The Financial Services Modernization Act of 1999

Testimony of Thomas E. Geyer
Commissioner of Ohio Division of Securities Chair, Securities Activities of Banks Project Group
Before the Senate Banking, Housing and Urban Affairs Committee,
United States Senate

February 24, 1999

Summary

  • As the national voice of the state securities agencies, NASAA supports financial services reform based on true functional regulation that will continue to provide essential investor protection and strengthen the integrity of our securities markets.
  • Financial services reform must be congressionally directed, not dictated on an ad-hoc basis by federal regulators and agencies.
  • NASAA strongly supports and upholds the ideals of functional regulation of securities activities of all entities. We welcome banks, as well as insurance companies, into the securities business and urge that they be subject to the same complementary state/federal securities oversight system that is currently in place.
  • NASAA believes that the Discussion Draft of the Financial Services Modernization Act of 1999 contains the concept of functional regulation with respect to operating subsidiaries and affiliates. However, a distinction continues to be made for securities activities of national banks resulting in dysfunctional regulation.
  • As banks and other entities become full players in the securities industry, they must be subject to functional regulation in order to ensure investor protection and marketplace integrity.

Introduction
Mr. Chairman and Members of the Committee:

I am Tom Geyer, Commissioner of Securities for the State of Ohio, and I appreciate the opportunity to discuss several important issues associated with the staff discussion draft of The Financial Services Modernization Act of 1999 (“Discussion Draft”) on behalf of the North American Securities Administrators Association (“NASAA”).

NASAA has long supported comprehensive, congressionally-directed financial services modernization and believes it is overdue. Such modernization is essential for American institutions that wish to compete successfully in the global marketplace. But we must keep in mind that sweeping financial services reforms will profoundly affect millions of individual investors across the United States. We have been working with Congress to craft legislation to modernize the financial services system and at the same time preserve the investor protections in place today.

While I am testifying on behalf of NASAA, I also represent individual investors, like my wife, who is an attorney; my father, a schoolteacher in Columbus, Ohio; and my grandfather, a retired veterinarian in Hamilton, Virginia. As I express NASAA’s position on financial services modernization, I will describe what we believe its impact will be on retail securities customers. I would respectfully suggest it is incumbent upon the Congress to judge the impact that any reform effort will have on your constituents as individual investors. We hope that our expertise and experience as state securities regulators will be useful to you.

There is no denying we have moved from a nation of savers to a nation of investors. Americans have put more of their savings in mutual funds than in insured bank accounts. With a record number of households investing in the securities markets, investor protection, which is the basis for confidence in the U.S. markets, has to be a top priority as you move forward with this legislation.

The U.S. securities industry has not only benefited, it has clearly thrived as a result of the existing structure of shared regulation among the states, the Securities and Exchange Commission (“SEC”) and the self-regulatory organizations (“SROs”). Our federal counterparts at the SEC tend to focus upon the oversight of large corporate offerings and the globalization of the marketplace. State securities regulators, however, are closest to the investing public and serve as the local cop on the beat.

State securities regulators license securities professionals; we are the first to receive investor complaints; and, we are active in enforcing the laws. The states have led numerous enforcement actions especially in the area of micro-cap fraud. Most importantly, we put crooks in jail. During the years 1996 and 1997, there were more than 500 criminal convictions for violations of state securities laws.

This securities regulatory system is so effective that the U.S. enjoys a capital marketplace that is the absolute envy of the world. I suggest to you that we have the most successful securities market on the planet because of the complementary state-federal securities regulatory system that is in place, not in spite of it. In other words, individuals are willing to put their hard-earned money in IRAs, mutual funds and 401(k)s because there are laws that ensure the securities marketplace will be honest and fair. The federal/state regulatory system requires the licensure of people selling products, compels the entities to provide full and fair disclosure about securities offerings and provides for the surveillance of the people who operate in the securities markets.

NASAA worked closely with this Committee during the deliberations on the National Securities Markets Improvement Act of 1996 (“NSMIA”). As a result, the states have experience with streamlining regulation, and know firsthand that with true functional regulation it is possible to bifurcate without weakening regulatory oversight or unduly confusing the marketplace.

FUNCTIONAL REGULATION
Our main message to you today is that NASAA strongly supports and upholds the ideals of functional regulation of securities activities and products. We are pleased with the concepts of functional regulation as included in the Discussion Draft. However, additional language is needed to make it clear that securities customers at banks have the protections of federal and state securities laws as well. We share the position expressed by the Securities Industry Association that functional regulation means “…the SEC, the SROs and the state securities agencies should regulate securities activities regardless of what entity performs those activities.”

When the Securities Exchange Act was enacted in 1934, it excluded banks from the securities regulatory regime for brokers and dealers because Congress believed that bank securities activities were sufficiently limited by the Glass-Steagall Act that passed the previous year. Over time other federal agencies have diminished this exclusion, and we support the congressional effort to bring certainty to, and create a construct for, the regulation of financial services for the future.

The Discussion Draft would eliminate the Glass-Steagall restrictions on securities activities by banks. However, the Discussion Draft does not address other federal agency laws or actions that would otherwise inhibit the functional regulation of securities activities. Without additional language, the Discussion Draft will allow banks to conduct securities activities outside the established securities regulatory framework, which would result in unequal investor protections dictated by where the product is sold.

