NASAA Testimony on H.R. 10 – The Financial Services Competitiveness Act of 1997

Testimony of Denise Voigt Crawford
Texas Securities Commissioner
President-Elect, North American Securities Administrators Association
Chairman, Securities Activities of Banks Committee
on Behalf of the
North American Securities Administrators Association
Before the
House Committee on Banking and Financial Services
United States House of Representatives

May 22, 1997

Mr. Chairman and Members of the Committee:

I am Denise Voigt Crawford and I appreciate the opportunity to discuss several important issues associated with financial modernization on behalf of the North American Securities Administrators Association (“NASAA”). NASAA was organized in 1919. Our membership consists of the 65 state, provincial and territorial securities administrators in the 50 states, the District of Columbia, Canada, Mexico and Puerto Rico.

As the national voice of the state securities agencies responsible for investor protection and the efficient functioning of the capital markets on the local level, we commend Chairman Leach and the Committee for your efforts to evaluate the existing structure of our financial institutions and reconcile conflicting views in order to bring about comprehensive financial services reform. Your determination to explore all of the critical issues and continue to move forward with a bill this year should be applauded.

NASAA believes that it is the responsibility of Congress to direct any comprehensive financial services reform and, to that end, NASAA has appeared before the Congress on a number of occasions to reiterate our strong support for Congressionally directed financial services reform that will continue to provide essential investor protection and faith in the integrity of our securities markets. Investor protection, which is the basis for investor confidence in the securities markets, should be a top priority as Congress explores ways to modernize the financial system.

Mr. Chairman, at last week’s hearing, you stated there was no one at the table representing “John Q. Public,” and that is precisely what I and my fellow state commissioners do every day when insuring compliance with securities laws at the local level. Distinguishable from our federal counterparts who tend to focus upon the oversight of large corporate offerings and the internationalization of the marketplace, state securities regulators are concerned with small investors who are saving to pay for their retirement, their children’s college education or a variety of other needs. We hope that our expertise and experience as state securities regulators will be useful to you.

NASAA is disturbed by the trend toward federal regulators and agencies dictating policy that impacts existing law without Congressional oversight. This ad hoc manner of restructuring the financial services industry without coordination or statutory change needs examination. State securities regulators view Congressional analysis of the current system and Congressional action to modernize regulation as the key to meaningful reform.

Our main message to you today is that NASAA strongly supports and upholds the ideals of functional regulation. As you are well aware, until recently the Glass-Steagall Act prohibited banks from engaging in most securities activities. That no longer holds true in today’s marketplace.

As an example, the Federal Reserve Board’s amendments to Section 20 of the Glass-
Steagall Act permitting a nonbank subsidiary of a bank holding company to underwrite and deal in securities has cleared the way for Bankers Trust to acquire Alex. Brown. Today, banks engage in a broad range of broker-dealer and investment advisory activities that are parallel to and competitive with the services of registered securities firms and registered investment advisers.

NASAA welcomes banks, as well as insurance companies, into the securities business. It is our hope that over the long term, increased competition will inure to the benefit of the investing public, particularly small investors who will reap the benefits of one-stop shopping.

Mr. Chairman, for the reasons set forth in our written testimony, NASAA believes that the Securities and Exchange Commission and state securities regulators should be the only primary regulators of securities activities regardless of the legal structure of the entity engaging in such activities.

A person investing in securities should receive the same disclosures and have the same investor protections whether he or she deals with a broker-dealer, a bank, an insurance company or a mutual fund. Employees who sell securities should be subject to the same licensing qualifications whether their employer is a bank, an insurance company or a securities firm.

As you know, traditional bank examinations focus on the financial viability, or so-called “safety and soundness,” of the financial institution. This form of examination concentrates on the oversight and review of the health of the institution. Securities broker-dealer reviews encompass some risk assessment, but focus on customer-based transactions. This type of review includes a thorough examination of customer new account forms, customer account activity and customer asset allocation to insure that the party who bears the risk (the customer) has been treated fairly. Thus, sales practices that contribute substantially to the broker-dealer’s overall financial health, or safety and soundness, may nonetheless be subject to disciplinary action. This type of oversight is essential if investors, especially small investors, are to have the degree of confidence in our capital markets to encourage and sustain their participation.

