Testimony Regarding Financial Modernization

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                           TESTIMONY OF
                     ARTHUR LEVITT, CHAIRMAN,
             U.S. SECURITIES AND EXCHANGE COMMISSION

                CONCERNING FINANCIAL MODERNIZATION

      BEFORE THE COMMITTEE ON BANKING AND FINANCIAL SERVICES

                  U.S. HOUSE OF REPRESENTATIVES

                           May 22, 1997

Chairman Leach and Members of the Committee:

     I appreciate the opportunity to testify on behalf of the

Securities and Exchange Commission (“Commission”) regarding

modernization of the laws governing financial services.  This is

a significant issue that has defied consensus for more than a

decade.  I commend you, Chairman Leach, for your continuing

efforts to bring financial regulation up to date with the

financial markets.

I.  Overview

     Over the past decade, the financial services industry has

evolved to permit diversity in services and providers of

services.  Today, a bank is as likely as a broker-dealer to sell

securities to a first-time investor.  A bank may also advise

mutual funds.  While these developments provide banks with

greater flexibility and new areas for innovation, they also leave
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investors at risk.  When a bank sells a security or advises a

mutual fund, the bank is not subject to most federal securities

laws and regulations because it is exempt from the definitions of

“broker,” “dealer,” and “investment adviser.”  As a result of

these 60-year old exemptions, securities activities engaged in by

banks are governed by the federal banking statutes, and not the

federal securities laws.

     The Commission believes that banking regulation is not an

adequate substitute for securities regulation, especially when a

bank fully engages in a public securities business.  Banking

regulation focuses on the safety and soundness of banking

institutions and preventing the failure of banks.  In contrast,

securities regulation focuses on disclosure, investor protection,

and the maintenance of fair and orderly markets.  Moreover,

securities regulation encourages innovation on the part of

securities firms.  Significantly, securities regulation does not

protect broker-dealers from failure.  It relies on market

discipline rather than a federal safety net.  These significant

differences in philosophy and approach between banking and

securities regulation reflect the real differences between the

banking and securities worlds.  

     As the debate on financial services reform moves forward, it

is important to recognize that businesses in the United States

depend on our capital markets and the securities industry to
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support their exceptional growth.  The American public has the

confidence to invest in securities because of the strong

investor-oriented regulation of those markets.  In 1996 alone, it

is notable that businesses raised approximately $1.2 trillion

from investors, without the benefit of federal deposit insurance,

through the entrepreneurial efforts and risk-taking of securities

firms.-[1]-

     The Commission believes that any legislation modernizing

financial services must take into account the critically

important factors that serve as the underpinnings for the success

of our nation’s securities industry.  Specifically:

     ∙    Investor protection must be maintained.  Investor

          protection must continue to be a cornerstone of the

          securities markets if they are to build on their

          present strength.  Meaningful functional regulation is

          essential to ensure that investors receive the same

          protection whether they deal with banks or securities

          firms.

     ∙    The vitality of the markets must be preserved.  While

          traditional banking services need to be regulated to

---------FOOTNOTES----------
     -[1]-     This figure includes firm commitment public
               offerings and private placements, and does not
               include best efforts underwritings.  (Securities
               Data Company)
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          ensure bank safety and soundness, this approach is

          inconsistent with the risk-taking that is essential in

          the securities industry.  Securities firms affiliated

          with banks need to engage in risk-taking and

          entrepreneurial activities without an overlay of

          restrictive banking-style regulation that focus on

          safety and soundness.

     ∙    Competitive opportunities should be available to all

          firms providing financial services.  Banks and

          securities firms should be given the opportunity to

          compete on an equal basis -- to the extent that banks

          may conduct securities activities, securities firms

          should be allowed to conduct banking activities.

     As Congress considers how to permit affiliations between the

banking and the securities industries, it is important to

remember that Congress’ actions likely will have a profound

effect on investors, the securities industry, and the securities

markets generally, as well as on banks.  Both H.R. 10 and H.R.

268 approach financial services reform largely from the banking

perspective.  As securities regulators, the Commission urges

Congress also to consider the implications of reform on the

securities industry and the securities markets.   
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     The way each of these key factors is addressed in H.R. 10

and H.R. 268 is discussed below.

II.  Functional Regulation to Assure Investor Protection

     The statutes that form the foundation for both banking and

securities regulation remain based on the 60-year old assumption

that the Glass-Steagall Act prohibits banks from engaging in most

securities activities.  Although that assumption is outmoded, the

laws continue to exempt banks from the requirements applicable to

brokers, dealers and investment advisers even though banks

conduct these activities.-[2]-  This means that a bank’s

securities activities are subject to the bank regulatory scheme

with its primary focus on the safety and soundness of the bank,

rather than the securities regulatory scheme, focused on

disclosure, investor protection, and the maintenance of fair and

orderly markets.  

     As the Commission has urged for more than a decade, a system

of functional regulation would eliminate the inconsistencies

between regulation of securities activities of banks and

---------FOOTNOTES----------
     -[2]-     See, e.g., 15 U.S.C. §§ 78c(a)(4), 78c(a)(5), and
               80b-2(a)(11).
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securities activities of Commission-regulated entities, providing

enhanced investor protection.-[3]-

     The present regulatory scheme is increasingly likely to

create problems.  Today, individual investors have more savings

invested in mutual funds than in insured bank accounts.-[4]-

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     -[3]-     See, e.g., Testimony of Arthur Levitt, Chairman,
               U.S. Securities and Exchange Commission,
               Concerning H.R. 268, The “Depository Institution
               Affiliation and Thrift Charter Conversion Act,”
               Before the Subcomm. on Financial Institutions and
               Consumer Credit of the House Comm. on Banking and
               Financial Services (Feb. 13, 1997); Testimony of
               Arthur Levitt, Chairman, U.S. Securities and
               Exchange Commission, Regarding H.R. 1062, The
               Financial Services Competitiveness Act of 1995,
               Before the Subcomm. on Telecommunications and
               Finance and the Subcomm. on Commerce, Trade and
               Hazardous Materials of the House Comm. on Commerce
               (June 6, 1995); Testimony of Arthur Levitt,
               Chairman, U.S. Securities and Exchange Commission,
               Concerning The “Financial Services Competitiveness
               Act of 1995” and Related Issues, Before the House
               Comm. on Banking and Financial Services (Mar. 15,
               1995); Testimony of Richard C. Breeden, Chairman,
               U.S. Securities and Exchange Commission,
               Concerning Financial Services Modernization,
               Before the Subcomm. on Telecommunications and
               Finance of the House Comm. on Energy and Commerce
               (July 11, 1990); Memorandum of the Securities and
               Exchange Commission (under Chairman David Ruder)
               to the Subcomm. on Telecommunications and Finance
               of the House Comm. on Energy and Commerce
               Concerning Financial Services Deregulation and
               Repeal of the Glass-Steagall Act (Apr. 11, 1988).

     -[4]-     Specifically, at the end of 1996, $3.6 trillion
               was invested in mutual funds.  Data compiled by
               Office of Economic Analysis, U.S. Securities and
               Exchange Commission, based on January 1997 Federal
               Reserve Bulletin and 1997 Mutual Fund Fact Book;
               see Remarks by Eugene A. Ludwig, Comptroller of
               the Currency, before the Exchequer Club, Nov. 20,
               1996 (OCC News Release 96-127).
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As we move toward the next century, this trend is likely to

continue, particularly if recent proposals to privatize, or semi-

privatize, the social security system are adopted.-[5]-  If

investors purchase their mutual fund shares through a bank,

rather than a registered broker-dealer, they receive a different,

lower, standard of investor protection.  If the mutual fund they

purchase is advised by a bank, rather than a registered

investment adviser, again, investors receive a different, lower,

standard of investor protection.

