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do testify under oath. Do either of you desire to be advised by coun-
Mr. LEVITT. No.
Mr. DINGELL. Gentlemen, the Chair advises then that copies of the rules of the subcommittee, and of the House of Representatives are there before you in the red and the blue books for your information as you appear and testify before us.
Gentlemen, if you will then please rise and raise your right hands.
Mr. DINGELL. Gentlemen, you may each consider yourselves under oath. The Chair now recognizes you for such statement as you choose to give.
TESTIMONY OF HON. ARTHUR LEVITT, JR., CHAIRMAN, SECU
RITIES AND EXCHANGE COMMISSION, ACCOMPANIED BY
Mr. LEVITT. Chairman Dingell and members of the subcommittee, I appreciate this opportunity to appear before you on behalf of the Securities and Exchange Commission. Accompanying me this morning is Barry Barbash, the Director of the Division of Investment Management. We are here today to discuss the concerns that Mellon Bank's acquisition of the Dreyfus Corporation raises regarding the current regulatory structure governing the securities activities of banks.
Now is the time for us to take action on the issue of functional regulation. This proposed merger, which will create the largest bank mutual fund operation in the United States with 4 percent of all mutual fund assets, I think provides us with the perfect opportunity to plan ahead. It provides the ideal backdrop to ensure that the American people will never see their financial regulators pointing their fingers at one another about who let what slip through the cracks of oversight.
The $1.85 billion of Mellon-Dreyfus is just one of the most striking examples of the recent growth of bank involvement in the mutual fund industry. Today, 113 banks and bank subsidiaries advise almost 1000 mutual funds with $204 billion in assets, which is more than 10 percent of total mutual fund assets.
Banks also are increasingly active in public sales of mutual fund shares, by some estimates, accounting for more than one-third of all new sales of money market funds. Under the current law, banks that act directly as broker-dealers or investment advisers are excluded from the Securities Exchange Act of 1934 and the Investment Advisers Act of 1940.
These exclusion date from a time when banks were insignificant participants in the securities business mostly because of the restrictions of the Glass-Steagall Act. Applying broker-dealer and adviser regulation to banks, therefore, seemed unnecessary at that time.
Those days have passed, and this vintage structure makes less sense in the 1990's when the interpretation of the Glass-Steagall
Act has been broadened piecemeal without the benefit of a sound statutory foundation of functional regulation.
Banks already are major participants in the securities markets, and it is likely that their role will continue to grow as their customers move from insured deposits into mutual funds and other uninsured securities products. Will the bank exclusions, a historical vestige of a simpler time, continue in effect?
Because of its size, the Mellon-Dreyfus merger dramatically highlights the SEC's concerns regarding the current regulatory structure governing the securities activities of banks. If the merger is completed as originally proposed, Dreyfus is going to become a subsidiary of Mellon Bank, not the Mellon holding company. Dreyfus will remain subject to oversight under the Federal securities laws only because it has agreed to remain a separate entity, at least for the time being.
If the bank were to choose to conduct these same activities itself directly, and not through a separate corporation, the framework of the Federal securities laws would not apply. The concern that the Federal securities laws should apply to bank securities activities, and in particular to bank mutual fund sales, arises from three policy objectives.
First, protecting investors by avoiding overreaching and confusion. Second, ensuring undivided loyalty to the customer by avoiding potential conflicts of interest between banks and their affiliated mutual funds. Third, ensuring that investor protection, rather than bank safety and soundness and depositor protection, remains the foremost concern of regulation, examination, and enforcement programs.
Although the parties to the Mellon-Dreyfus transaction have taken voluntary steps to address many of these concerns, there is no guarantee that the relationship between the mutual fund activities and banking activities will not change in the future because of either economic or competitive pressures. And no statutory safeguards apply to the growing number of banks that, like Mellon, are expanding their bank mutual fund activities.
This is just the beginning. These banks should not have the option of declining to submit to securities regulation.
Of course, a major danger fostered by the current regulatory structure is that investors may not realize that the mutual fund or other security sold to them by or through their bank is not federally insured.
The SEC has long been at the forefront of publicizing this danger. Last May, the Commission staff took this issue head on by requiring prospectus cover pages of bank-marketed mutual funds, and funds with names that are similar to banks, to prominently disclose that the shares are not insured.
We sponsored an eye-opening survey which demonstrated that 66 percent of bank mutual fund shareholders believed that their funds were insured. And we are actively working with the mutual fund industry to close the regulatory gaps through investor guides and investor bulletins and whatever other devices can be employed to change this very serious misperception.
Some policymakers ask whether cooperation between the SEC and other Federal banking regulators is the answer to these concerns. In fact, because of efforts that Comptroller Ludwig and I initiated, the SEC and the banking agencies have been working together on an informal basis for some time.
However, I would say that these efforts are merely a stopgap. They make the best of a difficult situation by relying largely on personal relationships and personal goodwill. Joint regulatory and inspection efforts, I think, can never really substitute for institutional relationships grounded in sound public policy and written into law after years and years of experience that will survive long after I and other current regulators have left our offices.
