Speech by SEC Commissioner:
Securities Regulation After Glass-Steagall Reform
by Commissioner Norman S. Johnson
U.S. Securities & Exchange Commission
At "SEC Speaks in 2000"
March 3, 2000
My topic today focuses on the new financial services reform legislation, the Gramm-Leach-Bliley Financial Services Modernization Act of 1999. Earlier this morning you heard from members of our staff discussing the new bill. The issue of financial services reform has long interested me, and during my four years as a Commissioner, I have had regular discussions with my colleagues and the staff as various proposed bills made their way through the legislative process. My remarks today are intended to support and supplement the staff's earlier remarks. Because my time is limited, I will focus on the "big picture": what effect will this new legislation likely have on the Commission's ability to regulate the securities activities of banks? As always, I speak only for myself and not for the Commission, my fellow Commissioners or the Commission's staff.
Although the events leading up to last year's legislation are complex, I will attempt to summarize them. In response to abuses thought to have contributed to the 1929 market collapse, Congress passed the Glass-Steagall Act, a law that established high barriers between banking and securities businesses. At the risk of oversimplification, Glass-Steagall created a system in which financial firms could engage in securities underwriting or commercial banking, but not both. Over time, however, and particularly in the last two decades, banking regulators have used their administrative discretion to relax prohibitions imposed by Glass-Steagall. Banks sell and advise mutual funds. Securities firms have increasingly affiliated themselves with banks. Bank affiliates engage in securities underwriting, an activity at the core of the Glass-Steagall prohibitions.
Now the Commission's traditional concerns in this area, which I share, have not arisen from questions about the wisdom of whether firms should be permitted to engage in both underwriting and commercial banking. Rather, the Commission's concerns go to the heart of our role as protector of investors and regulator of the nation's securities markets. As you all know, the Commission does not try to insulate securities firms or other market participants from risks they incur in their business activities. Nor does the Commission advise investors about which securities to purchase. Instead, the Commission tries to promote fair and orderly markets by requiring that issuers make full disclosure to investors and by imposing specific capital, supervision, disclosure and antifraud requirements on securities firms.
In contrast, banking regulators focus on the safety and soundness of the banking system. For instance, banking law doctrine includes a "source of strength" concept that requires affiliates of a weak bank to provide financial support. In addition, banking regulators monitor the condition of banks. Regulators further control bank risk-taking by imposing restrictions on capital, bank lending and other business activities and by relying on a program of confidential, governmental examinations.
The Commission has consistently acknowledged the differing philosophy and aims of banking regulators. But, at the same time, the Commission has insisted that when banks engage in securities activities, they should do so through a separate corporate structure, fully subject to securities regulation and the mandate of investor protection. This concept of "functional regulation" has not always been popular with all segments of the financial community, but has much to recommend itself, in my view, in terms of fairness and logical and regulatory consistency. Simply put, businesses should compete on a level playing field.
While the new bill does not fully embrace "functional regulation," it does not represent the death knell for the concept that some had predicted. On the contrary, in many respects, the bill represents a significant step towards functional regulation. It appears that the Commission's negotiators managed to achieve considerable success in advancing the Commission's views about functional regulation under contentious and difficult legislative conditions. I certainly commend the staff members who were involved for their efforts and dedication.
At the risk of repeating some of what you heard earlier, the parts of the new bill most relevant to the Commission include the following:
- The bill allows banks and securities firms to affiliate through a "financial holding company" structure -- the Federal Reserve will serve as the so-called "umbrella" regulator, but the affiliates will be subject to functional regulation.
- The bill will also permit well-managed, well-capitalized, well-rated banks to establish a new type of bank subsidiary to engage in securities underwriting and dealing, but not insurance underwriting or real estate investment.
- As to broker-dealer activities, while the new law eliminates the blanket bank exemptions contained in the Exchange Act, it also provides for new targeted exceptions that will permit banks to engage in certain activities traditionally thought of as securities activities. Banks that cannot take advantage of the new exceptions, however, will either have to register with the Commission or conduct such activities through a subsidiary or affiliate regulated by the Commission.
- Finally, the bill eliminates bank exemptions from the Investment Advisers Act as to investment advisory activities. The bill also amends the Investment Company Act to address conflicts of interest posed by bank advisory activities.
Some of these changes will surely have a greater effect on the Commission's day-to-day procedures than others. But it is fair to say that a new day has dawned. Predictions are always problematic, but I will venture a few. With this new legislation, the Commission will have to coordinate its efforts closely with banking regulators. The Commission will share functional regulation of entities that are part of bank holding companies and thus subject to umbrella regulation by our banking counterparts. Because of this overlapping and concurrent regulatory scheme, a potential for conflicts will always exist. Nonetheless I remain hopeful that we can work together with banking regulators to meet the challenges arising from this hybrid system.
The new legislation will likely have a significant effect on the entire structure of our markets. Some have questioned whether independent securities firms can survive in this new environment. These commentators have pointed to countries such as Canada and the United Kingdom where similar legislation led to the takeover of many independent securities firms by banks. In those countries, banks now dominate financial markets. I do believe, however, that bigger is not always better. If securities firms show the creativity, initiative and persistence that has marked their past successes, they will continue to thrive by better serving their customers.
Finally, I concur with those observers who believe that the devil is in the details. Naturally, both banks and securities firms are scrutinizing the exceptions and loopholes in the bill for their own business advantage. Of course, some firms may try to move different business segments to benefit from what they would regard as a more favorable regulatory environment. Such a business strategy may be unfortunate, with the potential to do harm to investors. Nevertheless, these maneuvers were possible to some extent even before the financial services reform bill. More importantly, I think that if the Commission and our banking counterparts coordinate our efforts, we can reduce the incentives to pursue such strategies.
In sum, I think the Gramm-Leach-Bliley Act holds promise for investors and securities firms. In terms of the Commission's ability to carry out its regulatory mandates, I believe the glass is more than half-full, not half-empty. I am hopeful that the Commission can work together with our banking counterparts to take full advantage of the opportunities presented by this new regulatory landscape.