hindered in their ability to detect violations of the federal securities laws.18/ D. Need for Additional Legislation The Mellon/Dreyfus merger underscores the need for functional regulation of bank securities activities. The Commission currently regulates all mutual funds under the Investment Company Act, including bank advised funds. Due to statutory provisions that exclude banks from regulatory requirements that apply to investment advisers and brokerdealers, however, the Commission has only limited ability to regulate the banks that advise and/or sell interests in such mutual funds. The Commission believes that these bank exclusions should be eliminated in light of the dramatic increase in bank securities activities over the past decade, and especially since banks are among the largest participants in the securities business (as illustrated by the Mellon/Dreyfus merger). As previously noted, because banks are excluded from the Act's definition of "investment adviser," Commission examiners cannot comprehensively view a bank advised mutual fund's operations because the adviser's records are not available for inspection.19/ This creates a particularly significant gap with respect to the evaluation of potential conflicts of interest between a mutual fund and its adviser.20/ As discussed above in 18/ Regardless of how the merger occurs, it will cause an "assignment" of Dreyfus' investment advisory contracts with 19/ Bank fiduciary activities are inspected by the federal banking regulators. These inspections, however, do not focus on issues such as conflicts of interest under the Investment Company Act nor are they coordinated with Commission inspection and enforcement efforts, which focus on securities law issues. 20/ As noted above, the staff has been advised that Dreyfus will remain a registered investment adviser. The Mellon/Dreyfus merger, thus, does not appear to pose these problems (continued...) Part II.B., banks that advise mutual funds also face certain conflicts of interest that the Investment Company Act does not explicitly address. Because banks are excluded from the Securities Exchange Act of 1934, they are not regulated as broker-dealers.21/ Instead, banks that engage directly in securities activities are governed by a federal bank regulatory system that focuses generally on bank safety and soundness issues. While the federal banking regulators have adopted certain recordkeeping and confirmation requirements for securities transactions, 22/ they do not have a comprehensive regulatory scheme for the securities activities of banks.23/ Banks do not have to register or satisfy specific capital requirements in order to engage in direct securities activities, and the banking regulations contain no provisions comparable to the federal securities law rules respecting securities training and qualification, suitability, and other sales practice issues.24/ 20/(...continued) 21/ 22/ 23/ 24/ directly, although Mellon Bank's acquisition of the Boston Company funds' investment adviser does. Banks at the present time may engage directly in securities activities through their own employees, and/or indirectly through contractual arrangements with registered brokerdealers, pursuant to which registered representatives offer and sell securities in association with the bank. The concerns raised here pertain to direct bank securities activities. Unfortunately, because banking regulators do not receive formal notice or registration when banks commence securities activities, it is hard to estimate how many banks currently engage directly in such activities. See, e.g., 12 C.F.R. SS 12.1-12.7; 208.8 (k); and 344.1- Although banks are excluded from broker-dealer regulation, banks (and bank sales of securities) are subject to the antifraud provisions of the federal securities laws and to Commission enforcement of such laws. Moreover, bank affiliates and subsidiaries are not excluded from brokerdealer regulation, and must register with the Commission if they engage in broker-dealer activities. These issues were discussed previously in a Memorandum of the Securities and Exchange Commission to the Subcommittee on Telecommunications and Finance of the House Committee on Energy and Commerce Concerning Financial Services Deregulation and Repeal of the Glass-Steagall Act (April 11, 1988). In recent months, the federal banking regulators have adopted guidelines applicable to bank sales of mutual funds and other nondeposit investment products.25/ These efforts are an important first step. However, four separate sets of banking guidelines are no substitute for the uniform, comprehensive scheme provided for broker-dealer regulation under the federal securities laws. Investors are entitled to a single, consistent standard of protection, whether they purchase securities from a national bank, a state member or nonmember bank, a thrift, or a registered broker-dealer. Nor are the guidelines comparable in content to the federal securities laws. For example, the OCC's guidelines charge each bank with developing its own testing and qualification programs -- which means that there will be no uniform testing and qualification standards for bank personnel engaged in sales of securities. An additional difference with critical significance for investor protection is that the banking guidelines, unlike requirements under the federal securities laws, are not legally enforceable by the banking regulators or by customers.26/ 25/ See Office of the Comptroller of the Currency ("OCC") Banking Circular No. 274 (July 19, 1993); letter from Richard Spillenkothen, Director, Division of Banking Supervision and Regulation, Board of Governors of the Federal Reserve System, on "Separation of Mutual Fund Sales Activities from Insured Deposit-Taking Activities" (June 17, 1993); Federal Deposit Insurance Corporation Supervisory Statement on State Nonmember Bank Sales of Mutual Funds and Annuities (Oct. 8, 1993); Office of Thrift Supervision Bulletin 23-1, "Guidance on the Sale of Uninsured Products" (Sept. 7, 1993). The National Credit Union Association currently is preparing guidelines for credit union sales of mutual fund shares to customers. See James B. Arndorfer, Regulator Setting Guidelines for Mutual Fund Disclosure, AMERICAN BANKER, Dec. 10, 1993, at 9. 