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PROPOSED MELLON-DREYFUS MERGER

THURSDAY, MARCH 3, 1994

HOUSE OF REPRESENTATIVES,
COMMITTEE ON ENERGY AND COMMERCE,
SUBCOMMITTEE ON OVERSIGHT AND INVESTIGATIONS,

Washington, DC. The subcommittee met, pursuant to notice, at 10:05 a.m., in room 2123, Rayburn House Office Building, Hon. John D. Dingell (chairman) presiding.

Mr. DINGELL. The subcommittee will come to order.

Before we begin, the Chair has a couple of administrative matters to address.

First, the subcommittee has sent a number of investigative letters to the parties to the proposed transaction and to the Federal banking and securities regulators. Without objection, these letters and the responses thereto, together with the exhibits and the briefing memorandum for these hearings, will be included in the hearing record as an appendix. (See p. 400.)

Also without objection, the Chair would like to insert in the record following the testimony of the second panel yesterday an explanation to clarify the sale of Lincoln bonds through the issuer exemption from broker-dealer registration. There was some confusion on this, and the Chair thinks that the record should be clear as to what happened and what the circumstances were.

So, without objection, those two matters will be attended to.

This morning the subcommittee continues its review of the public policy implications of the proposed acquisition of the Dreyfus Corporation by the Mellon Bank. This subcommittee and the full committee have had long standing concerns about the overlap of securities activities and banking activities. These concerns are heightened by a transaction that if approved will create the largest bank mutual fund operation in the country.

The subcommittee heard yesterday that consumers are vastly confused about whether securities products purchased through banks are federally insured. We have also heard that bank marketing practices, as well as factors inherent in any bank sales of securities products, contribute to this confusion. Problematic practices have included the following:

One, use of bank facilities to market securities. Two, hiring of bank personnel, including inexperienced personnel, to market securities. Three, cross-selling by bank employees. Four, using the bank's customer base. Five, inadequate disclosure of risk. And six, contradictory messages about the uninsured nature of the securities.

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The subcommittee has heard that the core of the problem was the association between the bank—with its Federal insurance and the security. Even more worrisome, we heard that confusion reigns despite written disclosures and oral statements.

We also heard yesterday about how unscrupulous marketers targeted—and I am now quoting from some of their instructions to their employees—"the weak, meek, and ignorant” and about the terrible human costs of this confusion. Yet we also were told that the present regulatory system has not offered, nor indeed can it offer, needed protection to investors. Investors in bank mutual funds also find themselves unwittingly in a statutory limbo without the most basic safeguards.

Today we will have before us Eugene Ludwig, the Comptroller of the Currency who, under present law, is all that stands between the fox and the henhouse. In fact, he may eventually serve as doorman to the henhouse. He stands without some of the most basic weapons that have evolved to protect securities investors-express suitability requirements, express training and qualification standards for brokers, private rights of action, securities arbitration, rescission rights, and others. He stands without a mandate to protect the securities investor. His mandate is simply to protect the safety and the soundness of the bank.

Mr. Ludwig recognizes that banks have an obligation to their customers to have them understand that mutual funds are not federally insured. He also acknowledges that bank regulators must address the risks associated with mutual fund activities. He also notes that conflicts of interests can result from mutual fund activities and that these conflicts can be substantial. He will also testify today about some of the actions that he has taken to address these concerns, as well as some of the procedural reforms now underway.

But are the paper protections for consumers being put in place going to be enough? Are the compliance policies and procedures recommended by the recent joint interagency statement on retail sales of non-insured investment products enough? We heard yesterday that they are not. We will ask Mr. Ludwig: Is it appropriate to continue to allow banks to engage in these kinds of activities during a period of great customer confusion? We heard requests yesterday for a pause in new approvals while consumer protections are put in place. We will ask Mr. Ludwig about this.

Do the bank regulators have sufficient statutory authority to protect investors? We heard yesterday they do not. We will again ask the Comptroller: Should we have confidence that the bank regulators will protect investor interests even to the detriment of the bank, or will they protect them at all if the bank's stability and economic well-being are at stake. We heard little yesterday to give us that confidence. We will again ask the Comptroller.

Also testifying today are the top officials from Mellon Bank and the Dreyfus Corporation whose proposed transaction has been the focus of much concern. They have recognized many of the dangers to consumers inherent in this acquisition and will offer a voluntary agreement to address many of them. We commend them for this. But billions of dollars are flowing into mutual funds every week. With that kind of profit at stake, and the potential peril to those investors who don't understand what is at risk, the question is:

Can we rely on volunteerism? On the basis of the record today, I am not sure we can.

As we heard yesterday there are inherent problems that need to be addressed. Consumer confusion is common place despite similar types of protections. The subcommittee will ask these four officers how they plan to address these problems and what level of consumer confusion is acceptable to them as their transaction goes forward.

The Chair wants to express the appreciation to all the witnesses for appearing here today. We look forward to hearing their testimony.

The Chair recognizes my good friend from Colorado.
Mr. SCHAEFER. Thank you, Mr. Chairman.

You have basically said it all. This is the second day of hearing on this very important subject designed to make sure that the consumers in this country are protected. I just look forward to hearing the testimony of the various witnesses we have before us today.

I thank the Chair for allowing Mr. McMillan here today. I think he has an opening statement if the chairman will allow him to do it.

Thank you.
Mr. DINGELL. The Chair thanks the gentleman.

The Chair advises Mr. Ludwig that we do welcome you to the subcommittee. Mr. Ludwig, we are happy that you are with us.

We recognize first the Honorable Eugene A. Ludwig, Comptroller of the Currency. Mr. Ludwig, this is the first time you have appeared before this subcommittee. I know that you understand that it is the practice that all witnesses who appear here testify under oath.

