Risky Business in the Operating Subsidiary: How the OCC Dropped the Ball

Testimony of Denise Voigt Crawford
Texas Securities Commissioner and Past-President
North American Securities Administrators Association, Inc.
Before the U.S. House of Representatives Committee on Commerce, Subcommittee on Oversight and Investigations

June 25, 1999

SUMMARY OF NASAA TESTIMONY

  • As the national voice of the state securities agencies, NASAA supports financial services reform that will continue to provide essential investor protection and strengthen the integrity of our securities markets.
  • NASAA strongly supports and upholds the ideals of functional regulation of securities products as well as securities personnel regardless of where such activities actually occur.
  • To dismiss or discount the accumulation of decades of experience of regulating securities activities by the Securities and Exchange Commission, state securities agencies and self-regulatory organizations, investors would be exposed to untold risks and diminished confidence in our markets for unknown or quantifiable benefits.
  • Confusion by investors regarding the current role banks play in providing financial services has been demonstrated by state and federal enforcement cases. Even with the adoption of recent guidelines relating to the sale of securities on bank premises by the banking industry, violations of rights to privacy relating to financial information and cross-marketing have been found to be practices used by banks as evidenced by recent state enforcement cases.
  • Traditional banking regulation does not include any concept of screening, testing or licensing of bank employees. No direct mandate exists to require banks and their employees make full and fair disclosure of all material facts regarding a bank-sponsored securities product. Banking regulation does not provide private rights of action for wronged purchasers of investments. The complementary federal/state securities oversight system, in conjunction with the self-regulatory organizations, provides all of those features in its regulation of securities sales activity.

INTRODUCTION
Chairman Upton and Members of the Subcommittee:

I am Denise Voigt Crawford, the Texas Securities Commissioner and Past-President of the North American Securities Administrators Association (“NASAA”)1. I commend you and Congressman Klink for conducting these hearings, and I appreciate the opportunity to discuss several important issues associated with the regulatory oversight of securities activities at banks. NASAA has testified before Congress over the years to support congressionally directed financial services modernization that will protect investors and preserve faith in the integrity of our securities markets.

With a record number of households investing in the securities markets, investor protection, the basis for confidence in the securities markets, should be a top priority as Congress moves forward with legislation that reforms our financial services markets. We hope our expertise and experience as state securities regulators will be useful to you.

Our federal counterparts at the Securities and Exchange Commission (“SEC”) tend to focus on the oversight of large corporate offerings and the globalization of the marketplace. State securities regulators, on the other hand, are closest to the investing public and serve as the local cops on the beat.

FUNCTIONAL REGULATION
NASAA strongly supports and upholds the ideals of functional regulation of securities activities and products. We believe it is a core element of investor protection.

We welcome banks, as well as insurance companies, into the securities business, but under the same complementary state/federal securities oversight system. We believe it neither rational nor plausible to adopt a course calling for federal banking regulators to recreate within their ranks and walls the essential enforcement culture, regulatory schemes and systems essential to monitor securities activities and, more specifically, police abusive securities sales practices. It is completely impractical to expect them to do so in the near term and to the extent provided by the NASDR and other SROs, the SEC and the states. Even an attempt would be unnecessary, constituting a wasteful duplication of resources and money, and the dismissal of decades of proven securities regulatory experience.

Residents of our states investing in securities should receive the same disclosures and have the same investor protections whether they invest through a brokerdealer, a bank, an insurance company or a mutual fund. Those who sell securities should be subject to the same licensing qualifications and oversight whether their employer is a bank, an insurance company, a securities firm, or something else.

THE NationsSecurities CASE
Actions taken by state securities regulators in Texas in 1996 and Florida in 1997 exemplify the unique problems and risks to consumers posed by retail securities sales operations affiliated with and operating on the premises of banks. These actions also underscore the benefits of functional regulation of these affiliates or subsidiaries by state securities regulators.

Texas and Florida securities authorities received numerous investor complaints regarding securities sales activities of NationsSecurities, a registered broker-dealer subsidiary of NationsBank. As a result of their investigations, Texas and Florida securities regulators brought enforcement actions in which they alleged NationsSecurities misrepresented the safety and risks associated with a particular investment vehicle.

In the Texas action, among the investors involved were NationsBank depositors who had been targeted because they wanted higher returns on their money than what was provided by certificates of deposit. NationsBank proprietary investment products (whose title included the words “Government Income Term Trust”) were marketed to them, in some cases with the misrepresentations that investments were safe, conservative, low risk, and high yield, backed by AAA-rated government securities. In fact, the investments were risky and volatile, involving derivatives based on collateralized mortgage obligations. Shortly after these products were sold to unsuspecting investors, their value declined sharply.

In a settlement reached with the Texas State Securities Board, NationsSecurities was required to make offers of rescission to investors and undertake significant compliance enhancements. The firm also provided $275,000 in funding for an extensive Texas investor education program. Subsequent settlements were reached with Florida securities authorities ($250,000) and with the SEC ($4 million fine), National Association of Securities Dealers – Regulation, Inc. (“NASDR”) ($2 million fine, three individuals fined, suspended and censured) and the Office of the Comptroller of the Currency (“OCC”) ($750,000 fine) on related issues. Private class action suits were settled as well, according to press reports, for nearly $40 million.

