold experience, and 
the profitability of merchant banking activities come from the 
ability to develop companies over a substantial time period, 
waiting for the appropriate market windows for exit and 
liquidity purposes. It seems particularly inappropriate to 
require prior Federal Reserve staff review of every proposed 
merchant banking investment holding which exceeds the 
regulatory maximum and to impose a capital charge for longer 
term investments. Requiring such a process will only provide an 
unfair degree of leverage to portfolio companies in dealing 
with their merchant banking investors if such companies know 
that an investor could be forced to dispose of its interest or 
suffer adverse regulatory consequences.
    It also dramatically changes the negotiating between the 
financial holding company seller and the potential buyer who 
would be smart enough to know the consequences to the seller if 
it fails to compete the sale. We submit that any abuses 
associated with holding investments beyond some regulatory 
benchmark be addressed through the normal supervisory and 
examination process.
    In closing, I very much appreciate the opportunity to raise 
these points with you. As a senior officer of an entity that 
until recently functioned outside the Gramm-Leach-Bliley 
framework, I can appreciate perhaps more than most the 
significant and potentially harmful impact of the imposition of 
rules and limitations which, for all of their good and well-
appreciated intention, simply do not translate well to the 
actual operations of the merchant banking bills.
    While we greatly appreciate the efforts of the Federal 
Reserve and Treasury staff to improve the joint rules, we still 
believe that, even in their current form, they give significant 
advantages to other non-financial holding company competitors. 
We do not believe that this was your intention, and we look 
forward to further dialogue to remedy this situation.
    Mr. Chairman, thank you.
    [The prepared statement of Peter A. Grauer can be found on 
page 137 in the appendix.]
    Mr. Bachus. I thank the panel.
    Mr. Kabel, one problem on the cross-marketing we have is 
the Gramm-Leach-Bliley Act does prohibit some of the cross-
marketing, but in that I think we have created an inequity, and 
I think Mr. Baker and I plan to offer an amendment or some 
legislative proposal to amend Gramm-Leach-Bliley to allow the 
same cross-marketing abilities to be extended to products or 
services of portfolio companies held under merchant banking 
authorities. We are going to address that.
    Mr. Kabel. Well, thank you, Mr. Chairman. We certainly 
support that and would like to work with you on that and 
promoting it.
    Mr. Bachus. Thank you. We are not sure whether that will 
fix the problem, but it should, and they say it is a 
prohibition in the bill. Also, you heard what Mrs. Kelly, you 
noted that she had questioned Governor Meyer about that.
    Mr. Kabel. Actually, the Bank Private Equity Coalition 
would actually encourage a look again at the statute. I know 
that it has been stated rather explicitly that there is no 
discretion, but frankly it would be better if the regulators 
would look at it again and perhaps review that, and we would 
ask--we are going to encourage them to do that.
    Amending a statute is difficult, and I think people 
certainly on the panel understand that better than anyone else, 
but we would hope they would do that. And it has created some 
difficulty. I think these gentlemen could address that better, 
but there are certain relationships that they would like to 
have with online companies and so forth which they can only 
have if they are an investor, and the cross-marketing 
restrictions has prevented them from having those 
relationships.
    Mr. Bachus. Thank you. I think these are the usual kinks 
that you have with a new act, so I think we will hopefully work 
through that.
    Mr. Grauer, I understand your analysis insofar as it 
applies to large merchant banking operations such as CS First 
Boston, but should--or maybe I will ask it, shouldn't we be 
concerned that loosening up the joint rules in the manner you 
suggest would be inappropriate for comparatively small 
financial holding companies of which, by my count, there are 
more than 400, including 12 in Alabama?
    Mr. Grauer. To the contrary, Mr. Chairman. I think that our 
suggestions are even more relevant as it relates to the smaller 
financial holding company operations in their merchant banking 
operations, that they should be given the same latitude as the 
larger funds have to be able to conduct their activities 
regardless of whether they are operating out of a major money 
center or anywhere else in the country. We think that is both 
sound investment judgment and also basically good for the 
economy.
    Mr. Bachus. In fact, the view that I posed is sort of 
prejudicial toward your smaller companies. Many of them do have 
that expertise. I do agree with your answer.