To replace this patchwork quilt, I would hope that Congress can ensure that the expert securities regulator designated nearly 60 years ago, the SEC, can protect investors through uniform rules consistently applied to all participants in the securities markets. Five basic points demonstrate the urgent and compelling need for functional regulation:
First, investor protection must be the priority when banks engage in securities activities. Bank safety and soundness and protection of the bank's depositors are certainly appropriate priorities when regulating banking activities that concern taxpayer insured funds. But there are other priorities when it comes to regulating bank activities in the securities marketplace.
The banks' customers in its securities activities have different interest from the banks' depositors and the FDIC and other regulators. I think one of the great SEC Chairman in history, William Cary, put it better than anything I could think of when he said in 1963: "The great objectives of banking regulation are controls over the flow of credit in the monetary system, the maintenance of an effective banking structure, and the protection of depositors. [But) these objectives neither utilize the same tools nor achieve the same results as (SEC standards of] investor protection.”
Second, 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-dealer, and a comparable scheme simply does not exist under banking law.
For example, bank securities sales personnel are not subject to a uniform qualification, examination, and disciplinary program that focuses on the potential for abuse that exists in connection with securities activities.
Third, customer confusion about bank sold securities simply has to be eradicated. Sales of mutual funds conducted in a bank's lobby next to the very windows which take bank deposits, or sales conducted by bank employees, may mislead customers into believingand indeed they have misled customers into believing—that these mutual funds may be federally insured.
Common or similar names may also mislead bank customers. In spite of voluntary measures and efforts by banking regulators, recent surveys-led by an SEC-sponsored survey that was, I might add, corroborated by at least two subsequent surveys conducted by other organizations-indicate a troubling degree of investor confusion about the status of their investment in bank mutual funds.
Fourth, functional regulation would certainly be more rational than our current patchwork system. In an era of regulatory consolidation and reinventing government, a separate regulatory scheme is certainly redundant and wasteful from the taxpayer's perspective—it hardly seems appropriate for the Federal bank regulators to hire and train what becomes no more than a “mini-SEC” staff.
Finally, functional regulation would eliminate the existing regulatory gaps. Under the fragmented regulatory scheme enforced today, the Commission is unable to supervise securities activities conducted directly by banks. In an increasingly complex and interconnected financial services marketplace there is an increased danger that fraud one day might simply slip through the cracks because the SEC lacks full access to records in an examination. This, I think, is a significant and an avoidable systemic risk.
The Commission believes that these concerns have really been fully addressed by functional regulation and the bill to address that program introduced by Chairmen Dingell and Markey and Congressmen Moorhead and Fields-H.R. 3447. The Commission strongly supports this bill as a means of enhancing investor protection and eliminating the current regulatory duplication and vulcanization that inevitably result from Federal statutory exclusions for bank securities activities.
H.R. 3447 would promote consistent, functional regulation of all market participants that offer the same products and perform the same functions. It would apply proven, legally enforceable brokerdealer competency standards, supervision requirements, suitability and sales practice rules, and financial responsibility requirements to banks and bank employees involved in securities sales.
The bill would also address the conflicts of interest between banks and their affiliated investment companies. The SEC is pleased to reiterate, reinforce and restate its support for H.R. 3447, and to urge its prompt enactment.
Mr. Chairman, I welcome the opportunity to be before you today, and to address questions that you or your colleagues may have.
[Testimony resumes on p. 32.)
ARTHUR LEVITT, CHAIRMAN
Chairman Dingell and Members of the Subcommittee:
I appreciate this opportunity to appear before the Subcommittee on Oversight and Investigations, on behalf of the Securities and Exchange Commission, to comment on the proposed acquisition of The Dreyfus Corporation ("Dreyfus“) by Mellon Bank, N.A. and its parent bank holding company, Mellon Bank Corporation ("Mellon"). The Mellon/Dreyfus merger will result in the largest bank mutual fund operation in the United States. As such, it raises in the most dramatic context to date the Commission's concerns regarding the current regulatory structure govering the securities activities of banks. My testimony today will focus on these concerns, especially the functional regulation issues that are highlighted by the proposed transaction. I also will comment on H.R. 3447, a functional regulation bill introduced by Chairmen Dingell and Markey and Congressmen Moorhead and Fields, which
the Commission strongly supports.
1. The Proposed Mellon/Dreyfus Transaction
On December 6, 1993, Mellon and Dreyfus announced their agreement to merge in a
transaction valued at $1.85 billion. 1/ If the merger is completed as originally proposed, Dreyfus will become a subsidiary of Mellon Bank. Dreyfus is a registered investment adviser that advises mutual funds with $72.2 billion in assets (the sixth largest family of mutual funds in the United States). 2/ Ranked by asset size, Mellon is the 21st largest bank holding company in the United States. Mellon Bank, its lead banking subsidiary, is currently 22nd among banks in mutual fund assets under management. Mellon Bank already
See Mellon Bank & Dreyfus, "Mellon Bank Corporation and the Dreyfus Corporation to Merge in Stock Transaction Valued at $1.85 Billion," Dec. 6, 1993.
See Lipper Analytical Services, Lipper Directors' Analytical Data (4th ed. 1993) ("Lipper Directors' Dala"). All asset figures are as of September 30, 1993.