     To assure adequate investor protection, the Commission

believes that bank securities activities must be brought within

the securities regulatory framework.  Such an approach would

ensure that the securities activities of all market participants

-- regardless of the structure in which they are conducted --

would be subject to a single set of standards, consistently

applied by one expert regulator.  

     Broker-Dealer Activities.  As noted earlier, banks that

engage directly in broker and dealer activities are exempt from

the definitions of broker and dealer in the federal securities

---------FOOTNOTES----------
     -[5]-     See “Report of the 1994-1996 Advisory Council on
               Social Security” (Jan. 1997); see also “Oversight
               on Social Security Investments in the Securities
               Markets,” Hearings Before the Senate Comm. on
               Banking, Housing, and Urban Affairs (Apr. 30,
               1997); “The Future of Social Security for this
               Generation and the Next,” Hearings Before the
               Subcomm. on Social Security of the House Comm. on
               Ways and Means (Mar. 6 and Apr. 10, 1997).
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laws, and therefore their purchases and sales of securities to

customers are exempt from federal securities

regulation.-[6]-

     Because the federal banking regulatory framework focuses

primarily on the safety and soundness of banking institutions, it

does not specifically address important aspects of direct bank

brokerage activities.-[7]-  For example:

     ∙    Banking statutes and rules neither comprehensively

          address sales practice issues nor impose express duties

          to supervise bank securities sales personnel;

     ∙    Banks are not subject to self-regulatory organization

          account transfer rules that require a broker-dealer to

          transfer a customer’s account upon demand;

---------FOOTNOTES----------
     -[6]-     Bank securities activities are, however, subject
               to the antifraud provisions of the federal
               securities laws.  Moreover, bank affiliates and
               subsidiaries, as opposed to banks themselves, are
               not exempt from the federal securities laws, and
               must register with the Commission when they engage
               in securities activities.  As discussed later in
               this testimony, the securities activities of these
               affiliates and subsidiaries also are subject,
               inappropriately in our view, to bank safety and
               soundness supervision.

     -[7]-     The federal banking regulations do contain limited
               recordkeeping and confirmation requirements
               relating to bank securities transactions. See,
               e.g., 12 C.F.R. §§ 12.1-12.9 and 12.101-102, 12
               C.F.R. §§ 344.1-344.10, and 12 C.F.R. § 208.24.   
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     ∙    Bank employees who sell securities currently are not

          subject to specific qualification and continuing

          education requirements;

     ∙    Banking statutes do not provide private rights of

          action;-[8]-  

     ∙    Bank securities customers have no forum to address

          grievances such as the Commission’s supervised

          arbitration forum available to customers of securities

          firms;-[9]- and

---------FOOTNOTES----------
     -[8]-     See, e.g., In re Fidelity Bank Trust Fee
               Litigation, 839 F. Supp. 318 (E.D. Pa. 1993),
               aff’d, 43 F.3d 1461 (3d Cir. 1994); In re
               Corestates Trust Fee Litigation, 837 F. Supp. 104
               (E.D. Pa. 1993), aff’d, 39 F.3d 61 (3d Cir. 1994).
               Banks are subject, however, to the anti-fraud
               provisions in section 10(b) of the Securities
               Exchange Act and Rule 10b-5 thereunder.
               Therefore, bank customers presumably can bring
               private actions alleging fraud against banks under
               these provisions.  But see Simpson v. Mellon Bank,
               N.A., [1993-94 Transfer Binder] Fed. Sec. L. Rep
               (CCH)   98,027 (Dec. 17, 1993).

     -[9]-     See also, Testimony of Mary Griffin, Insurance
               Counsel, Consumers Union, Concerning the
               “Depository Institution Affiliation and Thrift
               Charter Conversion Act” (H.R. 268), Before the
               Subcomm. on Financial Institutions and Consumer
               Credit of the House Comm. on Banking and Financial
               Services (Feb. 25, 1997) (explaining one problem
               with H.R. 268 is that the bill does not provide a
               recourse mechanism for consumers to recover losses
               directly from the wrong-doer, “unlike the investor
               protection rules under securities laws that
               provide a grievance forum for consumers”).
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     ∙    Banking regulators’ disciplinary actions are not fully

          disclosed, depriving investors of basic information

          with which to protect themselves.-[10]-

     Recent efforts by bank regulators to incorporate aspects of

the federal securities laws into the bank regulatory scheme

represent a step forward, but have not resolved the most pressing

regulatory gaps.-[11]-  While the Commission fully supports

---------FOOTNOTES----------
     -[10]-    The banking agencies are required to “publish and
               make available to the public” final orders issued
               in connection with enforcement proceedings. (12
               U.S.C. § 1818(u).  The releases usually do not
               describe the nature of the violation and the
               enforcement action taken, however.  Rather, they
               list enforcement actions, and typically include
               the docket number, names of the parties involved,
               type of action taken, date of the action and
               whether the action was by consent.  In contrast,
               Commission and self-regulatory organization
               disciplinary proceedings are aggressively
               publicized.  Commission press releases describe
               the nature of proceedings and the identities of
               the parties disciplined.  In addition, as mandated
               by the Securities Exchange Act, the NASD operates
               an “800” telephone number hotline, which allows
               investors to obtain information about the
               disciplinary and civil liability records of
               broker-dealers’ registered representatives.

     -[11]-    For example, the federal banking regulators have
               issued guidelines that address some sales practice
               issues.  See Board of Governors of the Federal
               Reserve System, FDIC, Office of the Comptroller of
               the Currency and Office of Thrift Supervision,
               “Interagency Statement on Retail Sales of
               Nondeposit Investment Products” (Feb. 15, 1994).
               As the Commission has testified before, while
               these guidelines represent an important step
               forward, they are advisory and therefore, not
               legally binding, and may not be legally
               enforceable by bank regulators or customers.  See
               Testimony of Arthur Levitt, Chairman, U.S.
                                                   (continued...)
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addressing gaps in investor protection, it has serious concerns

regarding the creation of a “separate, but unequal” regulatory

scheme for banks that may serve to compete with, and undermine,

the securities regulatory scheme.  For example, one recent

proposal sponsored by the banking regulators would impose

qualification requirements on bank employees who sell mutual

funds and other securities to bank customers.-[12]-  While

the goal of this initiative is laudable, it notably would not

impose on banks standards for qualifying supervisors or a duty to

supervise bank securities sales forces.  It also would not

provide for self-regulatory organization inspections and

oversight.  Moreover, it may encourage banks that currently are

selling securities through registered broker-dealer subsidiaries

and affiliates to move these activities into the bank itself,

where they are subject to fewer restrictions.  

     The Commission believes that a parallel, but unequal, system

of securities regulation administered by banking regulations --

within the general framework of federal banking regulation, which

focuses primarily on the safety and soundness of banking

---------FOOTNOTES----------
     -[11]-(...continued)
               Securities and Exchange Commission, Concerning The
               “Financial Services Competitiveness Act of 1995”
               and Related Issues, Before the House Comm. on
               Banking and Financial Services (Mar. 15, 1995).