    I guess the last thing I will say, I have got a minute, Mr. 
Whaley, one of the things that we have asked the Fed and 
Treasury to respond to is why aren't all merchant banking 
investments grandfathered so that financial holding companies 
and bank holding companies do not have to reconfigure their 
internal capital allocations for existing activities. We think 
that is appropriate, so we are responding to that.
    Mr. Whaley. Well, I appreciate that that would be very 
beneficial to everyone. I mean, it is kind of an issue of 
fairness in equity, but to have a capital charge after the fact 
is like a retroactive tax increase, and so I think that it 
would just be a fairer way to implement the regulation to 
grandfather existing investments.
    Mr. Bachus. And it could cause profitable investments to 
become unprofitable. So I would agree with you. I would be 
interested in their response to that request.
    At this time, I would recognize the gentlelady from New 
York.
    Mrs. Maloney. Thank you, Mr. Chairman.
    I understand you were not pleased with the original rules 
that came out as they affected SBICs in the revised standard. 
What are your comments on it? Are there any remaining concerns 
affecting SBIC merchant banking investments of which Congress 
should be aware, and your comments on their current rules on 
SBICs.
    Mr. Whaley. The new rules do go a long way with respect to 
SBICs. They still assess a capital charge to the extent there 
is more than 15 percent of capital base. In a SBIC, there isn't 
an incremental charge, and SBICs are also counted in the 
aggregate total as to whether--as to which level of capital 
charge is appropriate. So they have improved it quite a bit, 
but there still is some implicit additional capital charge with 
larger SBICs.
    Mrs. Maloney. I asked the first group this question, but I 
would like to hear from the industry what you think about the 
proposed merchant banking capital rule and how it compares with 
the new proposed Basel capital standards. Do you have any 
comment on that?
    Mr. Kabel. Mrs. Maloney, if I could comment by way of 
background, I think all of our institutions have taken the 
position that we don't feel there is a need for special capital 
rules period for merchant banking, that existing capital rules 
standards for the bank holding companies were sufficient to 
take into consideration the risk. Because we simply do not 
agree with the proposition that merchant banking investments 
are riskier. We just simply do not agree with that.
    Frankly, I am not an expert of capital of any kind, much 
less the new Basel, but our position has been, BPEC's position, 
and it will be again in our comment letter to the Federal 
Reserve Board on the revised proposed rules, that they should 
simply utilize internal capital models to the maximum extent 
possible, which I think most people would agree are very well 
done. The purpose of these capital models is to reflect the 
actual risk inherent within the merchant banking portfolio. And 
then if through the examination process those models are viewed 
to be inadequate then impose specific capital with the inherent 
regulatory authority.
    Mrs. Maloney. OK. Thank you very much.
    Mr. Whaley. We would share that view, by the way.
    Mrs. Maloney. Thank you.
    Mr. Bachus. Mr. Baker.
    Chairman Baker. Thank you, Chairman Bachus.
    I would like to suggest, Mr. Chairman, that we consider on 
the principal elements that have been mentioned here today that 
perhaps you and I and other interested Members, perhaps Mrs. 
Maloney, consider, although the final rule has been 
promulgated, a letter of comment concerning some of the obvious 
deficiencies in the current reg, which would include the 
routine management definitions, comment on the aggregate 
limits, certainly including the holding period.
    I have before me what the Gramm-Leach-Bliley provisions are 
with regard to holding period. It is, quote, to enable the 
deposition thereof on a reasonable basis consistent with 
financial viability. Now to take that and to translate it into 
a specific term, as we were repeatedly told earlier that the 
Congress legislated with regard to these matters, seems to be a 
bit at contravention with what the language says.
    There are a couple of other additional elements I would 
like to throw on the pile, one of which, with regard to a 
holding company forming a private equity fund, and you start 
out with the plan to have only a 20 percent stake and, because 
of the way the fund is structured, the holding company winds up 
with a 25 percent stake, that fund then no longer qualifies as 
a private equity fund. Then you have got to go back to your 
investors and tell them they are no longer part of a qualifying 
fund, and you are now subject to these restrictions.
    It is just sort of common-sense business formation issues 
that have no consequence with regard to safety and soundness or 
risk to the markets.