Do you have any objection to so doing?
Mr. LUDWIG. Not at all.

Mr. DINGELL. The Chair advises that since you are testifying under oath that it is your right to be advised by counsel during your appearance here. Do you so desire?

Mr. LUDWIG. I do not.

Mr. DINGELL. Very well. The Chair advises you that copies of the rules of the subcommittee, rules of the House, rules of the full committee are there at the table before you, to inform you both of your rights and limits on the powers of the subcommittee as we go into the proceeding in which we are about to start.

Ms. Broadman, are you to testify, too?
Ms. BROADMAN. No, I am not here to testify.

Mr. DINGELL. We will not swear you. If you choose to testify or you are going to testify, we will have to have your testimony under oath.

Ms. BROADMAN. I would be happy to be sworn in.
Mr. DINGELL. Then maybe we just better do it that way.

Very well, if you have no objection then, please rise and raise your right hand.

(Witnesses sworn.]

Mr. DINGELL. You may each consider yourself under oath. If you will proceed with your written statement, the Chair will recognize you for that purpose.

TESTIMONY OF HON. EUGENE A. LUDWIG, COMPTROLLER OF

THE CURRENCY, ACCOMPANIED BY ELLEN BROADMAN, DI. RECTOR FOR SECURITIES, INVESTMENTS, AND FIDUCIARY PRACTICES

Mr. LUDWIG. Thank you, Mr. Chairman and members of the subcommittee.

I appreciate this opportunity to testify on the sale of mutual fund investments by banks and specifically on the proposed acquisition of the Dreyfus Corporation by Mellon Bank.

Both the general subject area and the particular application raise important public policy issues. You are to be commended for your efforts to focus public attention on these issues.

I have a detailed written statement that discusses bank sales of mutual funds and the Mellon Dreyfus proposal. In the interest of time, I would like to submit the written statement for the record and focus my discussion this morning on what I have done in the last 11 months to create a regulatory environment for bank mutual fund sales that protects and promotes the interest of the consumer. I will also discuss the broad characteristics of the Mellon-Dreyfus proposal within this context.

Bank trust departments have acted as investment advisers, transfer agents, and custodians for mutual funds for decades. Retail sales of proprietary mutual funds were sanctioned and underway long before I become Comptroller.

In recent years, however, this area of bank activity has seen rapid growth. More than 150 banks—national banks, State member banks, and State nonmember banks now offer their own proprietary mutual funds.

The net assets of proprietary mutual bank funds doubled between 1989 and 1991, and doubled again between 1991 and 1993, reaching $200 billion in 1993. Bank sales of third-party mutual funds—those managed by firms outside the banking industry, also grew rapidly. These third-party funds account for roughly half of all bank mutual fund sales.

This growth in bank mutual fund activity raises new issues for bank regulation from both the safety and soundness perspective and from the perspective of consumer protection.

Since I took office last April I have worked hard to address those issues through a series of actions. Many of those actions have yet to bear fruit, some are bearing fruit already. In particular, I am working toward accomplishing five objectives.

First, to make sure that banks remain within the law as they offer mutual funds to the public.

Second, to make sure that customers understand that mutual fund shares purchased from banks are not federally insured.

Third, to make sure that banks handle their mutual fund operations in a way that does not threaten the safety of the bank or pose undue risk to the bank insurance fund.

Fourth, to make sure that banks address potential conflicts of interest.

And, fifth, to make sure we, the regulators, have the resources to respond to further sales growth in investment products going forward.

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To advance these objectives, we have over the last 10 months taken several specific steps.

Number one, I assigned one of my two senior policy advisers to coordinate OCC efforts in the mutual fund area.

Two, within 3 months of my arrival at the OCC, we published detailed guidelines governing the retail sale of mutual funds and other nondeposit investment products by banks. This guidance emphasized consumer protection, particularly by meaningful disclosure.

Three, we organized a working group of all Federal regulators of banks and thrifts to develop interagency guidelines on bank retail sales of mutual funds, guidelines that the agencies released jointly last month.

Four, I urged industry leaders to find a way for banks and thrifts to police themselves in this area, and have repeatedly addressed industry groups on this topic. Partly as a result of this effort, the bank trade associations for the first time adopted joint retail investment product sales guidelines last month.

Five, we have developed a program of mutual fund examinations and have issued new examination procedures to assure that national banks comply with our guidelines. We have devoted substantial time and effort to developing the mechanism for systematic, systemic supervision and examination aimed specifically at bank mutual fund activities.

Six, we are working with the SEC in a variety of ways, including investigations and enforcement actions, information sharing, and periodic staff meetings on policy issues. Further, we have joined the SEC in a research effort, based on a comprehensive survey of households, to improve our understanding of why some consumers are confused when they purchase mutual fund shares and to learn what kinds of disclosures work best in addressing that confusion. Through the use of focus groups in this first phase of this research, we are already gaining important insights into these issues.

Seven, we have published a brochure entitled “Deposits And Investments: There is a Critical Difference" to alert bank customers to the risks in nondeposit products sold by banks. We are distributing the brochure through the Consumer Information Center. We believe more than a million copies of this brochure have now been printed.

Mr. Chairman, my efforts in this area reflect my personal commitment to keep the OCC at the forefront of bank supervision in general and to protect the consumer in particular.

I also bring those commitments specifically to the Mellon-Dreyfus proposal. Because of the importance I assign to both the supervisory and consumer protection issues attending this application, I have taken the unusual step of soliciting public comment on it, and on a similar proposal by First Union National Bank to acquire Lieber & Company and the Evergreen Asset Management Corporation.

We are currently reviewing the Mellon application. In that review, we are particularly focused on the commitments in the proposal and on the availability of appropriate safeguards to ensure that customers understand which products offered by the combined entity would be federally insured and which would not be federally

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