     -[12]-    Office of the Comptroller of the Currency,
               Treasury; Board of Governors of the Federal
               Reserve System; Federal Deposit Insurance
               Corporation, Qualification Requirements for
               Transactions in Certain Securities (Jan. 9, 1997).
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institutions -- would deprive investors purchasing and selling

securities directly through banks of important regulatory

protections.    

     In the Commission’s view, functional regulation is necessary

to eliminate gaps in investor protection, as well as to provide a

level playing field between banks and brokers engaged in the same

securities activities.-[13]-  Unfortunately, however, the

Commission believes that neither H.R. 10 nor H.R. 268 would

implement an adequate level of functional regulation.  

     H.R. 10 would eliminate the bank exemption from the

definitions of broker and dealer, but would introduce 16

significant new exemptions for banks that engage in specific

types of securities activities.  Among others, H.R. 10 would

exempt bank sales of asset-backed securities and privately placed

securities, two areas of significant market growth.    As a

result, it appears that banks could continue to operate a public

securities business largely outside the framework of the federal

securities laws.  

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     -[13]-    In this regard, Commissioner Wallman has noted
               that, as distinctions between securities and
               nonsecurities financial products diminish, other
               forms of financial service regulatory reform may
               be worthy of long-term consideration.  Remarks of
               Commissioner Steven M.H. Wallman before the SIA
               Conference on the National Securities Markets
               Improvement Act of 1996 (Jan. 9, 1997).
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     Most significantly, H.R. 10 would provide for an open-ended

exemption for transactions in securities that the Federal Reserve

Board characterizes as “qualified financial contracts,” which

potentially could include any securities contract.  Similarly,

H.R. 10 would provide for an exception for bank transactions in

securities that are deemed by the Federal Reserve Board to be

“banking products.”  The Commission strongly opposes these open-

ended exemptions which would perpetuate a lesser scheme of

banking regulation for significant bank securities activities.  

     H.R. 268 would retain the statutory exemption for banks from

the definitions of “broker” and “dealer” for those banks not

operating under the bill’s new financial services holding company

framework.-[14]-  As a result, it would not resolve any of

the issues that have arisen over the last decade with respect to

bank securities sales.   

     As the regulator charged with oversight of the securities

industry and maintenance of fair and orderly markets, the

Commission must have a comprehensive view of that industry and

all its participants.  Allowing banks to continue conducting

significant securities activities outside of the federal

---------FOOTNOTES----------
     -[14]-    Basically, H.R. 268 would allow a bank to choose
               between continuing its current operations under
               the current rules or affiliating with a securities
               firm or other financial firm under a financial
               services holding company pursuant to a new
               regulatory framework.
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securities regulatory scheme would disable the Commission from

effectively supervising and overseeing a growing segment of the

securities industry.  

     The Commission believes that financial services legislation

could provide limited, defined exemptions or exceptions from

securities regulation for a narrow class of traditional banking-

related securities activities or for a low volume of activities

engaged in by a small local bank.  However, any additional

exemptions would essentially codify the existing regulatory

inconsistencies and frustrate functional regulation, which the

Commission views as a vitally important component in financial

services modernization.  

     Investment Advisory Activities.  As of December 31, 1996,

119 banks advised 2,857 mutual funds (including individual

classes), representing approximately 28% of all funds registered

with the Commission.  Also, as of that date, assets of bank-

advised funds totaled $493.2 billion, or 15% of total mutual fund

assets.-[15]-  By contrast, in 1990, banks advised 517

funds with total assets of $85.9 billion.  Despite this dramatic

growth, banks remain exempt, as discussed above, from the

definition of “investment adviser” in the Investment Advisers

Act.  Consequently, banks that advise registered investment

---------FOOTNOTES----------
     -[15]-    Lipper Analytical Services, Inc., Lipper Bank-
               Related Fund Analysis (1996).   
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companies are not subject to the substantive requirements

applicable to other investment advisers.  This hampers effective

Commission oversight of bank-advised mutual funds by depriving

Commission examiners access to all the books and records normally

available when a fund adviser is registered with the Commission.

     The Commission supports the proposal in H.R. 10 that would

require banks, or their separately identifiable departments or

divisions, that advise registered investment companies to

register as investment advisers.-[16]-  This would ensure

that federal securities laws and regulations would apply to these

activities, permitting the Commission to see the complete picture

of investment adviser activities in its examinations of mutual

funds.

     In contrast, the Commission is concerned that H.R. 268 would

eliminate the bank exemption from “investment adviser” only if

the bank affiliates with a securities or other financial firm

under a financial services holding company.  Thus, a bank could

continue to advise a mutual fund outside of Commission oversight.

The Commission objects to maintaining this regulatory structure

because, as described above, it prevents the Commission from

effectively examining activities that may harm mutual fund

---------FOOTNOTES----------
     -[16]-    A more detailed analysis of the technical issues
               arising under the Investment Company Act and the
               Investment Advisers Act is included in an appendix
               to this testimony (“Appendix A”).
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shareholders, particularly at a time when individual investors

are investing more of their savings in mutual funds than in

interest-bearing bank deposit accounts.   

     Investment Company Conflicts of Interest.  In a related

area, the Commission is concerned about increasing conflicts of

interest resulting from bank involvement in mutual

funds.    Currently, the Investment Company Act places some

restrictions on transactions between banks and affiliated

investment companies.  These restrictions were crafted, however,

at a time when Congress could not have contemplated the dramatic

change in the scope of these activities that has occurred in the

past decade.  

     The Commission supports the provisions in H.R. 10 that would

improve the oversight of conflicts that exist when banks transact

business with affiliated investment companies.-[17]-  For

example, a bank affiliated with a registered investment company,

and any affiliated person of such bank, would be prohibited by

H.R. 10 from lending money to such investment company in

contravention of any rules or regulations that the Commission may

prescribe.  Also, the banking regulators would be required to

provide the Commission with the results of any examination,

reports, records or other information related to the investment

advisory activities of any bank registered with the Commission.

---------FOOTNOTES----------
     -[17]-    See Appendix A.
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     In contrast, the Commission is concerned about provisions in

H.R. 268 that would reduce the Commission’s ability to police

conflicts of interest, as we have testified before.-[18]-

This would happen because H.R. 268 would remove certain

limitations under the Investment Company Act that now apply to

all fund affiliates, and replace them with new limitations that

apply solely to the activities of banks that operate under the

new financial services holding company framework of H.R. 268.  As

discussed earlier in this testimony, maintaining the bank

exemption under the Investment Advisers Act, as provided in H.R.

268, also would continue to hinder Commission oversight of bank-

advised mutual funds.-[19]-

     Committee of Regulators.  The Commission has significant

concerns about the usefulness of a new regulator, such as the

National Financial Services Committee proposed in H.R. 268 or the

Banking and Financial Services Advisory Committee proposed in

---------FOOTNOTES----------
     -[18]-    See Testimony of Arthur Levitt, Chairman, U.S.
               Securities and Exchange Commission, Concerning
               H.R. 268, “The Depository Institutions Affiliation
               and Thrift Charter Conversion Act,” Before the
               Subcomm. on Financial Institutions and Consumer
               Credit of the House Comm. on Banking and Financial
               Services (Feb. 13, 1997).

     -[19]-    At present, Commission examiners do not have
               access to all the books and records of a fund
               adviser that is a bank, because the bank currently
               is not required to register as an adviser.  The
               Commission and the banking regulators have agreed,
               however, to conduct joint inspections of banks and
               their affiliated mutual funds.  Joint inspections
               will not, however, correct the underlying laws in
               the existing regulatory structure.  
==========================================START OF PAGE 18======
H.R. 10.  The Commission supports the existence of working

groups, such as the existing Working Group on Financial Markets,

to ensure effective sharing of information and, when appropriate,

collaboration on issues of interest to more than one regulator.

