104th
Congress: Democratic Perspectives 103rd-107th
Congress Committee Activity We strongly support the principal purpose of H.R. 1062--to modernize this nation's financial services regulatory framework in order to improve U.S. financial services providers' competitiveness at home and abroad. The record before this Committee, and before our sister committee, the Committee on Banking and Financial Services, establishes a clear need for responsible changes to that framework.
However, as demonstrated by the testimony of the six panels of witnesses who testified before the joint hearings of this Committee's Subcommittee on Telecommunications and Finance and Subcommittee on Commerce, Trade and Hazardous Materials, there is great concern among those who represent the affected industries, those who speak on behalf of consumers and investors, and those who are called upon to administer and enforce our laws and regulations about the policy choices made by the Banking Committee in crafting H.R. 1062. As noted by SEC Chairman Arthur Levitt at the June 6 hearing, `H.R. 1062 as a whole . . . does not strike an optimal balance between preserving bank safety and soundness, and the needs of investors and the marketplace as a whole.' Representative Christopher Cox observed that the bill was `not sufficiently visionary' and, with specific reference to the bill's new Interagency Banking and Financial Services Advisory Committee, created `excessive, burdensome, and duplicative' layers of new regulation. Representative Markey characterized the bill's regulatory and operational framework as `Byzantine.' We agree.
As evidenced by the opening statement of the chairman of the Committee on Commerce, Representative Thomas J. Bliley, Jr., there are strong bipartisan reasons to oppose H.R. 1062. (That statement appears as an appendix to these views.) Our primary concerns can be summarized as follows:
As introduced, H.R. 1062 (originally H.R. 18) required the most significant and risky securities activities to be carried out in a separately-capitalized, SEC-registered affiliate of the holding company. As reported by the Banking Committee, H.R. 1062 would now permit many of those securities activities to be carried out directly in the bank through separately identifiable departments or divisions (SIDs). We concede that the distinction between activities conducted in a `separately-capitalized affiliate' and those conducted `within a separate department in the bank' sounds technical and obtuse. But the distinction is crucial. The fact is that, if securities activities are conducted in a bank `SID,' all of the bank's capital would be available to support the securities activities conducted in the bank SID. As such, the bank would not be insulated from risk, and the federal safety net, including federal deposit insurance, would be put at risk if those securities activities led to significant losses.
Proponents of H.R. 1062's current structure argue that the securities activities that can be done in the bank in a SID, e.g., mortgage-backed securities and private placements, are low-risk. However, this is not necessarily true. CMOs (collateralized mortgage obligations, a type of mortgage-backed security) are extremely complex, risky, and volatile and have caused huge, multi-million dollar losses to investors. `Private placement' describes the method of offering and selling a security and not the nature of the instrument that is the subject of a private placement transaction: while such a transaction does not carry the market risk of an `underwriting,' the instrument being placed could be a `structured note' (a type of derivative security that has caused devastating losses) or a limited partnership interest such as figured in the billion dollar Prudential debacle. Allowing banks to deal in these instruments thus exposes banks to considerable risks and potential liability. All of this would be avoided if these securities activities were simply moved into a separately-capitalized affiliate of the bank's holding company.
H.R. 1062 also grants the Federal Reserve Board unfettered discretion to modify or tear down the `firewalls' between banks and securities firms. Firewalls protect against risk to insured deposits and prevent conflicts of interest between affiliated companies. The Banking Committee Report's Minority Views calls this power `ill conceived, unwarranted and potentially dangerous.' An amendment to address this problem was offered and withdrawn during Committee consideration.
H.R. 1062 set out to create a level regulatory and competitive playing field by repealing the blanket exemptions for banks from registration and regulation under the federal securities laws. This should have permitted each of the affected industries to play under the same rules under the same expert regulator to achieve consistent protections for investors and markets and economical and efficient examinations and enforcement within the affected industries. However, as finally reported by the Banking Committee H.R. 1062 contained new `mini' exclusions for banks: specifically it provides eleven specific exclusions or exemptions for bank brokerage activities and five new exclusions or exemptions for bank dealer activities. This includes open-ended authority for the Federal Reserve Board to determine that certain `securities' should be `more appropriately treated as banking products' and permitted to remain in a bank SID. The bill's numerous new exemptions would leave a significant number of bank securities activities outside the regulatory framework and investor protections established under the federal securities laws. Moreover, the SEC testified that SIDs could pose practical problems relating to SEC examinations and enforcement.