    Second, the area where I have the most difficulty on all of 
this is things that were previously permissible which now 
appear to be in contravention of the new rule, under Section 
4(c)(6) of the Bank Holding Company Act, bank affiliated firms 
have made investments under that provision without any risk to 
safety and soundness historically, that now the agencies have 
determined or the Fed has determined to apply the new capital 
charge to those investments which previously had no capital 
charge against them.
    So we have--in my view of the world, we have gone backward, 
Mr. Chairman, instead of forward in promulgating rules which 
enable cooperative ventures to benefit the economy and 
investors. We are now taking a business practice previously 
authorized that has not presented market risk to my knowledge 
and saying you will now be subject to the new capital charge 
which did not previously exist.
    I would suggest, Mr. Chairman, that certainly all other 
matters which you deem appropriate to include in such a letter, 
that we will try to get Members of both subcommittees to join 
together in this, I think there are bipartisan concerns that 
the consequences of this action will deter what this Congress 
tried to do over longer than a decade to modernize our 
financial regulatory system.
    Mr. Grauer, particularly with regard to your firm's 
responsibility with the Louisiana State Teachers Pension Fund--
you caught my attention when the word Louisiana got thrown in--
where you have historically managed minority interest 
investments for the benefit of that fund, am I understanding 
that the total assets available to your organization is equal 
to or exceeds $5 million?
    Historically, you have been able to enter into restrictive 
covenants that had certain restrictions which would enable you 
to take appropriate actions--``appropriate'' being defined as 
whatever you think it is in order to protect the interest of 
the individual investing teacher. Am I understanding the rule 
modification properly, that you would either have that ability 
now significantly limited or eliminated in making such 
covenants or agreement with minority investments of the sort 
you have engaged in?
    Mr. Grauer. We believe the rules have been significantly 
limited.
    Chairman Baker. Would there be cause of concern for the 
Teachers Fund to rethink their investment strategy, or what is 
the outcome of this?
    Mr. Grauer. Each investor, and particularly the Teachers 
Fund, goes through an extensive due diligence process before 
they ever commit equity to any capital funds. One of the 
aspects of that due diligence is to go through and evaluate our 
track record, both with successful investments and less 
successful investments; and I think they have satisfied 
themselves that, as is a professional manager such as ourselves 
and others, we are not alone in this world by having the 
ability to move quickly and exercise discretion over these 
investments. It has gone a long way not only to protecting 
their investments but maximizing their returns.
    I think in the absence of that flexibility we would be 
looked upon by them much less favorably than perhaps someone 
who is not subjected to the financial holding company 
limitation under Gramm-Leach-Bliley.
    Chairman Baker. So you probably feel some obligation 
henceforward to advise your customer--your client that we have 
had these changes in law which do not enable us to take certain 
actions. Consequently, we want you to be aware of this. As a 
result of our due diligence process that here--now are the 
rules under which we operate, and it could potentially steer 
the teachers investment guidance in a different direction.
    And, for the record, I am not promoting anyone's private 
profitability at the expense of the teachers. What I am 
concerned about is getting the best return for the teachers 
with the best possible return available.
    I don't know if you'll say it, but my summation is the rule 
unintentionally precludes them from getting the best 
professional management advice for the return for the teachers.
    Mr. Grauer. We would agree with that.
    Chairman Baker. Thank you. Thank you very much.
    Mr. Chairman, I yield back my time.
    Mr. Bachus. Thank you.
    Chairman Baker. I had one other question. There was 
testimony provided by the SIA which I don't think has been made 
part of record, Mr. Chairman. It is here. I would like to ask 
that be made part of the record.
    Mr. Bachus. Without objection, that testimony or letter 
will be included in the record.
    Chairman Baker. Thank you, Mr. Chairman.
    [The information can be found on page 153 in the appendix.]
    Mr. Bachus. Mr. Grauer, the holding period also concerns 
Chairman Baker and me. You mentioned the necessity of a forced 
sale or having to unload the investment when equity markets are 
depressed. I would ask the other two gentlemen, can you see any 
justification for having a holding period, other than just the 
broad language of the Act which basically says as long as it is 
justified?