Empowering a group to set standards and define activities across

the horizon of financial services, however, would not likely add

substantial value to the day-to-day responsibilities of financial

services regulators.  Indeed, it is contrary to functional

regulation because it removes decision-making from the hands of

the expert regulator, and slows down the decision-making process.

A substantive regulator does its job best with clear

responsibilities and clear lines of authority.

III.  Maintaining the Vitality of the Securities Markets

     Legislation modernizing financial regulation must accurately

reflect the financial markets as they exist today.  Legislation

also must anticipate the needs of the financial services industry

into the twenty-first century.  With advances in

telecommunications and technology, the need for such meaningful

reform becomes even more critical.
==========================================START OF PAGE 19======
     The Commission questions, however, whether either H.R. 10 or

H.R. 268 provides sufficient flexibility to anticipate the likely

evolution in financial services.  

     Holding Company Regulation.  The regulatory models offered

by both bills are based predominantly on the existing “top-down”

regulatory model of the Bank Holding Company Act.  This model

provides for comprehensive regulation of all activities in

holding company affiliates, with the ultimate goal to ensure that

the affiliates’ activities do not threaten the safety and

soundness of affiliated banks.  The traditional holding company

model of regulation has never applied to securities holding

companies and appears to be less and less appropriate for many of

the nonbank activities now conducted by banks and their

affiliates.-[20]-  

---------FOOTNOTES----------
     -[20]-    H.R. 10 also offers a “special operating
               subsidiary” regulatory model that would permit
               special operating subsidiaries of banks, subject
               to oversight by the Comptroller of the Currency,
               to engage in activities that are “part of or
               incidental to the business of banking,” including
               underwriting, dealing in, and distributing
               securities of any type.  Special operating
               subsidiaries would also have authority to
               organize, control, manage and act as investment
               advisers to mutual funds.  The Commission believes
               that the same concerns regarding consolidated
               supervision arise regardless of whether a bank
               affiliates with a broker-dealer under a holding
               company or through an operating subsidiary
               structure.  Notably, the special operating
               subsidiary option in H.R. 10 would not provide the
               proposed reduced holding company oversight
               contained in H.R. 10 or the new holding company
               approach based on risk assessment contained in
                                                   (continued...)
==========================================START OF PAGE 20======
     Imposing a bank regulatory structure that is less flexible

than the securities regulatory structure on the U.S. securities

markets may not be a good idea.  As noted earlier, U.S.

businesses raise huge amounts of capital in our securities

markets.  This capital is raised through the entrepreneurial and

risk-taking efforts of securities firms.  Financial services

modernization must preserve the ability of securities firms to

assume risks, without layers of safety and soundness regulation,

to ensure the continued vitality of the U.S. securities markets

and the resulting flow of capital to the U.S. business community

at large.  It is critically important for the domestic economy

that U.S. securities firms remain innovative and competitive.

     H.R. 10 does provide for reduced approval, capital,

reporting and examination requirements for certain financial

services holding companies engaged primarily in nonbanking

activities and for certain investment bank holding companies.

This lighter supervision would be available only within the Bank

Holding Company Act structure, however, and only with approval of

the Federal Reserve Board.  The Commission appreciates this

effort to minimize the extent to which bank holding company

regulation would apply to holding companies with minimal levels

---------FOOTNOTES----------
     -[20]-(...continued)
               H.R. 268.  Commissioner Wallman notes further that
               provided appropriate protections are in place, the
               particular form of entity -- subsidiary or
               affiliate --should be irrelevant to the
               Commission.
==========================================START OF PAGE 21======
of banking activities.  The Commission supports a new holding

company approach based on the risk assessment model, however, for

effective regulation of a multi-service holding company, as

described below.

     Lead Regulator.  If a lead regulator is necessary, as

provided in both H.R. 10 and H.R. 268, the oversight of any

holding company in which a securities firm is the largest

affiliate in a holding company structure should be allocated to

the Commission, not to a bank regulator.  The Commission has the

experience and expertise to oversee companies conducting

primarily a securities business, and would defer to the

appropriate banking regulator with regard to regulation of any

affiliated bank.-[21]-

     Risk Assessment Oversight.  In lieu of traditional

consolidated holding company regulation, the Commission supports

an approach based on strong functional regulation, effective

---------FOOTNOTES----------
     -[21]-    Chairman Greenspan has testified on behalf of the
               Federal Reserve Board before Chairman Roukema’s
               Subcommittee that “[t]he case is weak . . . for
               umbrella supervision of a holding company in which
               the bank is not the dominant unit and is not large
               enough to induce systemic problems should [the
               bank] fail.”  Testimony of Alan Greenspan,
               Chairman, Board of Governors of the Federal
               Reserve System, Regarding H.R. 268, The Depositary
               Institution Affiliation and Thrift Conversion Act,
               Before the Subcomm. on Financial Institutions and
               Consumer Credit of the House Comm. on Banking and
               Financial Services (Feb. 13, 1997) (“Federal
               Reserve Testimony”).
==========================================START OF PAGE 22======
firewalls and risk assessment of affiliates’ activities.  The

Commission believes that a risk assessment model of oversight

would permit effective monitoring of non-banking activities,

while preserving bank safety and soundness regulation for bank

affiliates.  In addition, oversight based on a risk assessment

model looks towards a financial services industry of the future,

when related entities may have an even broader range of

activities than we presently anticipate.  

     The main benefit to a risk assessment model of supervision

in a restructured financial system is that it would not constrain

broker-dealers’ ability to innovate at the fast pace demanded by

the capital markets, while it would leave regulators free to

concentrate on focused supervision of the regulated entity.

Chairman Greenspan has cautioned that regulators must be careful

“that consolidated umbrella supervision does not inadvertently so

hamper the decisionmaking process of banking organizations as to

render them ineffectual.”-[22]-  While we commend the

Federal Reserve Board’s efforts to reduce the routine supervisory

umbrella presence in holding companies, we believe that any

requirement to obtain prior approval before engaging in new

activities -- a bank-style regulatory approach and an element of

consolidated supervision -- would unnecessarily hamper the

operation of securities firms.

---------FOOTNOTES----------
     -[22]-    See Federal Reserve Testimony.  
==========================================START OF PAGE 23======
     The Commission’s current use of a risk assessment model,

coupled with the Commission’s net capital rules, provides the

Commission with the ability to identify and respond in a timely

manner to risks that could potentially harm the broker-dealer and

ultimately the U.S. investor.  The risk assessment model the

Commission uses is set forth in Section 17(h) of the Securities

Exchange Act of 1934.  The model requires broker-dealers to

provide information routinely to the Commission regarding

potential risks to the broker-dealer that could be posed by the

activities of their affiliates.  The Commission also can obtain

additional information if necessary, such as in periods of market

stress.-[23]-

     The risk assessment model of regulation is designed to alert

regulators of impending problems, while minimizing the regulatory

burdens imposed on regulated broker-dealers and their affiliates.