In his Business Week Commentary of May 18, 1998, David Greising discussed both the NationsBank settlements and the need for functional regulation of securities activities at banks.

The abusive atmosphere at the securities division of NationsBank Corp. in the early 1990s was shocking even for veteran stockbrokers. Working at the bank’s branches, they were told to hawk NationsBank’s investment products to bank customers without explaining that they were brokers, not bankers.

…The case shows how difficult is it to regulate stockbrokers working for banks, in part because bank regulators usually lack the skills or the inclination to root out securities fraud.

…Banks have pushed to stay under the umbrella of banking regulators, who have precious little experience with brokerage derring-do. But in an era when every ambitious bank is copying the playbook of Merrill Lynch & Co., not J.P. Morgan & Co., that’s a recipe for regulatory undersight. It leaves regulators unable to stop sleazy selling practices by stockbrokers dressed in bankers’ pinstripes2.

It is well known and oft repeated that the essential goals of banking regulation are safety and soundness of the banks, while the essence of securities regulation is protection of the investor. These are very different premises; and as distinct as the systems and skills required to achieve them.

Banking regulation imposes broad financial reporting requirements and limitations, and relies upon auditors and examiners to review both the adequacy of the finances and the level of regulatory compliance. It is very much geared to accounting and analysis. To avoid the worst of all banking nightmares, a run on the bank, secrecy and confidentiality are paramount concerns. The regulators make sure that depositors’ confidence in the solvency of their institutions is maintained.

Traditional banking regulation does not include any concept of the screening, testing or licensing of banker employees. Traditional banking did not include the concept of selling investment products on a commission basis. Banking regulation contains no direct mandate that banks must make — and see to it that their employees make — full and fair disclosure of all material facts regarding a banksponsored securities product or risk regulatory sanction. Banking regulators do not have a system in place to track bank employees who may move from one bank to another, perhaps without disclosing past customer-related problems. They cannot track such people, nor is there a database available for the public to access to make inquiry on their own. Banking regulation does not provide private rights of action for wronged purchasers of investments, nor is there established any means of alternative dispute resolution. Sanctions imposed on banks for banking law and regulatory violations are generally not publicized, probably because to do so could or would undermine the safety and soundness of the institution.

The complementary state/federal securities oversight system, in conjunction with the self-regulatory organizations, provides all of those features in its regulation of securities sales activity.

Finally, as the NationsSecurities and subsequent enforcement actions make clear, banking customers remain confused and highly susceptible to believing that securities investments offered and sold to them at banks are somehow insured against loss by federal deposit insurance. This potential for misunderstanding means that it is even more important for bank-sited brokerage personnel to provide potential investors with clear disclosure relating to the investment products they consider purchasing from the bank rather than at more traditional broker-dealers.

Another issue of concern relating to bank sales of securities involves bank customers’ rights to privacy and cross marketing practices. For example, a securities customer phoning or visiting the office of his or her securities brokerdealer does not expect to be referred to a desk where products federally insured against loss are available. Can the same be said for a bank depositor visiting his or her bank branch to make a deposit or renew a CD who is directed to a salesperson located on the bank floor and offered a “government backed fund?”

PENDING FEDERAL LEGISLATION
Most retail securities activity currently conducted on bank premises is conducted through broker-dealers registered with and regulated by state and federal securities authorities. We believe this should remain the norm. As the bills before both Houses of Congress are given further consideration, NASAA would request that certain key concepts be included to maintain the current level of investor confidence in the U.S. securities markets. There has been significant and consistent support to preserve and give full force and effect to state securities enforcement authority in any final legislation under consideration to become law. In addition, full functional regulation should be required of securities products as well as securities personnel in any entity where securities sales occur. Also important, any modernized financial services law should require the functional regulation of all entities or persons performing similar, if not almost identical, services in order to protect all investors equally.

In conclusion, it is undeniable that financial markets and services are blending. Regulators have met and will continue to meet the challenges of coordinating efforts to achieve the greatest good at the lowest cost. But as securities regulators, our prime directive remains investor protection, not cutting costs. Synergies will continue to develop among corporations and regulators in dealing with macro issues of major conglomerates and international mergers. Retail investment consumers need the protection not so much from conglomerates and global mergers, but from overaggressive and abusive salespeople who would take advantage of their confusion and concerns; protections that state securities regulation, functional regulation, afford.

Thank you for your kind attention.

Endnotes:
1The oldest international organization devoted to investor protection, the North American Securities Administrators Association, Inc., was organized in 1919. It is a voluntary association with a membership consisting of the 65 state, provincial and territorial securities administrators in the 50 states, the District of Columbia, Canada, Mexico and Puerto Rico. In the United States, NASAA is the voice of the 50 state securities agencies responsible for grass-roots investor protection and efficient capital formation.
2David Greising, “Commentary,” Business Week, May 18, 1998, p. 154

June 25, 1999

Issues & Advocacy, Legislative Activity, Testimony