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insured. We are coordinating our review with the Securities and Exchange Commission, and are specifically interested in the SEC's experience regulating Dreyfus, and in whether the SEC had any particular concerns of which we should be aware as we process Mellon's proposal.

Of course, we also want to safeguard the safety and soundness of the combined entity. We will carefully consider the controls utilized by these two entities, and we will carefully consider the adequacy of capital. I cannot tell you whether we will approve this application, but I can assure you that we will not approve it without addressing the important consumer and safety and soundness issues it raises. Let me emphasize that the issue of adequate consumer protection will be an important part of our consideration.

Mr. Chairman, I have spent the last 11 months working to mobilize the OCC, the Federal bank regulatory establishment, and the banking industry itself to address the supervisory and consumer protection issues raised by the growing volume of bank mutual fund activity. We are making progress, but we still have far to go.

I am fully committed to this effort and I am confident that in cooperation with the SEC, my fellow bank and thrift regulators, and industry and consumer leadership, we will overcome the challenges we face in this area.

Thank you. I welcome your questions.
[Testimony resumes on p. 295.)
[The prepared statement of Mr. Ludwig follows:)

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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, N.A., a national bank supervised by the Office of the Comptroller of the Currency (the OCC). Bank sales of mutual funds, and this proposal in particular, raise public policy issues of concern to both the banking industry and the public. I commend you for your efforts to focus attention on these issues.

Last year in a major policy address, I made it clear that any decision I make regarding the activities of banks will turn on whether I have the authority to approve an activity and, where I have that authority, on whether the activity can be conducted in a safe and sound manner by banks and on whether the activity benefits consumers of financial services. I developed those criteria because I recognized that in our dynamic financial services market supervisors must regularly decide what products and services banks may offer.

I believe that bank involvement in mutual funds meets those criteria and consequently represents sound public policy. As I will describe in greater detail, such involvement rests upon clear legal authority and poses safety and soundness issues that are no more complex or demanding than others our examiners face day in and day out. Bank involvement in mutual funds also presents clear consumer benefits. It offers customers greater convenience and greater choice in shopping for mutual fund services, and it permits banks to compete on a equal footing with other providers of financial services, enhancing competition in the market for mutual funds.


Supervisory diligence will be needed if consumers are to take the full measure of these benefits, and the OCC has begun that effort. It has been clear to us for a long time that the safety of deposit insurance is inscribed on the minds of bank customers. Bank involvement in mutual funds sales puts that well-deserved sense of security to a new test, for there is a tendency among customers to believe that mutual fund products are as safe as insured deposits. They are not. Banks must take--and we will make sure they take--every step necessary to educate their customers about the true risks of mutual funds. This exercise in disclosure and public education, will help to ensure that customers are not misled, and that they make intelligent and well-educated decisions when deciding to buy or not to buy bank mutual fund products.

In my first year as Comptroller of the Currency, I have also worked to ensure that national banks conduct their business in a way that makes their products and services available to all people. Mr. Chairman, I believe that there is a link between new products and services and the ability of banks to serve the needs of all citizens. In particular, I am convinced that over the long haul locking banks away from profitable opportunities will reduce both their safety and soundness and the competitive vigor of financial markets.

As you are well aware, retail sales of mutual funds by commercial banks have grown dramatically in recent years. More than 150 banks--including national banks, state members banks, and state non-member banks--now offer their own, "proprietary" mutual funds. The net assets of proprietary 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), which still account for roughly half of all bank mutual fund sales, also grew dramatically.

Mutual funds activities are not entirely new to banks or their regulators. Under OCC supervision, bank trust departments have acted as investment advisors, transfer agents, and custodians for mutual funds for more than 20 years. Some banks have also provided their customers with access to third-party mutual funds through their brokerage operations. But the rapid expansion in recent years of bank mutual fund activities brings into closer focus a number of important regulatory policy considerations:

The Glass-Steagall Act prohibits banks from engaging in certain securities activities. Bank regulators must ensure that banks limit their mutual fund activities to those permitted by law, and that they avoid activities that are prohibited by Glass-Steagall.

The notion that bank customers are protected from loss by the FDIC is deeply ingrained in the public perception of bank products. Bank regulators must ensure that bank customers understand that mutual fund shares purchased from banks are not federally insured.