If a broker-dealer has financial difficulty, the net capital rule

and the customer protection rule allow the Commission to

liquidate a broker-dealer, no matter how large, in an orderly

manner without significant loss to the Securities Investor

---------FOOTNOTES----------
     -[23]-    In addition to the risk assessment rules, the
               Commission requires broker-dealers to promptly
               report net capital and other operational problems
               and prohibits the withdrawal of excessive amounts
               of capital from a broker-dealer.  If a broker-
               dealer falls below its required minimum net
               capital, the Commission’s answer is to require the
               broker-dealer to immediately cease conducting a
               securities business.  
==========================================START OF PAGE 24======
Protection Corporation (“SIPC”) or the United States

government.-[24]-

     H.R. 268 includes elements of a risk assessment model but

introduces an element of uncertainty into broker-dealers’

activities.  The bill threatens the flexibility necessary for

broker-dealers to compete by authorizing bank regulators to

impose additional “safety and soundness” limitations on the

activities of banks’ securities affiliates.  Instead, we believe

that any controls necessary for bank safety and soundness should

be established in the bank by the bank regulator and necessary

controls for investor protection should be established in the

broker-dealer by the securities regulator or through firewalls

established by Congress.

     Congress has the opportunity to include in financial service

legislative reforms a risk assessment oversight system that

focuses on the risks of the activities of particular affiliates,

rather than the potential effect of those risks on the safety and

soundness of bank affiliates.  If Congress believes additional

oversight of a holding company is needed to monitor adequately

financial conglomerates, the Commission suggests that Congress

consider an expanded risk assessment model that offers more

---------FOOTNOTES----------
     -[24]-    SIPC protects the funds and securities of
               securities firms’ customers if the firms fail
               financially.
==========================================START OF PAGE 25======
flexibility than an approach based on top-down holding company

regulation.  

     Firewalls.  Regardless of which framework Congress

ultimately adopts for the oversight of financial markets,

carefully tailored firewalls addressing not only bank safety and

soundness concerns, but also conflicts of interest and adequate

customer disclosures, are particularly important.  For example,

Congress deemed it prudent in the Exchange Act to prohibit a

broker-dealer from overreaching to investors by lending them

funds to purchase securities being underwritten by the broker-

dealer.-[25]-  Firewalls should be established to similarly

prohibit banks from overreaching by lending funds to investors to

purchase securities being underwritten by their brokerage

affiliates.  Similarly, banks should be required to obtain

transaction-by-transaction consent from their customers to

prevent their affiliated broker-dealers from dumping their poorly

performing securities into the bank’s trust department.  

     Firewalls should not prevent development of competitive

opportunities for financial services holding companies.  On the

other hand, they should be strong enough to protect the federal

deposit insurance fund, to prevent banks from passing on any

possible funding advantages to their affiliates, and to restrict

any possible self-dealing and improper conflicts.

---------FOOTNOTES----------
     -[25]-    15 U.S.C. § 78k(d)(1).
==========================================START OF PAGE 26======
To the extent that firewalls are predicated on bank safety and

soundness, the Commission generally defers to Congress and the

banking regulators.  

     The Commission generally supports the firewalls in H.R. 10

and H.R. 268 that would require a securities affiliate of a bank

to make certain disclosures to its customers.  For example, the

bills would require disclosure that the securities being sold are

not FDIC-insured, not bank deposits, and not bank-guaranteed.  

     The Commission has reservations, however, about the way that

firewalls would be administered under H.R. 10 and H.R. 268.  The

bills would place sole authority in the Federal Reserve Board

(under H.R. 10) or the “appropriate Federal banking agency”

(under H.R. 268) to modify existing firewalls, to impose

additional firewalls, and to establish (by regulation or order)

the firewalls covering director and executive officer interlocks.

In order for firewalls to work effectively, securities and

banking regulators both must examine for compliance and must

communicate with each other about the effectiveness of the

firewalls from each side.  

==========================================START OF PAGE 27======
IV.  Competitive Opportunities to Provide Financial Services

     Banks now may affiliate with securities firms and engage in

securities activities to an extent unimaginable fifteen years

ago.  Fifteen years ago, we all thought that the Glass-Steagall

Act barred banks from affiliating with securities firms.  Now the

Glass-Steagall Act seems no more than a vestigial formality -- a

technical hurdle for a bank to jump before entering the

securities business.  

     Banking regulators routinely interpret the Glass-Steagall

Act and related banking laws to give banks and bank holding

companies the ability to own securities firms as special

operating subsidiaries and as so-called “Section 20”

subsidiaries.  This year, for instance, it is likely that Bankers

Trust New York Corporation will acquire Alex. Brown & Sons Inc.,

a full-service securities firm; SBC Warburg, a foreign investment

bank, probably will acquire Dillon, Read & Co., a blue-chip

broker-dealer; and it is possible that Zions First National Bank

---------FOOTNOTES----------
     -[26]-    The Office of the Comptroller of the Currency
               currently is reviewing an application by Zions
               First National Bank for authority for an operating
               subsidiary to underwrite, deal in, and invest in
               municipal revenue bonds (activities that a bank
               itself may not conduct).  The Federal Reserve
               Board recently amended its rules to raise from 10
               percent to 25 percent the amount of revenue that a
               Section 20 subsidiary may generate from bank-
               ineligible (i.e., securities) activities.  This
               amendment will allow Bankers Trust New York
               Corporation to proceed with its proposed
                                                   (continued...)
==========================================START OF PAGE 28======
will be allowed to underwrite and deal in municipal revenue bonds

through a subsidiary.-[26]-  

     The Glass-Steagall Act does not provide similar flexibility

for securities firms.  At present, the law, as a practical

matter, prohibits a securities firm from acquiring a bank.  This

has the effect of prohibiting securities firms from entering the

banking business -- either by establishing banking affiliates or

by establishing special bank subsidiaries.  

     The provisions permitting bank ownership of securities firms

presently create competitive inequalities among securities firms.

For example, securities firms affiliated with banks continue to

have advantages due to access to the Federal Reserve System

payments system.

     The Commission supports legislative efforts to permit

affiliation among banks and securities firms.  In particular, as

we have said many times, to the extent banks are allowed to own

securities firms, securities firms should be allowed to own

banks.

     H.R. 10 would make progress toward a two-way street by

allowing for “investment bank holding companies.”  These entities

would be subject to limited bank regulation and would be allowed

to conduct a broader array of activities than financial services

---------FOOTNOTES----------
     -[26]-(...continued)
               acquisition of Alex. Brown & Sons Inc., which will
               operate as a Section 20 subsidiary.
==========================================START OF PAGE 29======

holding companies.-[27]-  In addition, financial services

holding companies meeting certain criteria would have the

opportunity to qualify for lighter, albeit still banking, Federal

Reserve Board oversight and expanded activities.  This oversight

would still be banking oriented, however.  Beyond this, H.R. 10

still would require, pursuant to bank holding company-like

regulation, a securities firm to divest most of its commercial

business in order to acquire a bank.  As described earlier, the

Commission believes that traditional bank holding company-like

regulation by the Federal Reserve Board may not always be

appropriate, especially if a holding company’s banking affiliates

comprise only a small amount of the holding company’s overall

activities.  

     An effective financial regulatory system must allow

securities firms to continue to engage in entrepreneurial, risk-

taking activities crucial to the capital formation process

without the constraints of bank-like regulation.  The risk-based

oversight model described above would be especially important

when financial services regulation permits securities firms to

own banks.  Safety and soundness principles that serve as the

traditional basis for banking regulation would likely frustrate,

---------FOOTNOTES----------
     -[27]-    “Financial services holding companies,” which
               would replace bank holding companies under H.R.
               10, would be one of the possible structures under
               which banks and securities firms could affiliate
               pursuant to H.R. 10.
==========================================START OF PAGE 30======
rather than support, many of the activities of non-bank

affiliated entities providing a variety of financial services.  

