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March 28, 1991
TO: BOARD OF GOVERNORS NO. 20-91
MEMBERS - ONE PER COMPLEX NO. 15-91
RE: ADMINISTRATION BILL ON FINANCIAL SERVICES RESTRUCTURING
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The Bush Administration has released its bill to reform the
deposit insurance system and to restructure the financial
services industry. The bill has been introduced in both Houses
of Congress.
A copy of the bill and the accompanying section-by-section
analysis is attached. Set forth below is a brief summary of the
bill's provisions, focusing on investment company and other
securities powers. Please note that the summary is based on
preliminary review by the Institute staff and does not cover all
provisions in the bill.
Provisions Concerning Securities Powers
General. Under the bill, banks would be permitted, through
separate affiliates or subsidiaries, to engage in various
securities activities, including investment company activities.
Specifically, the bill would repeal Sections 20 and 32 of the
Glass-Steagall Act, which prohibit banks from being affiliated
with firms "engaged principally" in securities activities and
limit common directors, officers and employees between commercial
and investment banks. (Section 221 of the bill)
Under the bill, banks could be affiliated with securities
firms, as well as insurance companies and other companies engaged
in financial activities, under common "financial services holding
companies" (or "FSHCs"), which would replace bank holding
companies. Most securities activities, including investment
company activities, would be required to be carried out in a
separate securities affiliate of the FSHC, subject to full SEC
regulation (Sections 201 and 203). In this regard, the bill
adopts the general framework endorsed by the Institute. Banks
not affiliated with separate securities affiliates would be
permitted to sell investment company securities through a
subsidiary of the bank (rather than a separate holding company
affiliate); however, bank subsidiaries would be barred from
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sponsoring, organizing or controlling registered investment
companies.
Generally, only FSHCs that fall within the highest of five
"zones" established with respect to capitalization ("Zone 1") or
that meet other capital standards would be permitted to own
securities affiliates; however, existing "Section 20 affiliates"
would be grandfathered for a three year period.
Securities affiliates would be required to make certain
disclosures to customers and receive written acknowledgments of
the disclosures from customers. The required disclosures include
that the affiliates are not insured institutions and that the
securities they offer are not federally insured. The SEC would
be authorized to adopt regulations governing these required
disclosures. In addition, the appropriate federal banking agency
would be authorized to adopt certain "firewalls" governing
activities such as disclosure by a bank of nonpublic customer
information to its affiliates and credit support by a bank for
its securities affiliate. (Section 203) The types of
transactions subject to restrictions under Sections 23A and 23B
of the Federal Reserve Act also would be expanded. (Section 223)
Ownership by Commercial Firms. The bill would allow
commercial firms to acquire FSHCs, but only if the FSHC falls
within Zone 1. These firms would be considered "diversified
holding companies". Additional firewalls would be applied to
transactions between the insured institution and the diversified
holding company and its affiliates. Most importantly, a bank
could not loan money to an affiliated diversified holding company
or any of its affiliates. (Section 204) In this way, the bill
provides for a full "two way street", and adopts the position
endorsed by the Institute.
Reporting and Other Obligations. FSHCs would be required
to maintain certain records and make certain reports to the
appropriate federal banking regulator. Diversified holding
companies also would be required to make similar reports. The
bill would direct banking agencies to "consult with and, to the
extent possible, use reports obtained by" the "functional
regulator" of the diversified holding company, FSHC or affiliate
(which, in the case of a securities affiliate, would be the SEC)
to obtain the needed information. Similarly, banking agencies
could conduct examinations of holding companies but would be
required to consult with or make use of reports obtained by the
SEC in the case of securities affiliates. The SEC would be given
reciprocal access to reports and would be permitted to make
reciprocal examinations of insured depository institutions with
respect to activities that could have a material impact on a
securities affiliate. (Section 205)
Banking regulators would be permitted to issue cease-and-
desist orders against holding companies and, under certain
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circumstances, order divestment in response to activities
constituting a serious risk to a depository institution. (Section
205)
Amendments to the Securities Laws. The bill would repeal
the exemptions in the Securities Act for securities issued or
guaranteed by bank and thrifts (other than certain traditional
bank instruments such as deposits, letters of credit, etc.)