Under the current banking regulatory scheme, it appears that investors through banks are receiving a lower standard of protection than investors who conduct securities business through broker-dealers. This is evidenced by complaints received by state securities regulators concerning inadequate suitability/risk disclosure; misleading references to Federal Deposit Insurance Corporation (“FDIC”) and Securities Investor Protection Corporation (“SIPC”) coverage; a blurring of the distinctions between bank and brokerage activities; and agents who are inadequately trained and supervised. Investors deserve the same protections regardless of where and how they choose to invest in our capital markets. It is disturbing to think that the current bull market, combined with many first-time investors through banks, could be “masking” fraud and abuse.

In the most simple terms, modernization of the financial services system is a matter of permitting all financial service providers to compete on the same terms. The competition, however, must not be impacted by regulatory advantage or disadvantage. From NASAA’s perspective, it is essential that all financial service providers be subject to the same securities regulatory standards. Alarmingly, it appears that the legislation being considered by the Committee would permit certain broker-dealer activities to operate outside the established state and federal securities regulatory framework. This would have an untoward effect on the integrity of the securities markets, and of course, on individual investor protections.

In addition to the lack of a two-way street that disadvantages securities firms vis-a-vis banks, securities markets and securities investors are put at risk by H.R. 10. This risk results from the bill’s suggestion that certain broker-dealer activities, when conducted by a bank, would not be subject to the established state and federal securities regulatory framework. Thus the activity would take place without regard to essential state securities law regulations, governing such fundamental issues as securities salesperson licensing and disqualification, oversight of broker-dealer operations, conduct standards and enforcement provisions. Permitting securities to be sold under two different regulatory systems directly and detrimentally impacts market integrity and investor protection.

For example, it encourages “bad brokers” to migrate to banks in order to evade state securities enforcement actions directed at fraudulent and abusive practices. It also calls into question the enforceability of federal market conduct requirements, such as the T+3 delivery rule and rules governing clearing arrangements, impairing the integrity and uniformity of the securities marketplace. On the investor protection side, disregard of state securities licensing standards is the disregard of a vital consumer safeguard.

As noted previously, NASAA believes that the Securities and Exchange Commission and state securities regulators should be the only primary regulators of the securities activities of banks, yet H.R. 10 appears to ignore the seminal role of state securities regulators in the overall regulation of financial institutions. It is the state securities administrator that is the closest to the investing public, that serves as the local cop on the beat. It is the state securities administrator who reviews the local securities offerings and oversees the integrity of the local securities marketplace. It is the state securities administrator that is the necessary jurisdictional and substantive complement to the Securities and Exchange Commission. To disregard state securities regulation in connection with the modernization of the financial services system is to upset the delicate and well-reasoned regulatory balance that has resulted in the unprecedented success of the United States securities markets. Further, if state securities law is disregarded, to what extent may other state laws, such as state insurance, corporate and commercial codes, be disregarded to the detriment of market integrity and consumer protection?

NASAA whole-heartedly supports financial services modernization, but only to the extent that financial service providers are on the same plane. There must be true functional regulation. NASAA would urge that the existing state and federal securities regulatory system, including this system of specific securities examination and oversight, be applicable to all financial service providers. To hold otherwise would create an unlevel playing field, impair market integrity and investor protection, and skew competition based on regulatory advantages and disadvantages.

Section 141 of H.R. 10 would create an Interagency Banking and Financial Services Advisory Committee (“Committee”) composed of three national banking regulators (the Chairman of the Board of Governors of the Federal Reserve System, the Chairman of the Federal Deposit Insurance Corporation and the Comptroller of the Currency), the Secretary of the Treasury, the Chairman of the Securities and Exchange Commission and the Chairperson of the Commodity Futures Trading Commission. The Committee would make recommendations to the Federal Reserve regarding the types of activities that may be financial in nature for the purposes of the Financial Services Holding Company Act, and to the OCC regarding the types of activities that may be incidental to banking. NASAA supports this type of coordinating body, but believes that changes to the Committee’s composition and function as described below would enhance its effectiveness.

Both U.S. federal and state securities regulation provide oversight of the richest, most liquid and successful capital marketplace in the world. We each possess great experience and expertise and we do not duplicate each other’s work. Therefore, it seems unwise to exclude one or the other of these expert parties.