V.   Commerce and Banking

     A regulatory structure that reflects today’s financial

marketplace and anticipates the future of financial services

should permit, at a minimum, some indirect mixing of commerce and

banking.  This is true especially when a securities firm or an

insurance company is part of a financial services holding

company.  Commercial companies and securities firms have always

been allowed to affiliate.-[28]-  Broker-dealers often hold

equity investments in commercial firms as a result of merchant

banking activities.  In addition, we understand that most

insurance companies have commercial affiliations.  The Commission

appreciates, however, that mixing commerce and banking presents

difficult and unique issues from the banking perspective.

VI.  Concluding Remarks

     The Commission generally supports efforts to update federal

financial services laws to recognize the changes in the financial

services industry and to plan for the future, subject to the

---------FOOTNOTES----------
     -[28]-    Currently, for example, The Travelers Group Inc.
               owns Smith Barney Inc., Equitable Companies, Inc.
               owns Donaldson, Lufkin & Jenrette, Inc., and The
               Prudential Insurance Company of America owns
               Prudential Securities Incorporated.
==========================================START OF PAGE 31======

concerns described above.  The Commission encourages the

Committee to make investor protection a top priority as you

consider modernizing the laws governing financial services.  To

do so, the laws must delineate clearly a rational system of

functional regulation.  A financial services industry in which a

substantial level of securities activities occur outside of the

system of securities laws and regulations is a financial services

industry that provides less than full investor protection.  

     Again, we sincerely thank you for offering us the

opportunity to appear before the Committee today and to provide

our thoughts for your consideration.  The Commission and its

staff stand ready to provide you with assistance as the debate on

financial modernization continues.
==========================================START OF PAGE 32======
APPENDIX A

                Bank Investment Company Activities

     The Commission commends Congress’ efforts in H.R. 10 and

H.R. 268 to update the provisions of the Investment Company Act

and the Investment Advisers Act to address issues that have

arisen out of increased bank involvement in the mutual fund

business.  As a general matter, the Commission favors modernizing

the regulatory scheme governing mutual funds to recognize and

address the greater involvement of banks in the mutual fund

industry.  However, the provisions of H.R. 268 that would amend

the Investment Company Act and Investment Advisers Act would

apply only to banks that are affiliated with a financial services

holding company (“FSHC”).  Banks that are not affiliated with a

FSHC would continue to operate under the present regulatory

scheme.  As a result, two banks engaged in the same mutual fund

activities could be subject to entirely different regulatory

schemes.  The Commission believes that entities engaged in the

same activities should play by the same rules and compete on a

level playing field.  For this reason, and as discussed in more

detail below, the Commission strongly recommends that the

provisions of H.R. 268 relating to investment companies and

investment advisers-[29]- be made applicable to all banks

---------FOOTNOTES----------
     -[29]-  Subpart B of Title III of H.R. 268 (sections 311-
324).
==========================================START OF PAGE 33======

that participate in the mutual fund business, as in H.R.

10.-[30]-

     Regulation under the Investment Advisers Act  

     Both H.R. 10 and H.R. 268 would amend the definition of

“investment adviser” in the Investment Advisers Act to include

banks that advise investment companies.-[31]-  H.R. 268,

however, would amend the definition to include as investment

advisers only those banks that are affiliated with a FSHC.  The

Commission strongly supports amending the definition of

“investment adviser” in the Advisers Act to include all banks

that advise investment companies, as in H.R. 10.-[32]-

This change would level the playing field for all entities that

provide investment advice to mutual funds.  It also would help

the Commission to more effectively police the mutual fund

industry.-[33]-  

---------FOOTNOTES----------
     -[30]-  Subpart B of Title II of H.R. 10 (sections 211-224).

     -[31]-  Section 217(a) of H.R. 10; section 317(a) of H.R.
268.

     -[32]-  Both H.R. 10 and H.R. 268 would allow banks to
segregate their fund investment advisory activities in a
separately identifiable department or division (“SID”), and to
register the SID (rather than the bank as a whole) as an
investment adviser.  We support this provision, provided it
applies to all banks, not just those that are part of a FSHC, as
would be the case under H.R. 268.

     -[33]-  When examining mutual funds that are advised by a
bank that is not a registered investment adviser, Commission
staff is precluded from reviewing trading records related to bank
                                                   (continued...)
==========================================START OF PAGE 34======
  

     Conflicts of Interest

     Banks are now significant participants in the mutual fund

industry.  Because this was not the case when the Investment

Company Act and the Investment Advisers Act were enacted, these

statutes currently do not specifically address all the conflicts

of interest that may arise when banks provide investment

management and related services to funds.  H.R. 10 and H.R. 268

recognize these conflicts and seek to address them.-[34]-

The following paragraphs discuss the specific provisions of the

bills that address these conflicts of interest.

---------FOOTNOTES----------
     -[33]-(...continued)
customers other than registered funds.  This limitation makes it
difficult to uncover certain practices that may violate the
Investment Company Act.  For example, a bank that advises a
mutual fund could allocate more profitable trades to bank trust
accounts and less profitable trades to the mutual fund.  Bank
advisory personnel also could engage in frontrunning the
securities transactions of the fund by trading the same
securities for their personal accounts.  If all banks that advise
mutual funds were subject to the Advisers Act, the staff would
have access to books and records that might reveal these
practices.

     -[34]-  Many provisions of the Investment Company Act
arguably provide the Commission with sufficient general authority
to prevent abusive practices by banks affiliated with mutual
funds.  The provisions in the bills are intended to supplement
this general authority with specific authority to regulate bank
mutual fund activities.  Of course, any rulemaking undertaken by
the Commission pursuant to this authority would have to satisfy
the standards set forth in section 2(c) of the Investment Company
Act, which requires the Commission to consider, in addition to
the protection of investors, whether the rulemaking will promote
efficiency, competition, and capital formation.
==========================================START OF PAGE 35======
     Bank serving as fund custodian.  Under the Investment

Company Act, a bank may serve as custodian of assets of an

affiliated mutual fund.  Both bills would permit mutual funds to

use affiliated banks as custodians in accordance with Commission

rules.-[35]-  H.R. 268, however, would limit this ability

to banks affiliated with a FSHC.  Both bills similarly would

authorize the Commission to adopt rules prescribing the

conditions under which a bank affiliated with the underwriter or

depositor of a unit investment trust may serve as trustee or

custodian of the trust, although H.R. 268 would restrict this

authority to a bank that is affiliated with a FSHC.-[36]-

While the Investment Company Act already gives the Commission

general rulemaking authority regarding mutual fund custodial

arrangements, H.R. 10 and H.R. 268 would confirm that this

rulemaking authority extends to custodial arrangements involving

affiliated banks.  By specifically restricting the rulemaking

authority to banks that are part of a FSHC, however, H.R. 268

calls into question the Commission’s authority with respect to

banks that act as custodian to affiliated investment companies

but that are not part of a FSHC.  The Commission therefore

recommends that the grant of rulemaking authority in sections

311(a) and (b) of H.R. 268 be extended to all banks that serve as

custodian for affiliated investment companies, as in H.R. 10.  We

---------FOOTNOTES----------
     -[35]-  Section 211(a) of H.R. 10; section 311(a) of H.R.
268.