    Mr. Whaley. I cannot see a reason for having an absolute 
time limit to hold an investment. It is true that most 
investments are made and then liquidated within a 10-year 
period, but there are many circumstances where it makes sense 
to continue to hold them. Sometimes it is market circumstances 
that require you to hold them, and sometimes it is in the very 
best interest of the company that we have invested in for us--
it is very disruptive if we go to the company and say, you know 
what, we have all got to sell our positions because of this 
regulation. And it is a problem.
    Mr. Bachus. I can see where Uncle Sam would want it so, 
particularly if it has been successful and it would generate 
tax revenues. Other than that, I can't imagine.
    Mr. Kabel. Mr. Chairman, I think that is an excellent 
example of using this issue of time period. It is really an 
issue that should be dealt with through the examination 
process, as opposed to providing regulatory time periods, 
whereby, if you bump up against the 10-year period, then you 
are required to divest. Why not have the regulators look at 
these investments and ask why an institution is holding an 
investment for a certain period of time.
    There are some investments where there is no market for 
them. I am not sure what we should do with these investments 
when the subsidiary bumps up against the 10-year period. There 
may be absolutely no market for these investments. Often, they 
have already been written down to zero, and that is part of the 
process. The advantage of portfolio investing is that the 
institution invest in a lot of companies and a lot of different 
industries, and that is why the direct investment subsidiaries, 
on balance, have been extremely successful.
    You can say on an individual basis that an individual 
investment may be risky, but it is important to remember that 
these are banks who are doing the investing. These subsidiaries 
have to report to the bank holding companies, and they are 
prudently managed. I am not suggesting that the direct 
investment folks outside of banks are not prudently managed, 
because they are. It is a very successful business. These are 
people who really understand what they are investing in, and 
they understand how to add value to the companies in which they 
are investing.
    Chairman Baker. Mr. Chairman, can I jump in on that point?
    Mr. Bachus. Yes.
    Chairman Baker. I just want to make sure I understand the 
operative conditions under which the 10-year disposition rule 
works.
    Let's assume you have a holding you have had for 9 years 
and 4 months. You know the rule requires to dispose. So you go 
into the market. The other guy figures this out. Maybe he is 
not quite so anxious to close. Maybe the terms change. 
Something happens. It is not to your best financial interest.
    You then procedurally could go to the Fed and apply for an 
extension, but even if the extension were granted you would 
then have to have a 25 percent capital charge against the 
holding until you disposed of the asset. So that then drives 
down your margin or you have got to increase your price in 
order to dispose of the asset on the terms in which you 
originally contemplated. Are those facts close?
    Mr. Kabel. It is my understanding that is correct.
    Mr. Whaley. That is correct.
    Mr. Kabel. That is exactly what happens.
    Chairman Baker. So at the end of the day you have an 
arbitrary window. If it is a profitable center, you probably do 
not want to get rid of it. But yet if you are going to the 
market any time near the duration is coming to an end--if I was 
on the other side I would certainly like to have you in that 
position, knowing that if you didn't take my deal on the terms 
I suggested you will take the capital hit and then we will talk 
then. I love that.
    Mr. Grauer. Mr. Chairman, just as a point of clarification 
I think that capital charge could be as high as 100 percent.
    Chairman Baker. I am told it was at 100, but it was reduced 
in the modification. It could go down to as low as 25. 
Apparently, this is another one of those David Copperfield 
things. We don't know where it is.
    Mr. Bachus. Thank you.
    I will ask a general question of the panel, and it may give 
you an opportunity to expound on some of the comments of the 
first panel, too.
    I think underlying all this is the continuing debate on how 
safe are your activities and do they threaten the safety and 
soundness of your institution. Given the current economic 
conditions, how do you respond to the regulators' concern that 
merchant banking activities, if not subjected to close 
regulatory scrutiny and stringent capital requirements, could 
jeopardize the safety and soundness of those institutions that 
conduct such operations? How have merchant banking investments 
generally fared in comparison with other types of banking 
activities during tough economic times?
    We will just go from right to left.
    Mr. Grauer. I will make a stab, and my colleagues will 
elbow me if I am talking too long or perhaps getting off the 
point.