The risks inherent in mutual fund activities--particularly for banks entering the business for the first time or expanding the scope of their mutual fund activities-poses supervisory issues for bank regulators. We must ensure that banks structure and manage their mutual fund operations in such a way that they do not present unacceptable liquidity, operational, or legal risk to the bank or undue risk to the Bank Insurance Fund.

As with any nondeposit investment product, a bank's mutual fund activities can raise potential conflicts of interest with its fiduciary obligations to its customers. Regulators must ensure that banks have adequate controls to identify and manage potential conflicts of interest.

The growth of nontraditional banking activities, including mutual fund activities, exposes banks to new kinds and combinations of risks. Bank regulators must ensure that they have adequate supervisory policies and procedures in place, and adequate numbers of well-trained examiners to carry them out.

The Challenge to Bank Supervisors

The Senate confirmed me as President Clinton's choice to be Comptroller of the Currency on April 4 of last year. Shortly after my confirmation, I concluded that the dramatic increase in the scale of bank mutual fund operations called for decisive action. Many banks are entering into mutual fund ope ons for the first time, or increasing the scope of their operations


significantly. Some banks are doing so through large acquisitions that can have important implications for the bank's structure and governance. And banks' mutual fund sales efforts are now reaching a far broader set of customers than has traditionally been served by bank trust departments. These developments naturally raise the level of supervisory concern with how banks conduct their mutual fund operations. Let me list some of the things we've done in the last year.

I met with consumer groups to gain a better understanding of bank customer concerns.

I communicated to the banking industry, in several major speeches, the importance of adopting practices that would help ensure that their customers understand the risks of nondeposit products banks sell.

I assigned a Senior Policy Advisor, David Apgar, formerly of Lehman Brothers, a New York investment bank, to coordinate OCC efforts in the mutual funds


In July, 1993, we published detailed industry guidance on the retail sale of mutual funds and other nondeposit investment products--the first of its kind published by any bank regulatory agency.

We worked closely with the other Federal regulators of banks and thrifts to develop interagency guidelines, which the agencies released jointly last month.

I had a number of meetings with industry leaders to impress upon them the importance of taking steps to avoid customer confusion. Partially as a result of those meetings, the banking trade associations adopted retail investment sales guidelines.

The OCC developed a program of mutual fund examinations, and issued new examination procedures to ensure that national banks comply with our guidelines.

I had a number of meetings with SEC Chairman Arthur Levitt to discuss the issues surrounding bank sales of mutual funds, and we initiated ongoing staff-tostaff contacts to see how we could coordinate our supervisory efforts.

OCC and SEC staff have initiated a joint research effort, including a comprehensive survey of households, to improve our understanding of the sources of confusion when individuals purchase mutual fund shares and to learn what kinds of disclosures work best in addressing that confusion.


Working with the banking industry, the OCC has begun an effort to contact bank customers to learn directly from them about their experiences in purchasing mutual funds from banks.

We published a brochure entitled Deposits and Investments: There's A Critical Difference to alert bank customers to the risks in nondeposit products sold by banks. Nearly one million copies of the brochure have been made available to the public.

Mr. Chairman, our efforts in dealing with bank sales of mutual funds are an important part of my commitment to keep the OCC at the forefront of bank supervision. To meet that commitment, it is critical that we stay abreast of change and develop policies and practices that are appropriate in a dynamically changing market for financial services.

I will now turn to a discussion of the issues facing banks that engage in mutual fund activities and their supervisors.

Legal Authority

Although my tenure as Comptroller began after the significant statutory, judicial, and interpretive developments in this area, I have included this brief history and description of banks' legal authority for the convenience of the Subcommittee.

The authority of national banks to engage in activities related to mutual funds derives from the National Bank Act's grant of authority to engage in activities that are part of or incidental to the business of banking', and from national banks' express powers to provide fiduciary and custodial services and to act as transfer agents?. Banks and their affiliates or subsidiaries may provide investment advice to mutual funds and to customers, may broker mutual funds, may advertise and market their services, and may provide a range of administrative and shareholder-related services to mutual funds. Such services may include acting as transfer agent, custodian, and registrar, and providing record-keeping, accounting and related services. However, national banks have not been authorized to sponsor or distribute most mutual funds.

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