     -[36]-  Section 211(b) of H.R. 10; section 311(b) of H.R.
268.  
==========================================START OF PAGE 36======

also suggest technical amendments to these provisions in both

bills to clarify that investment companies may use affiliated

banks as custodians in the absence of Commission rules.

     Both H.R. 10 and H.R. 268 would amend section 36(a) of the

Investment Company Act, which authorizes the Commission to bring

an action in federal court against certain persons who engage in

personal misconduct that constitutes a breach of fiduciary duty

owed to an investment company.-[37]-  The amendments would

extend section 36(a) to cover misconduct by an investment company

custodian, although in the case of H.R. 268, this amendment would

be limited to a custodian affiliated with a FSHC.  The Commission

supports an amendment applicable to all persons who act as a

custodian to an investment company, as in H.R. 10.

     Lending to an affiliated investment company.  Section 212 of

H.R. 10 would prohibit any affiliated person of an investment

company, or any affiliated person of such a person, from lending

money to the investment company in contravention of such rules or

orders as the Commission may prescribe.  Section 312 of H.R. 268

contains a similar prohibition, although it is limited to an

affiliated person of an investment company that is affiliated

with a FSHC.  Loans to an investment company from an affiliate

carry the potential for overreaching.  For example, the affiliate

---------FOOTNOTES----------
     -[37]-  Section 211(c) of H.R. 10; section 311(c) of H.R.
268.  
==========================================START OF PAGE 37======
could charge the company an above-market interest rate.  The

Commission therefore supports a grant of authority to deal with

any problems that may arise in connection with affiliates lending

money to investment companies.  The authority contained in

section 312 of H.R. 268, however, covers only loans from

investment company affiliates that also are affiliated with a

FSHC.  Under H.R. 268, the Commission would continue to be unable

to regulate loans to investment companies from banks, broker-

dealers, and other entities that are not FSHC affiliates.

Because the potential for overreaching exists regardless of

whether a lender is affiliated with a FSHC, we favor the approach

adopted in H.R. 10.-[38]-

     Definition of “interested person.”  The Investment Company

Act deems certain persons with a material relationship to an

investment company or to a company’s investment adviser or

principal underwriter to be “interested persons” of those

entities.  The Act limits the number of interested persons who

may serve on the board of an investment company and uses the

---------FOOTNOTES----------
     -[38]-  As currently drafted, the provisions of H.R. 10 and
H.R. 268 that govern loans from banks to affiliated funds would
be incorporated into section 18 of the Investment Company Act,
which addresses a fund’s capital structure.  We recommend instead
that these provisions be incorporated into section 17 of the Act,
which addresses transactions between a fund and its affiliated
persons.  In making this revision, we also would suggest certain
technical amendments to make the language in both bills conform
to Investment Company Act section 17(a)(3), which prohibits an
affiliated person of an investment company, or an affiliated
person of that person, from borrowing money or other property
from the investment company or any company controlled by the
investment company.
==========================================START OF PAGE 38======
interested person concept to minimize conflicts of interests.

For example, the Act requires a fund’s investment advisory

contract to be approved annually by a majority of directors who

are not interested persons of the fund or the fund’s adviser.

     The Investment Company Act defines an “interested person” to

include any affiliated person of a registered broker-dealer.

Section 213 of H.R. 10 would modify this definition by replacing

the broad reference to registered broker-dealers with a more

tailored reference to persons who engage in secondary

transactions with a fund or with certain related

persons.-[39]-  That bill also would expand the definition

to encompass persons who lend money to a fund or certain related

persons.

     Section 313(a) of H.R. 268 would amend the definition of

“interested person” of an investment company in the same manner

as H.R. 10, but would limit its application to a person

affiliated with a FSHC.  As with the other provisions of the

bill, section 313(a) would draw unnecessary distinctions between

entities engaged in the same activities.  Under section 313(a),

broker-dealers and lenders not affiliated with a FSHC would not

---------FOOTNOTES----------
     -[39]-  This section would largely codify a distinction
drawn in rule 2a19-1 under the Investment Company Act. In
addition, we recommend technical amendments to both H.R. 10 and
H.R. 268 to clarify that, in determining whether a person is an
“interested person” of an investment company, it is necessary to
consider the person’s activities during the 6-month period
preceding the date on which the determination is made.
==========================================START OF PAGE 39======
be interested persons of the fund, and thus would not be subject

to various Investment Company Act provisions designed to minimize

conflicts of interest.  The Commission supports expanding the

definition of interested person, as in H.R. 10, to cover all

persons that engage in the transactions described above, whether

or not such persons are affiliated with a FSHC.

     H.R. 10 includes a conforming amendment to the definition of

“interested person” of an investment adviser of, or principal

underwriter for, an investment company, that is not contained in

H.R. 268.-[40]-  The Commission believes that this

provision is necessary to prevent the conflicts of interest

sought to be addressed by the interested person definition and

therefore recommends that H.R. 268 be revised to include a

conforming amendment to section 2(a)(19)(B) of the Investment

Company Act.

     Composition of board of directors.  Both bills contain

provisions that are intended to strengthen the independence of a

fund’s board of directors.  Section 213(c) of H.R. 10 and section

313(b) of H.R. 268 would amend section 10(c) of the Investment

Company Act, which currently prohibits an investment company from

having a majority of its board of directors consist of persons

who are officers, directors, or employees of any one bank.  H.R.

10 would extend this prohibition to cover officers, directors, or

---------FOOTNOTES----------
     -[40]-  Section 213(b) of H.R. 10.
==========================================START OF PAGE 40======
employees of any single financial services holding company

(including its subsidiaries and affiliates) or of any single bank

(including its subsidiaries).  The Commission supports this

provision.  H.R. 268 contains similar language, but would limit

the prohibition so that it would apply only to officers,

directors, or employees of a bank affiliated with a FSHC.  The

Commission opposes the limitation included in H.R. 268.  Section

10(c) is intended to prevent interlocking relationships between

investment companies and banks.  The rationale underlying section

10(c) applies whether or not a bank is affiliated with a

FSHC.-[41]-  

     Voting requirements when a bank holds controlling interest

in a fund as a fiduciary.  Section 222 of H.R. 10 and section 322

of H.R. 268 would address certain conflicts that may arise when

an investment company’s adviser (or an affiliate of the adviser)

holds a controlling interest in the investment company in a

fiduciary capacity.-[42]-  To ensure that the adviser does

not use its fiduciary authority to further its own interests

(such as by voting to perpetuate itself as adviser to the

investment company), both bills would require the fiduciary to

---------FOOTNOTES----------
     -[41]-  In fact, section 313(b) of H.R. 268 would actually
lessen the protections found in section 10(c) by permitting a
majority of a fund’s directors to be associated with a single
bank, provided that the bank is not affiliated with a FSHC.

     -[42]-  Section 2(a)(9) of the Investment Company Act
creates a presumption of “control” when a person owns more than
25% of a company’s voting securities.
==========================================START OF PAGE 41======
follow certain procedures when voting investment company

shares.-[43]-  Under H.R. 268, however, these voting

procedures would not apply if the investment adviser is not

affiliated with a FSHC.  The Commission supports the voting

procedures contained in section 222 of H.R. 10 and recommends

that section 322 of H.R. 268 be amended to eliminate the

exception for investment advisers not affiliated with a FSHC.  As

with other provisions of H.R. 268, we believe that there is no

principled reason to differentiate between persons affiliated

with a FSHC and those that are not.