26/ The guidelines are also troubling from a functional regulation viewpoint. In particular, the OCC's Banking Circular No. 274 suggests that the OCC may apply its guidelines (which are not identical to Commission and securities self-regulatory organization rules, and appear in some instances actually to conflict with those rules) to registered broker-dealers that sell securities on bank premises or have other contractual arrangements with banks. The OCC further suggests that its examiners may examine such registered broker-dealers for compliance with its guidelines as well as for compliance with federal securities laws and requirements. Since registered broker-dealers are already subject to Commission and self-regulatory organization (continued...) Thus, the new bank guidelines do not close the gulf that has long existed between federal securities regulation and the bank regulatory scheme for bank securities activities. Indeed, this gulf, recognized as early as 1977 in the Commission's Congressionally-mandated Report on Bank Securities Activities, 27/ continues to grow. In the past two decades, expansive administrative interpretations of the Glass-Steagall Act have allowed ever-increasing bank involvement in mutual fund and other securities activities. The Mellon/Dreyfus merger is the latest illustration of this trend. The size of the proposed merger demonstrates that the need for consistent and comprehensive regulation of bank securities activities is more pressing than ever. As discussed above in Part II.A., the Mellon/Dreyfus merger highlights the potential for increased customer confusion when banks sell mutual fund shares to their retail customers. Recent surveys indicate that a large number of investors misunderstand the risks involved with bank mutual fund investments specifically, the fact that federal deposit insurance does not cover bank sold or bank advised mutual funds.28/ - A number of pending bills address the problem of customer confusion and other issues arising from bank sales of securities and mutual funds. One bill recently introduced by Chairman Gonzalez and Congressman Schumer (H.R. 3306, the "Depository Institution Retail Investment Sales and Disclosure Act") would require the federal banking agencies to adopt sales practice and disclosure rules governing bank sales of mutual funds and other non-deposit investment products. H.R. 3306 would take some positive steps toward reducing customer confusion about the 26/(...continued) oversight and regulation under the federal securities laws, OCC examinations would likely duplicate or confuse existing efforts. 27/ See Report on Bank Securities Activities of the Securities and Exchange Commission Pursuant to Section 11A (e) of the Securities Exchange Act of 1934 (Pub. Law 94-29), August 1977. 28/ News reports also suggest that banks are not consistently nature of bank sold nondeposit investment products. For example, the bill would prohibit common or similar names for banks and their investment company affiliates or nondeposit investment products. It is troubling, however, that H.R. 3306 would discard a long-tested, successful securities regulatory framework, creating in its place a new regulatory scheme for bank securities activities, outside of and apart from the federal securities laws.29/ The bill would apply this scheme, moreover, not only to the direct activities of bank employees, but also to sales made by "any person" on behalf of a bank. This means that the new banking regulations adopted under H.R. 3306 could potentially apply to registered broker-dealers that have networking, leasing, or customer referral arrangements with banks, and perhaps even to those registered broker-dealers that provide clearing services to banks. The result would be duplicative or even conflicting regulation of registered broker-dealers. By contrast, the approach taken in the bill introduced by Chairmen Dingell and Markey (H.R. 3447, the "Securities Regulatory Equality Act") builds on the proven regulatory structure created under the federal securities laws. Although the bill would maintain a limited exclusion for certain unsolicited bank securities activities, it would generally require bank securities activities (including mutual fund sales) to be moved into separate corporate entities subject to the federal regulatory scheme for brokers and dealers. Outmoded exemptions for bank advisory activities and pooled investment vehicles would also be eliminated from the federal securities laws. This legislation would significantly improve the existing regulatory system and enhance investor protection.30/ H.R. 3447 would serve investors by applying proven, legally enforceable 29/ The laws enacted to govern bank municipal and government securities activities, by contrast, are grounded in the federal securities law concepts of market integrity and investor protection, and were appropriately incorporated into the federal securities laws rather than the federal banking laws. 30/ H.R. 3447 is virtually identical to legislation the |