We believe banks as well as insurance companies should be able to enter the securities business, but only if they are subject to the same complementary state/federal securities oversight system. Banking laws focus on safety and soundness regulation to ensure the viability of the financial institution. Securities laws, on the other hand, are designed to protect investors and maintain the integrity of the securities markets. State and Federal regulators combined have over 145 years of experience applying and interpreting these laws.

Residents of your states investing in securities must 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. Because banks may be the only financial institution they have ever dealt with or have access to, securities customers at banks must receive the same level of protections provided other investors. Individuals who sell securities should be subject to the same licensing qualifications whether they are associated with a bank, an insurance company, a securities firm or some other entity.

In NASAA’s view, the Discussion Draft attempts to move towards functional regulation, but additional investor protections are needed. The elimination of the Glass-Steagall barriers would statutorily authorize banks to conduct securities activities. Because of this, NASAA strongly supports the SEC’s position that it be given authority to regulate the securities activities of banks. Such authority is needed to bridge the investor protection gap that would result by permitting banks to sell securities outside the application of federal and state securities laws.

We appreciate the inclusion of language preserving state securities anti-fraud authority in proposed Section 104(c). However, we believe its application should be clarified to indicate it extends to national banks as well as bank holding companies. With our nation’s securities markets at all-time highs, state and federal regulators are faced with a potential “bull market in fraud” and our full enforcement arsenal must be maintained if not strengthened.

The preservation of federal and state securities anti-fraud enforcement jurisdiction must be clear and unequivocal.

NASAA also supports the concept of regulatory deference included in the Discussion Draft to reduce burdens on the regulated community. We appreciate your recognition that the Federal Reserve Board should defer examinations of state registered investment advisers to state securities regulators in proposed revisions to Section 5(c) of the Bank Holding Company Act (Section 111 of the Discussion Draft). We also recommend that similar deference be extended to the examination of brokers or dealers by state securities agencies. This practice would result in streamlined regulation and avoids duplicative examinations by securities and banking regulators.

BANK/SECURITIES ACTIVITIES
We recognize the importance and gravity of the broad changes the Discussion Draft would bring to our financial system and institutions. Given our central mission of individual investor protection, we urge you not to lose sight of the day-to-day impact the Discussion Draft would have on both the consumers who would buy investments at banks and those bank employees who would offer and sell the securities to them.

Today, although banks have been empowered to conduct certain securities activities directly, most banks choose to conduct consumer-level securities activities through state and federally registered broker-dealer affiliates, and subsidiaries or the use of third-party brokerage-arrangements. This helps the bank shield itself from securities liability and ensures that the securities activities are functionally regulated. We would encourage Congress to codify this current practice, which would ensure uniform investor protections for all of your constituents.

We urge you for a moment to focus on those individuals who sell securities products. Currently, such individuals must be licensed by state securities agencies. They are subject to a comprehensive and time-tested system of regulation that includes minimum qualification requirements, pre-screening and possible suspension or even revocation of their license for violations. Securities personnel are also subject to private recourse for violations of state, federal and SRO regulations, which are often pursued in civil actions or arbitrations.

However, the repeal of the Glass-Steagall barriers would statutorily authorize the possible creation of a largely unregulated “parallel universe.” Bank sales personnel would constitute a sales force offering a family of investments to consumers without the safeguards tied to the registration process enforced by state securities regulators.

An SEC report recently stated, “Licensing authority enables states to identify and prevent those individuals who present a serious risk to their citizens from entering or remaining in the industry.” Individuals purchasing securities from a bank should incur the same benefits derived from the state licensing process as persons purchasing from traditional brokerage firms. Further the report concluded, “Antifraud authority by itself does not give regulators the tools they need to detect and deter sales practice abuses and fraud.”

In addition, under the structure proposed in the Discussion Draft, one could reasonably expect an increasing volume of securities activities to be conducted by banks. Thus, a greater percentage of the securities marketplace would be taken out of the purview of securities regulators and could alter the time-tested regulations that have resulted in the United States having the preeminent capital markets.

Any creation of a “parallel universe” regulating securities activities outside the current functional regulatory framework is both inefficient and cumbersome. It is unnecessary to create a separate set of regulations to provide the same oversight for that which is already in place and has worked well. In addition, duplicate regulations for identical activities conducted through different entities will lead to confusion in the marketplace and the potential for inconsistent regulation.

Conclusion
Banks are now full players in the securities markets — their involvement in securities activities is no longer incidental or sporadic. Under functional regulation, all securities market participants would be subject to a single set of standards, consistently applied by an expert regulator. This is important to provide consistent investor protections to all customers and to protect the integrity of the securities marketplace.

Although NASAA has concerns about the Discussion Draft, I do want to reiterate our strong overall support for congressionally mandated financial services reform. As the process moves forward, we urge you to give special attention to the enormous impact the Discussion Draft would have on individual investors by permitting securities activities to be conducted outside the existing regulatory framework. NASAA believes investors in the securities markets are better served by functional regulation.

Mr. Chairman and members of the Committee, NASAA is committed to work with you to ensure the bill that eventually becomes law contains no diminution of protections for our nation’s investors. We are available to provide any technical assistance you desire as you continue in your efforts to achieve meaningful financial services modernization.

Thank you again for the opportunity to testify before you today.

February 24, 1999

Issues & Advocacy, Legislative Activity, Testimony