---------FOOTNOTES----------
     -[43]-  Specifically, the bills would require the fiduciary
to pass through voting rights to beneficiaries or certain other
designated persons, vote the shares it holds in proportion to all
other shareholders, or vote in accordance with Commission rules.

     The voting procedures required by the bills would not apply
to any investment adviser that provides investment advice to
church plans.  This exemption is unnecessary in light of recent
legislation that excluded church plans, and persons advising
church plans, from the scope of the Investment Company Act and
from registration under the Investment Advisers Act.  See § 508
of the National Securities Markets Improvement Act of 1996,
amending Investment Company Act § 3(c)(14) and Investment
Advisers Act § 203(b)(5).
==========================================START OF PAGE 42======

     Customer Confusion  

     Section 214 of H.R. 10 and section 314 of H.R. 268 are

intended to address potential customer confusion caused when

investors purchase securities on bank premises or purchase shares

of an investment company that has a name similar to that of a

bank.  We commend Congress for seeking to deal with this issue,

which has long concerned the Commission.-[44]-

     Both H.R. 10 and H.R. 268 would amend section 35(a) of the

Investment Company Act to prohibit investment companies or

sellers of investment company securities from representing or

implying that the investment company, or any security issued by

the company, is guaranteed by the U.S. government, insured by the

FDIC, or guaranteed by a bank.-[45]-  Section 214(a) of

H.R. 10 also would require any person who issues or sells

investment company securities to disclose prominently, in

accordance with such rules as the Commission may prescribe, that

---------FOOTNOTES----------
     -[44]-  Because common names can be a source of customer
confusion, the Commission staff has advised bank-sold and bank-
advised funds that the use of common names may be misleading.
The staff requires such funds to disclose prominently in their
prospectuses that fund shares are not deposits or obligations of,
or guaranteed or endorsed by, the bank and that the shares are
not federally insured by the FDIC, the Federal Reserve Board, or
any other agency.  The Commission has proposed to simplify this
disclosure requirement.  See infra note 18.

     -[45]-  Section 35(a) of the Investment Company Act
prohibits only representations that an investment company or its
securities are guaranteed, sponsored, recommended, or approved by
the United States.  
==========================================START OF PAGE 43======
neither the company nor any security issued by the company is

insured by the FDIC, guaranteed by an affiliated bank, or an

obligation of a bank.  Section 314(a) of H.R. 268 contains a

similar provision, but it would apply only to investment

companies or sellers of investment company securities that are

affiliated with a bank.

     The Commission supports the concept of a specific disclosure

requirement, but recommends that the bills be simplified in two

respects.  First, we believe that the disclosure requirement

should apply only to investment companies that are advised by, or

sold through, a bank.  We believe that customer confusion

resulting from common names between banks and bank-advised or

bank-sold mutual funds is not an issue with respect to funds that

are not advised by, or sold through, a bank.  Second, we

recommend that the disclosure statement required under both bills

be simplified to state in plain English that “an investment in

the fund is not insured or guaranteed by the FDIC or any other

government agency.”-[46]-

---------FOOTNOTES----------
     -[46]-  In its recent proposal to amend the registration
form used by open-end investment companies, the Commission
proposed that the prospectus disclosure requirement for bank-sold
or bank-advised funds be revised to include this simplified
statement, instead of the longer statement that currently is
required.  See Investment Company Act Release No. 22528 (Feb. 27,
1997) (release proposing amendments to Form N-1A); supra note 16
(discussing the disclosure statement that currently is required).
==========================================START OF PAGE 44======
     Both bills also would make it unlawful for any registered

investment company to adopt as part of its name, or the name of

any security it issues, any word or words that the Commission

finds are materially deceptive or misleading.-[47]-  These

provisions would authorize the Commission to adopt rules or issue

orders to prevent the use of deceptive or misleading names by

investment companies.  This amendment appears to be unnecessary,

as virtually identical language recently was added to the

Investment Company Act.-[48]-

     Section 314(b) of H.R. 268 also would provide that it is

deceptive and misleading for an investment company that is

affiliated with a bank that is affiliated with a FSHC to use as

part of its name, or the name of any security it issues, any word

that is similar to the name of the bank, in contravention of

Commission rules or orders.  Although the Commission supports the

regulation of deceptive and misleading names, we do not support

differentiating between investment companies whose names are

similar to a bank that is part of a FSHC and investment companies

whose names are similar to a bank that is not part of a FSHC.

Moreover, because it would apply only to banks that are part of a

FSHC, section 314(b) implies that the use of common names by

---------FOOTNOTES----------
     -[47]-  Section 214(b) of H.R. 10; section 314(b) of H.R.
268.

     -[48]-  See section 208 of the National Securities Markets
Improvement Act of 1996, codified at Investment Company Act §
35(d).
==========================================START OF PAGE 45======
funds whose affiliated banks are not part of a FSHC would not be

deceptive or misleading, and that the Commission does not have

rulemaking authority to regulate the names of such funds.  These

implications are contrary to the Commission’s position on common

names.  Finally, the authority conferred in section 314(b)

appears to be unnecessary because the Commission already has

sufficient authority under the Investment Company Act to make

rules and issue orders concerning misleading or deceptive fund

names.-[49]-

     Common Trust Funds  

     H.R. 10 and H.R. 268 would codify, with some changes, a

long-standing Commission position that the exception from the

securities laws available to bank common trust funds-[50]-

applies only if the fund is used solely to accommodate bona fide,

pre-existing trust clients of a bank, and is not advertised or

---------FOOTNOTES----------
     -[49]-  Investment Company Act § 35(d).

     -[50]-  The federal securities laws exempt interests in
common trust funds from the registration requirements of the
Securities Act of 1933 and exclude common trust funds from the
definition of investment company under the Investment Company
Act.  In addition, because interests in common trust funds are
exempted securities under the Securities Exchange Act of 1934,
persons effecting transactions in these interests need not
register as broker-dealers.  All three statutes limit the
exception to a common trust fund or similar fund maintained by a
bank exclusively for the collective investment or reinvestment of
moneys contributed thereto by the bank in its capacity as a
trustee, executor, administrator, or guardian.
==========================================START OF PAGE 46======
offered to the general public.-[51]-  Section 221 of H.R.

10 would modify the language of the common trust fund exception

in the Investment Company Act, and the companion provisions in

the Securities Act and the Exchange Act, to restrict the

exception’s applicability to a bank-maintained common trust fund

that meets three conditions.  First, the common trust fund must

be employed solely as an administrative convenience for the

management of accounts created and maintained for fiduciary

purposes.  Second, interests in the fund may not be advertised or

offered for sale to the public, except in connection with generic

advertising of the bank’s overall fiduciary services.  Third, the

common trust fund may not charge fees and expenses in

contravention of fiduciary principles established under

applicable federal or state law.  Section 321 of H.R. 268

contains a similar provision, but its restrictions would apply

only to a common trust fund maintained by a bank that is

affiliated with a FSHC.  

     The Commission generally supports codifying its position

with respect to common trust funds, as in section 221 of H.R. 10,

but does not support section 321 of H.R. 268.  Because H.R. 268

would apply only to common trust funds of banks affiliated with a

FSHC, it would result in the unequal regulation of common trust

funds.  It also would, by implication, overrule the Commission’s

common trust fund position with respect to banks that are not

affiliated with FSHCs, effectively permitting these banks to

---------FOOTNOTES----------
     -[51]-  Section 221 of H.R. 10; section 321 of H.R. 268.
==========================================START OF PAGE 47======
offer such funds to public investors without registration under

the Investment Company Act.