5 The existing regulatory system needs to be rationalized. The existing regulatory scheme for bank securities activities simply makes no sense. While bank affiliates and subsidiaries that engage in securities activities must register with the Commission like any other broker or dealer, banks that engage directly in securities activities continue to be exempt from broker-dealer regulation. In short, the law elevates corporate form over substance. The unique treatment afforded bank securities and mutual fund activities also stands in contrast to the regulatory schemes for bank municipal and government securities activities, which are regulated under the federal securities laws. Finally, the continued existence of a separate regulatory scheme for banks makes little sense in an era of regulatory consolidation. At a time when government resources are strained, it hardly seems appropriate for the federal bank regulators to hire and train a "mini-SEC" staff, to perform potentially duplicative and overlapping examinations, when a government agency already exists to do the job. Regulatory gaps need to be eliminated. Under the existing fragmented regulatory scheme, the Commission is unable to supervise bank securities activities, which are an increasingly important segment of the securities industry. As the regulator charged with oversight of the securities markets, the Commission needs to have a comprehensive view of those markets and the participants in them. Our nation's capital markets are the largest, best, and most liquid in the world, but their continued success depends in considerable part on fair and effective regulation, and public confidence in that system of regulation. Investors deserve a single, consistent standard of protection, whether they purchase securities from a bank or a registered broker-dealer. Currently, investors who purchase securities directly from banks are not protected by the securities regulatory scheme that exists for broker-dealers. While banks that sell securities and advise investment companies are excluded from federal securities regulation, federal banking law does not provide a comparable regulatory scheme for bank securities activities. For example, bank securities sales personnel are not tested for competence, nor are they subject to an examination and disciplinary program, such as the program administered by the National Association of Securities Dealers, Inc. ("NASD"), that focuses on the potential for abuse that exists in connection with securities activities. Investor protection must be a priority. Bank regulation and examination generally seek to ensure bank safety and soundness and depositor protection. Thus, bank regulators typically focus on maintaining the institution, rather than on investor protection. Notably, the guidelines issued recently by the federal banking regulators are not enforceable by the banking regulators or by bank customers. Moreover, federal banking laws do not generally contain private rights of action for investors and there is no banking laws counterpart to the securities arbitration scheme for bank securities investors. In contrast, investor protection is paramount under the federal securities laws, and the Commission's enforcement program is driven by investor protection principles. Customer confusion about bank-sold securities needs to be eradicated. Sales of mutual funds conducted in a bank's lobby or through bank employees may mislead customers into believing that the mutual funds are federally insured. Common or similar 6 names may also mislead bank customers. 11/ Despite voluntary measures and efforts on the part of banking regulators, recent surveys indicate a troubling degree of investor confusion about the uninsured status of bank mutual funds. 12/ The Commission believes these concerns are fully addressed by H.R. 3447, which the Commission strongly supports. Clearly, today's market realities indicate that the time has come for Congress to eliminate the existing statutory exclusions for banks. The remainder of this statement provides more comprehensive historical and background information on the existing regulatory structure for bank securities activities. It also comments in greater detail on H.R. 3447. 11/ 12/ The Commission's staff expressed its concern about the risk of customer confusion See e.g., Testimony of Chairman Arthur Levitt Before the Securities Subcommittee II. 7 Existing Regulatory Structure for Bank Securities Activities A. Historical Background When the Securities Exchange Act of 1934 ("Exchange Act") was enacted, banks were excluded from the regulatory scheme provided for brokers and dealers, based in large part on the assumption that the Glass-Steagall Act barred banks from engaging in most securities activities.13/ Although that presumption may have been warranted at the time, it is no longer valid. Over the last two decades, the federal banking regulators have expansively interpreted the Glass-Steagall Act in a manner that permits banks to engage in a wide range of brokerage and other securities activities that are comparable to, and competitive with, services offered by registered broker-dealers. Because the statutory exclusions remain in place, however, banks that engage in securities activities, including sales of mutual funds and other securities to the investing public, have the option of conducting those activities outside the framework of the federal securities laws. Based on the same reading of the Glass-Steagall Act, banks were (and remain) excluded from federal regulation as investment advisers under the Investment Advisers Act of 1940. Thus, even though banks now provide investment advice to a wide range of individuals and registered investment companies, they do so outside the regulatory structure established under the federal securities laws. The Commission is not expressly authorized to conduct inspections of banks that serve as investment advisers a limitation which in turn 13/ See Stock Exchange Regulation: Hearings on H.R. 7852 and H.R. 8720 Before the House Comm. on Interstate and Foreign Commerce, 73d Cong., 2d Sess. 86 (Feb. 16, 1934)(statement of Thomas G. Corcoran, an administration spokesman and a principal drafter of the Exchange Act). 8 hinders the Commission's ability to oversee the operations of the banks' affiliated investment companies. Federal banking law, moreover, does not fill the significant gaps created by the bank exclusions contained in the federal securities laws. As illustrated below, developments over the past two decades have only caused the gaps to grow wider. The Commission first analyzed the regulatory scheme for bank securities activities in 1977, when it issued a Report on Bank Securities Activities ("Bank Study"), as mandated by Section 11A(e) of the Exchange Act. 14/ Because bank securities activities were far less extensive at that time than they are today, the Commission did not recommend full brokerdealer registration for banks engaging in securities activities. Instead, the Commission recommended the enactment of legislation that would require the federal banking agencies to adopt and enforce, in consultation with the Commission, specific rules governing the conduct of banks engaged in securities activities, with a mandate to provide investor protection. In addition, the Commission urged that bank employees and bank examiners receive specific training in the securities laws and practices of the securities markets. Finally, the Commission recommended that the federal banking agencies be required to consult regularly with the Commission regarding their securities examination programs, share information regarding examination results, and inform the Commission of actual or potential violations of the federal securities laws. In response to the Bank Study, the federal banking regulators indicated that they could adopt the necessary regulations without a Congressional mandate. The federal banking 14/ See Report on Bank Securities Activities of the Securities and Exchange Commission Pursuant to Section 11A(e) of the Securities and Exchange Act of 1934 (Public Law 94-29), August 1977. 9 regulators, however, eventually adopted only limited recordkeeping and confirmation requirements for securities transactions. The other recommendations of the Bank Study were not implemented. In the early 1980s, banks began to offer publicly-advertised discount brokerage services. Because the bank regulatory scheme made no provision for investor protection, the Commission responded to this development in 1985 by adopting Rule 3b-9, which would have required banks engaged in public brokerage business to register with the Commission. 15/ However, Rule 3b-9 was struck down by the courts. 16/ The Commission subsequently recommended that Congress enact the Bank Broker-Dealer Act, legislation that would have brought most bank broker-dealer activities within the regulatory framework established under the federal securities laws. 17/ B. Overview of Current Regulatory Structure Before turning to recent developments relating to bank securities activities, it is important to consider the existing regulatory structure for bank securities activities and some of the more significant regulatory disparities that exist with respect to bank broker-dealer and investment adviser activities. 15/ 16/ 17/ At the time Rule 3b-9 was proposed, Commission staff negotiated extensively with ABA v. SEC, 804 F.2d 739 (1986), reh'g denied, No. 86-80 (D.C.Cir. Jan. 12, The Bank Broker-Dealer Act was introduced in the Senate by Senator D'Amato on |