H.R. 1062 also directs the federal banking regulators to adopt their own sales practice, disclosure, training and qualification, and other `standards.' H.R 1062 does not require those standards to be substantially similar to requirements under the federal securities laws. For example, banks would not be charged with an express duty to supervise their employees' securities activities, a key investor protection. As noted by the SEC, in footnote 18 at page 12 of their June 6, 1995 Testimony, section 111 of H.R. 1062 follows the approach taken by the federal banking agencies when they adopted `guidelines' in their 1994 Interagency Statement. The guidelines provided in the Interagency Statement do not create a comprehensive securities regulatory scheme for banks. They are advisory rather than legally binding, and may not be legally enforceable by the bank regulators or by bank customers. Furthermore, the guidelines do not establish precise standards of conduct; banks are given wide latitude to establish procedures and policies to implement them. Finally, the existing guidelines create regulatory confusion and overlap because they purport to apply to registered broker-dealers that sell securities in association with banks. The new `standards' to be adopted under H.R. 1062 will likely perpetuate these problems.
The bill will not rationalize financial services regulation; it will further complicate it. Specifically, under the structures contemplated by the bill, some securities activities will be regulated by the SEC (in broker-dealer affiliates and in SEC-registered SIDs) and other securities activities will be regulated by bank regulators (in the bank and in bank regulator-regulated SIDs). Some securities activities may be regulated by both. This will inevitably result in conflicting and overlapping (and thus burdensome) regulation, and opportunities for regulated entities to play regulators off against one another in a dangerous regulatory race to the bottom. An amendment to address this problem was offered and withdrawn during Committee consideration.
H.R. 1062 could seriously harm retail broker-dealers, especially the smaller firms that are the backbone of the securities industry.
While we enthusiastically support greater competition in our securities markets, as well as in all other sectors of the financial services industry, it is essential that the rules be fairly and evenhandedly enforced and that the competitors not be endowed by the government with unfair advantages. While a handful of large securities firms and banks potentially benefit from this bill's authorization of certain new financial activities within a holding company structure, most of the securities industry appears to gain only federally-subsidized bank competitors. These banks have lower funding costs (as a result of being insured depository institutions) and will carry lower regulatory costs and burdens by virtue of the bill's numerous exclusions/exemptions noted above. For example, the number of securities transactions that banks are allowed to engage in and still qualify for the bill's de minimis exemption appears to be excessive. This appears to be especially true when compared with the number of average annualized transactions carried out currently by most small broker-dealers who are required to be registered with the SEC, thus putting these firms at a competitive disadvantage. (In calendar year 1993, the SEC supervised over 8,600 broker-dealers with 34,000 branch offices and over 470,000 registered representatives. The overwhelming majority of these broker-dealers are small businesses.)
Moreover, as noted by many of the witnesses before the Subcommittees, H.R. 1062 poses significant obstacles to a true `two-way street.' H.R. 1062 requires that ownership of an insured depository institution be accomplished through a financial services holding company (FSHC). H.R. 1062 permits the FSHC to own a bank and a securities firm, but prohibits the FSHC from owning any `nonfinancial' company (such company must be divested within 5 years of the securities firm becoming an FSHC). While the bill provides that FSHCs may own certain `financial' companies up to 10% of the FSHC's capital and surplus (provided that any such company was acquired more than 2 years before the securities firm became an FSHC), the bill's definition of `financial' is unduly restrictive in that it excludes insurance and does not clearly include real estate, both of which are commonly though of as being financial. Because many securities firms have affiliates engaged in either or both of these activities, securities firms would have to divest or scale back considerably such operations in order to exercise the combined securities and banking powers granted by the bill. Insurance companies cannot avail themselves of the bill's competitive options at all.
Concerns also have been raised about the sweeping regulatory powers afforded to the Federal Reserve Board under this bill (especially provisions empowering the Federal Reserve to impose significant business limitations on securities firms) and their impact on securities firms within the new `investment bank holding companies' (and `financial services holding companies') as well as the impact on our innovative and vibrant securities markets. Moreover, H.R. 1062 replaces the Bank Holding Company Act's `closely related to banking' test with a `financial in nature or incidental to such financial activities' test for purposes of authorizing non-banking activities for financial services holding companies. This change broadens the types of activities that the Federal Reserve Board may permit FSHCs to conduct, directly or through subsidiaries. In determining what activities may be considered `financial in nature,' the Board is required to take into account `changes or reasonably expected changes in the marketplace,' `changes or reasonably expected changes in * * * technology,' and activities previously authorized under the Board's Regulation K for U.S. banks overseas (the latter include commercial activities such as travel agencies--see Banking Committee Report pp. 102, 103).