(Section 241)
The Securities Exchange Act would be amended to require
that bank brokerage activities generally be carried out by a
subsidiary or affiliate of the bank and not by the bank itself.
Banks could engage in certain specified brokerage activities
directly, including transactions in commercial paper and other
exempted securities, trust activities (unless the bank receives
incentive compensation and publicly solicits brokerage business),
"sweep accounts", transactions for employee benefit accounts, and
private placements. In addition, banks without broker-dealer
subsidiaries or affiliates could engage in up to 1,000 securities
transactions a year. Similarly, banks could generally engage in
dealer activities only through separate subsidiaries or
affiliates. (Section 242)
The bill would impose additional restrictions on the offer
and sale of securities on bank premises. In general, securities
issued by a bank or any affiliate could not be offered or sold to
the public in any part of the bank "commonly accessible to the
general public for the purpose of accepting deposits" ( i.e., bank
lobbies). However, this restriction would not apply to shares of
an affiliated investment company, provided that the sales are
effected by a registered broker-dealer. (Section 242)
1940 Act and Advisers Act Amendments. The Investment
Company Act would be amended to add certain "firewalls" between a
bank and an affiliated fund. Specifically, the SEC would be
authorized to adopt regulations governing banks acting as
custodians for affiliated management investment companies or as
trustees for affiliated unit trusts. The definition of
"interested person" would be broadened to include persons
affiliated with custodians, transfer agents, or entities that
execute transactions for, engage in principal transactions with,
or loan money to an investment company or any investment company
with the same adviser, principal underwriter, sponsor or
promoter. (This would include both banks that engage in such
activities as well as foreign broker-dealers not registered under
the Securities Exchange Act within the scope of the definition.)
Section 10(c) of the 1940 Act would be amended to extend the
current prohibition on the majority of a fund's board consisting
of directors, officers and employees of a single bank to
directors, officers and employees of a single bank and its
affiliates. (Section 243)
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In addition, the bill would give the SEC rulemaking
authority with respect to "loans, purchases or sales of assets,
and other transactions involving a bank, an affiliated person and
an affiliated registered investment company". The section-by-
section analysis states that this provision is intended to give
the SEC authority to address conflict-of-interest transactions
involving banks and affiliated funds (similar to the current
prohibitions under Section 17). (Section 243) This provision
differs from the Institute's consistent position, which has been
to urge the adoption of statutory firewalls which would prohibit
specified transactions (subject to SEC exemptive authority) such
as a bank (1) "dumping" trust assets into an affiliated fund, (2)
loaning money to an affiliated fund, (3) causing an affiliated
fund to purchase securities issued by a borrower from the bank,
and (4) loaning money to a company whose securities are held by
an affiliated fund.
The bill also contains a provision that would allow the SEC
to adopt regulations requiring prominent disclosure that shares
of an investment company affiliated with, or with a name similar
to, a bank, are not bank obligations and are not FDIC insured.
The SEC also would be permitted to issue orders that the use by a
fund of a name similar to a bank is deceptive and misleading.
(Section 243) The Institute has recommended that similar names
or logos be barred for a specified time period following
enactment of legislation granting banks mutual fund powers. The
bill does not contain special 1940 Act firewalls governing cross-
marketing, shared offices and the like, which have been
recommended by the Institute.
The Institute has consistently stated that, as part of any
legislation granting banks mutual fund powers, the current
exemptions from the 1933 and 1940 Acts for bank common trust
funds and bank collective funds for retirement plans should be
repealed. The Treasury bill would substantially narrow the
exemption for common trust funds by limiting it to those funds
not advertised or publicly offered, used only for fiduciary
purposes and not assessed a separate management fee. (In essence
this would codify current SEC interpretations of the scope of the
exemption.) Common trust funds would be permitted to convert to
registered investment companies on a tax-free basis.