    One of the things that we do, and I think all of us in the 
private equity business do, is when we--prior to making an 
investment we do an extensive amount of research on how we 
think the portfolio company will behave in different economic 
environments. And as we see those environments develop, either 
we are in them or we expect that they will occur, we try to 
capitalize our companies so they can weather the storm that 
occurs as a result of their business suffering through an 
economic downturn.
    So invariably there are some companies in all of our 
portfolios that don't do as well as others, but, by and large, 
most of them have been capitalized, particularly if those are 
businesses that are subject to economic cycles such that they 
will be able to come through those cycles with solid cash flow, 
the ability to service their debt, meet their payroll and 
fulfill all the various obligations to their constituents.
    So, number one, we try to plan for that ahead of time as we 
do the evaluation for each new investment that we look at. 
Number two, we also, once we are in an investment, try and take 
considerable care as we go through each annual operating plan 
cycle to look at the more macro-economic events that are in 
front of us and again try to batten down the hatches to the 
extent we need to by downsizing the expense base to the extent 
we have to, shutting down our capital expenditure programs to 
preserve cash and do various other things to ensure that we can 
get through the economic cycle.
    So those of us who have been in the business for a long 
time, such as firms as my own, we have been doing this for over 
16 years, we have been through a number of economic cycles, and 
I think we have prepared our portfolio to go through those 
economic cycles successfully. I think that is one of the 
factors that is not brought to bear in the kind of broader 
analysis that occurs in preparing legislation like Gramm-Leach-
Bliley where perhaps the level of professional investment 
expertise that each one of the major merchant banking firms 
have exercised and developed over the years is not necessarily 
taken into account. It is a business that clearly has risks 
associated with it, but certainly as professional managers we 
do our darnedest to be able to take those risk out of the 
equation day-in and day-out.
    Mr. Bachus. Thank you. I would note for the record that we 
have your resume, and it firmly establishes that you have been 
very successful in making these investments and that you 
certainly have the background to testify and to be an expert 
witness.
    Mr. Grauer. Thank you, Mr. Chairman.
    Mr. Whaley. That was very well said, Peter.
    I would just add to that the fact that, at Norwest, we have 
been in the private equity investment business for close to 40 
years now, which includes a number of upcycles and downcycles, 
and you learn to manage through those cycles really doing the 
kind of things that Peter alluded to. How that performs 
relative to other banking assets, I can't really respond 
succinctly to that, other than to say that there was a lot of 
discussion earlier today about risk and how you manage that 
risk. And it isn't the riskiest class of assets that banks 
have. I think risk is only half the equation.
    You have to look at the risk return situation, and I think 
we would be much more interested in managing a portfolio of 25 
equity investments, as opposed to 25 senior loans that are 
fully collateralized. Because you have less risk in the loan 
that is fully collateralized. You don't make a lot of money on 
a loan. You make a net interest margin, whereas in the private 
equity business you have the opportunity to make a number of 
times on your investment; and, on balance, I think that it 
affords the opportunity to make more money and make a more 
meaningful revenue stream for the bank holding company.
    Mr. Kabel. Mr. Chairman, I don't have much to add. These 
gentlemen have been in the business for many years.
    But each member of the Bank Private Equity Coalition is 
similarly situated in that they have all been in the business 
for many, many years. They have well-diversified portfolios, 
and they do understand how to manage risk. That is why they 
have been so successful.
    The regulators often during the course of the lengthy 
process--during the process leading up to Gramm-Leach-Bliley 
and certainly subsequently would say to my members, we are 
really not concerned about you. We are concerned about people 
entering the business.
    I can appreciate that. But, again, I fall back--the Federal 
Reserve examiners are excellent regulators. They understand how 
to look at portfolios. They understand how to talk to the 
executives of the organizations about what they see.
    So, again, I think we fall back on the fact that there was 
a system in place that was working. We promoted the specific 
merchant banking language in the Gramm-Leach-Bliley Act because 
we wanted in the statute a section that talked about classic 
portfolio investing that is exactly what the Gramm-Leach-Bliley 
provisions provide. That is why when we get into the 
definitional issues is where we are clearly running into 
problems. But we wanted that statutory provision because of 
some of the problems we have seen through the examination 
process over a period of years where examiners had different 
views as issues.