Although representation of the Securities and Exchange Commission would provide valuable insight into some of the global issues facing our financial markets, it would not provide much insight as to how regulatory policies affect individual investors, especially the smallest and most vulnerable investors. According to the Wall Street Journal (January 29, 1997), the SEC closed or solved 345 cases in 1996. State securities regulators solved or closed over 6,740 cases during that period. These statistics reflect the differing enforcement emphasis of the state and federal securities regulators. State securities regulators handle the majority of individual investor complaints and are thus in a much better position to observe the effects of regulatory policies on the individual investor, especially as such investors become an increasingly larger portion of the investing public. In a recent speech, SEC Chairman Arthur Levitt stated, “state regulators are closer to the scene and can uncover problems that are hard for us to see all the way from Washington.”

The heavy representation of federal banking regulators compared to all other financial services regulators would tend to skew the Committee’s policies towards the banking “safety and soundness” style of regulation. While this type of regulation is entirely appropriate for traditional banking activities where the FDIC and the government have assumed the risk for insured deposits, it is not appropriate for other financial services regulation. Securities regulation recognizes that the customer assumes most of the risk and the style of regulation reflects this different emphasis. This is why securities regulation stresses accurate disclosure of risks, suitability of investment recommendations and appropriate sales practices.

The proponents of H.R. 10 have recognized that the subtle differences in the views of the three federal banking regulators require that each of those three be represented on the Committee, yet they have ignored the far more substantial differences in the regulatory approach of the state and federal securities regulators. If the bill is not amended to include a representative of state securities regulators on the Committee, then it will have succeeded in creating yet another element of the federal bureaucracy that is out of touch with the individuals whose interests are supposed to be protected. (NASAA also believes that a state insurance regulator and a state banking regulator should be included.)

NASAA strongly recommends that H.R. 10 be amended to provide for state securities regulatory representation on the Interagency Banking and Financial Services Advisory Committee. This Committee’s coordinating structure might be broadened, so that any perceived need for an “umbrella regulator” would be eliminated.

NASAA believes that regulation of each financial entity should be focused on the specific functions being performed, not solely on the corporate structure. This approach would help assure the proper balance between the twin goals of expanded opportunities related to the provision of banking, securities and insurance services and the provision of important institutional and individual protections. Clearly, great care must be taken to avoid duplicative regulations and oversight that waste resources.

NASAA takes no position on how best to structure financial service entitites; however, we would urge Congress to require banks, securities firms and insurance companies to organize in a manner that will provide the most protection to investors and the FDIC. Clearly, functional regulation will be more efficient and effective if each financial service is a separate componant.

If banks believe that the regulation of certain existing entities is too restrictive, Congress should seek to eliminate the overly restrictive rules and regulations for all participants, rather than encourage banks to organize in a way that produces more risk to the bank and the investor. While ease of entry and increased competition are important goals, financial services reform efforts should not ignore the goals of maintaining protection of investors and the federal deposit insurance fund. If investors lose faith in the system, it will not matter how easy it is to enter.

Mr. Chairman, NASAA commends the Committee for tackling the daunting task of financial modernization to recreate the regulatory structure for the financial services industry. We strongly believe that any new or amended regulatory system should create functional regulation with roles for each regulator based on the particular services provided by the financial institution. Such an approach will create a level regulatory playing field for the securities, banking, and insurance industries, effectively utilize existing regulatory expertise, and, at the same time, eliminate the disparities caused by regulators with differing objectives reviewing identical services being provided in different financial institutions. This coordinated approach, most importantly, will provide continued investor protection by mandating roles for both federal and state securities regulators in the financial institution’s securities activities, while allowing banking and insurance regulators to carry out their respective mandates.

The division of labor among securities, insurance and banking regulators has served the public well for many decades. This division of labor should continue after the abolition of the barriers the Glass-Steagall Act imposed on bank activities. If banks or their affiliates venture into the securities arena, they should have to play by the same rules as securities firms, and be subject to the same regulatory scheme administered by the same regulators.

Thank you again for the opportunity to provide our views on these important matters. NASAA is available to provide any requested input or assistance you desire as you continue in your efforts to achieve meaningful financial services modernization.

May 22, 1997

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Issues & Advocacy, Legislative Activity, Testimony