(Section 245)
With respect to collective funds for retirement plans, the
bill directs the SEC to conduct a study of their regulation (as
well as the regulation of common trust funds and insurance
company separate accounts for retirement plans) and to report
legislative and administrative recommendations to the Congress
within 6 months. The section-by-section analysis states that the
purpose of this study "is to adopt a regulatory scheme that
protects investors in pooled investment funds on an equal basis,
regardless of whether the funds are pooled by investment
companies, banks or insurance companies". (Section 246)
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The bill also requires banks that serve as investment
advisers to investment companies to be registered under the
Investment Advisers Act (a position endorsed by the Institute).
A bank itself could serve as adviser by establishing an
identifiable division or department to perform the function,
which would be subject to SEC regulation. The SEC would be
required to notify the appropriate banking regulator before any
inspection or enforcement action against any FSHC, bank or bank
department or division registered under the Advisers Act, unless
the protection of investors requires inadequate action.
(Section 244)
Non-Securities Powers Provisions
Interstate Banking. The bill would allow FSHCs to acquire
banks on a nationwide basis and would permit full interstate
branching by both national and state banks three years after its
effective date. (Sections 261-264) (The Institute has
consistently called for nationwide banking so that securities
firms affiliated with banks could offer both securities and
banking products on a nationwide basis.)
Deposit Insurance Reform. The bill would reduce, to some
extent, the current scope of federal insurance for deposits. As
under current law, each depositor would be insured up to $100,000
per institution. In addition, a depositor could be insured up to
an aggregate of $100,000 per institution for deposits made in
connection with IRAs, Keoghs and other self-directed defined
contribution plans. (Section 101)
Deposits obtained through a "deposit broker" (as defined)
would no longer be insured. In addition, BICs would no longer be
eligible for deposit insurance. "Pass through" of deposit
insurance to pension plan beneficiaries would be eliminated,
except for self-directed defined contribution plans (and pension
plans of state and local governments).
The above amendments would take effect two years after the
date of enactment (except with respect to certain grandfathered
time deposits).
The FDIC is also directed to conduct a study on the
feasibility of reducing deposit insurance coverage to a $100,000
limit per depositor (as opposed to per institution).
Other provisions would (1) restrict solicitation of
deposits by institutions with low capital, (2) require the FDIC
to use "least cost resolution" in assisting troubled
institutions, (3) require the FDIC to establish a risk-based
deposit insurance premium system, (4) restrict risky activities
by state banks that are federally insured, (5) require the SEC
and banking regulators to develop regulations requiring
supplemental disclosure of the market value of assets and
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liabilities of banks, to be included in financial statements and
reports, and (6) require the FDIC to undertake a project to
determine whether a private reinsurance system would be feasible.
(Sections 102-109, 116)
Regulatory Reform. A new Office of Depository Institutions
Supervision, a bureau within the Treasury Department, would be
established. It would replace the OCC and the Office of Thrift
Supervision and would regulate national banks and thrifts. The
Federal Reserve Board would regulate state banks. Holding
companies would be regulated by the agency regulating the
principal bank subsidiary of the holding company. The FDIC would
remain responsible for deposit insurance and resolution of failed
institutions. (Sections 301-361)
BIF Recapitalization. The bill would recapitalize the Bank
Insurance Fund by granting the FDIC authority to borrow up to $25
billion from the Federal Reserve Banks. (Repayments would be
made out of increased premiums.) The bill also would impose an
aggregate ceiling on premiums of 30 basis points. (However, if
risk based premiums are adopted, individual institutions may be
assessed greater premiums.) (Section 401)
We will keep you informed of developments regarding this
and related legislation.
Craig S. Tyle
Associate General Counsel
Attachment