    The classic example that was often brought up was, 
depending on where you were situated in the country, you either 
could or could not have a member of a board of directors if you 
were an investor. I think anyone who looks at that objectively 
for safety and soundness would say, of course you want to have 
a member of the board of directors. The board of directors 
members are the ones who learn of the information first to know 
whether there is a problem.
    So that has been taken care of. Clearly, that is one of the 
advantages of having this provision enacted as part of Gramm-
Leach-Bliley. And I think just over a period of time hopefully 
we will be able to work our way through a lot of other issues 
hopefully in dealing with the Congress and hopefully in dealing 
with the regulators.
    Mr. Grauer. Mr. Chairman, if I could add one other thing. 
That is, particularly as it relates to some of the restrictions 
that I talked about under the new legislation on our ability to 
act in both majority and minority investments, in addition to 
the analytical framework that I described that we applied both 
before and as we look at investments, we monitor our portfolio 
companies literally on a monthly basis and in some instances on 
a weekly basis, depending on what they are doing, what kind of 
capital they are spending and what we think the cash flow 
implications of that are.
    We oftentimes will make changes. We will move in very 
quickly to do things. That is largely because we have 
consummated over the last 16 years over $50 billion worth of 
acquisitions. We have put to work over $5 billion worth of 
equity capital, over $7 billion of equity and no capital. We 
have dealt with some 160 investment opportunities over that 
period of time where we have had a portfolio shareholder 
interest.
    As a consequence, the same way you and your colleagues 
structure the legislation and other things that you do day-in 
and day-out both for your constituents and for our country, we 
do the same thing with our portfolio companies. And having 
either one hand or two hands tied behind our back and limiting 
our ability to do that we are not serving our constituents, 
people like the Louisiana teachers and the retirees that exist 
in that system, properly.
    I want to say one other point before we give up our time. 
We in your number of the 29 States that are represented on your 
two subcommittees, we manage a retirement system capital for 10 
of those States. We manage today--of the $22 billion of assets 
that we have under management--roughly 50 percent of that 
capital comes from the public pension fund retirement system, 
either public employees in the case of Utah--excuse me, in the 
case of Louisiana, it is the teacher system. In the case of 
Utah, who we manage over $800 million for, it is the public 
employee retirement system.
    We do the same thing for the States of Arkansas, 
Connecticut, California, Illinois, Massachusetts, Michigan, 
North Carolina, Pennsylvania, just so mention some of the 
representatives who are in your committees.
    We have to have the ability to make decisions and make 
those decisions on an unfettered basis not only to protect your 
constituents but also to generate the kind of rates of return 
that we expect our investors have put their monies with us as a 
fiduciary to accomplish.
    Mr. Bachus. Thank you.
    Chairman Baker.
    Chairman Baker. Mr. Chairman, I have no further comments. 
Thank you for your courtesy.
    Mr. Bachus. Ranking Member Waters had indicated she had no 
questions.
    Ms. Waters. No, I have no questions. I thank you. I did not 
have an opportunity to thank you for making sure that your 
subcommittee joined in to have this combined hearing, and we 
got a lot of information from it. Thank you.
    Mr. Bachus. Thank you.
    Finally I will just conclude, Mr. Kabel, we appreciate your 
comment about whether or not Gramm-Leach-Bliley does, in fact, 
prohibit cross-marketing that we have talked about. I know Mrs. 
Kelly's question presupposed that it did. We will go back and 
take a look at that. She had suggested that a regulation could 
possibly take care of that interpretation, that concern.
    So, with that, if any of you gentlemen want to make a final 
comment, we would invite it. But I think we have a wonderful 
record. I think we will close at this time.
    Mr. Kabel. Thank you very much.
    Mr. Whaley. We appreciate your leadership on this whole 
process. It has been very helpful from our end.
    Mr. Bachus. Chairman Baker particularly has expressed his 
concerns for over a year, which you all have concerns, and has 
alerted me to these concerns. So this won't be the end of the 
story. Thank you.
    Mr. Whaley. Thank you.
    Mr. Bachus. The hearing is adjourned.
    [Whereupon, at 1:20 p.m., the hearing was adjourned.]

                            A P P E N D I X



                             April 4, 2001

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