Accordingly, while H.R. 1062 has been described as `narrow' reform that only addresses the commingling of commercial banking and securities activities, it appears to give the Federal Reserve unbridled authority `by order, regulation or advisory opinion' to tear down the wall between banking and commerce and to create `universal banking' in this country without Congressional debate and instruction on a number of significant public policy questions. Among these portentous questions are whether federal deposit insurance and other components of the federal safety net should continue to extend to any such `universal bank.'
Concerns have been raised about attempts by the Comptroller of the Currency (OCC) (1) to authorize national banks to engage in a full range of securities activities in direct operating subsidiaries of banks, and (2) to use the National Bank Act to preempt and thus displace state insurance regulation of national banks' insurance sales. H.R. 1062 does not appear to resolve either concern.
For example, last year, the OCC issued a notice of proposed rulemaking to revise its rules as 12 CFR Part 5 governing corporate applications and notices (59 FR 61034 et seq. (November 24, 1994)) that, among other things, proposed to revise the current OCC regulations at Sec. 5.34 to permit national banks to establish or acquire operating subsidiaries. The OCC proposed to allow these operating subsidiaries to engage in activities (including full securities underwriting and insurance agency and underwriting activities) that are currently prohibited or restricted when undertaken directly by banks. Both Representative Dingell, in a seminal legal analysis by letter to the OCC dated January 30, 1995, and Banking Committee Chairman James A. Leach, by letter to the OCC dated April 5, 1995, challenged the legality of the OCC proposal. H.R. 1062 does not address this issue. Theoretically, the OCC could go forward with its proposal and establish a competing scheme to the framework established by H.R. 1062.
Further, as stated above, the OCC issued a notice of proposed rulemaking in March of this year indicating that the OCC is considering an interpretative ruling that would preempt all State licensing and consumer protection laws, including those governing insurance underwriters and agents, in their applicability to national banks. 60 Fed. Reg. 11930 (March 3, 1995) The competitive consequences of this proposal are alarming. The implications for consumers are even worse. The OCC ruling would mean that national banks selling insurance would not have to be licensed or regulated by the States. Since virtually all consumer protections under State insurance law are tied to licensing statutes, consumers purchasing insurance from unlicensed national banks will be denied essential protections they receive when buying a comparable product from an insurer or insurance agent. Worse yet, there are no analogous protections available under federal or State banking law to the solvency and consumer protection rules of State insurance law. An amendment to address this problem was offered and withdrawn during Committee consideration.
On May 9, 1995, the Banking Committee favorably reported H.R. 1062 as amended. On May 11, 1995, the Banking Committee reconvened to reconsider the vote on which H.R. 1062 was favorably reported. That Committee again favorably reported H.R. 1062 as amended. On May 18, 1995, the Banking Committee filed its report (Rept. 104-127, Pt. 1), and H.R. 1062 was then referred to the Committee on Commerce for a period ending not later than June 16, 1995, for consideration of such matters within that legislation as fall within the Rule X jurisdiction of the Commerce Committee. By letter dated May 24, 1995, the Speaker informed Chairman Bliley that Chairman Leach had agreed to extend this deadline to June 22, 1995 in light of the interruption of the 30-day sequential referral to this Committee by the Memorial Day District Work Period.
That same correspondence admonished Chairman Bliley to resist efforts `to rewrite matters within Banking's jurisdiction.' Furthermore, admonitions by the Republican Leadership to make no changes in H.R. 1062 as reported by the Banking Committee were made throughout this Committee's review period. Of course, because the Banking Committee itself acted extensively on securities matters within the Commerce Committee's well-established Rule X jurisdiction, this stricture to move the Banking Committee bill to the Floor, as is, turned the referral to the Commerce Committee into a charade. It severely constrained, indeed cut off, the ability of the Members of this Committee to address the shortcomings in this legislation discussed above. The end result forces this Committee to report defective legislation to the Floor of the House, without amendment and without recommendation. Having raised these issues, we understand that the issues and amendments that we raised in Committee will be permitted to be addressed as Floor amendments. We express our hope that our Republican colleagues and all Members of the House will commit themselves to working cooperatively to develop a sounder, more responsible final product. This legislation, before it leaves the House, must do a better job of protecting depositors, investors, and taxpayers, while providing a competitive framework to take our financial services providers into the next century.
John D. Dingell.
Henry A. Waxman.
Edward J. Markey.
Ralph M. Hall.
John Bryant.
Gerry E. Studds.
Frank Pallone, Jr.
Peter Deutsch.
Ron Klink.
Bart Stupak.
104th
Congress: Democratic Perspectives
103rd-107th
Congress Committee Activity