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74–626 PS 2001

PUSHING BACK THE PUSHOUTS:

THE SEC’s BROKER-DEALER RULES

JOINT HEARING

BEFORE THE

SUBCOMMITTEE ON

CAPITAL MARKETS, INSURANCE, AND

GOVERNMENT SPONSORED ENTERPRISES

AND THE

SUBCOMMITTEE ON

FINANCIAL INSTITUTIONS AND CONSUMER CREDIT

OF THE

COMMITTEE ON

FINANCIAL SERVICES

U.S. HOUSE OF REPRESENTATIVES

ONE HUNDRED SEVENTH CONGRESS

FIRST SESSION

AUGUST 2, 2001

Printed for the use of the Committee on Financial Services

Serial No. 107–43

(
(II)

HOUSE COMMITTEE ON FINANCIAL SERVICES

MICHAEL G. OXLEY, Ohio, Chairman

JAMES A. LEACH, Iowa

MARGE ROUKEMA, New Jersey, Vice Chair

DOUG BEREUTER, Nebraska

RICHARD H. BAKER, Louisiana

SPENCER BACHUS, Alabama

MICHAEL N. CASTLE, Delaware

PETER T. KING, New York

EDWARD R. ROYCE, California

FRANK D. LUCAS, Oklahoma

ROBERT W. NEY, Ohio

BOB BARR, Georgia

SUE W. KELLY, New York

RON PAUL, Texas

PAUL E. GILLMOR, Ohio

CHRISTOPHER COX, California

DAVE WELDON, Florida

JIM RYUN, Kansas

BOB RILEY, Alabama

STEVEN C. LATOURETTE, Ohio

DONALD A. MANZULLO, Illinois

WALTER B. JONES, North Carolina

DOUG OSE, California

JUDY BIGGERT, Illinois

MARK GREEN, Wisconsin

PATRICK J. TOOMEY, Pennsylvania

CHRISTOPHER SHAYS, Connecticut

JOHN B. SHADEGG, Arizona

VITO FOSELLA, New York

GARY G. MILLER, California

ERIC CANTOR, Virginia

FELIX J. GRUCCI, JR., New York

MELISSA A. HART, Pennsylvania

SHELLEY MOORE CAPITO, West Virginia

MIKE FERGUSON, New Jersey

MIKE ROGERS, Michigan

PATRICK J. TIBERI, Ohio

JOHN J. LAFALCE, New York

BARNEY FRANK, Massachusetts

PAUL E. KANJORSKI, Pennsylvania

MAXINE WATERS, California

CAROLYN B. MALONEY, New York

LUIS V. GUTIERREZ, Illinois

NYDIA M. VELA ́ ZQUEZ, New York

MELVIN L. WATT, North Carolina

GARY L. ACKERMAN, New York

KEN BENTSEN, Texas

JAMES H. MALONEY, Connecticut

DARLENE HOOLEY, Oregon

JULIA CARSON, Indiana

BRAD SHERMAN, California

MAX SANDLIN, Texas

GREGORY W. MEEKS, New York

BARBARA LEE, California

FRANK MASCARA, Pennsylvania

JAY INSLEE, Washington

JANICE D. SCHAKOWSKY, Illinois

DENNIS MOORE, Kansas

CHARLES A. GONZALEZ, Texas

STEPHANIE TUBBS JONES, Ohio

MICHAEL E. CAPUANO, Massachusetts

HAROLD E. FORD, JR., Tennessee

RUBE ́ N HINOJOSA, Texas

KEN LUCAS, Kentucky

RONNIE SHOWS, Mississippi

JOSEPH CROWLEY, New York

WILLIAM LACY CLAY, Missiouri

STEVE ISRAEL, New York

MIKE ROSS, Arizona

BERNARD SANDERS, Vermont

Terry Haines, Chief Counsel and Staff Director
(III)

SUBCOMMITTEE ON CAPITAL MARKETS, INSURANCE, AND

GOVERNMENT SPONSORED ENTERPRISES

RICHARD H. BAKER, Louisiana, Chairman

ROBERT W. NEY, Ohio, Vice Chairman

CHRISTOPHER SHAYS, Connecticut

CHRISTOPHER COX, California

PAUL E. GILLMOR, Ohio

RON PAUL, Texas

SPENCER BACHUS, Alabama

MICHAEL N. CASTLE, Delaware

EDWARD R. ROYCE, California

FRANK D. LUCAS, Oklahoma

BOB BARR, Georgia

WALTER B. JONES, North Carolina

STEVEN C. LATOURETTE, Ohio

JOHN B. SHADEGG, Arizona

DAVE WELDON, Florida

JIM RYUN, Kansas

BOB RILEY, Alabama

VITO FOSSELLA, New York

JUDY BIGGERT, Illinois

GARY G. MILLER, California

DOUG OSE, California

PATRICK J. TOOMEY, Pennsylvania

MIKE FERGUSON, New Jersey

MELISSA A. HART, Pennsylvania

MIKE ROGERS, Michigan

PAUL E. KANJORSKI, Pennsylvania

GARY L. ACKERMAN, New York

NYDIA M. VELA ́ ZQUEZ, New York

KEN BENTSEN, Texas

MAX SANDLIN, Texas

JAMES H. MALONEY, Connecticut

DARLENE HOOLEY, Oregon

FRANK MASCARA, Pennsylvania

STEPHANIE TUBBS JONES, Ohio

MICHAEL E. CAPUANO, Massachusetts

BRAD SHERMAN, California

GREGORY W. MEEKS, New York

JAY INSLEE, Washington

DENNIS MOORE, Kansas

CHARLES A. GONZALEZ, Texas

HAROLD E. FORD, JR., Tennessee

RUBE ́ N HINOJOSA, Texas

KEN LUCAS, Kentucky

RONNIE SHOWS, Mississippi

JOSEPH CROWLEY, New York

STEVE ISRAEL, New York

MIKE ROSS, Arizona

SUBCOMMITTEE ON FINANCIAL INSTITUTIONS AND CONSUMER CREDIT

SPENCER BACHUS, Alabama, Chairman

DAVE WELDON, Florida, Vice Chairman

MARGE ROUKEMA, New Jersey

DOUG BEREUTER, Nebraska

RICHARD H. BAKER, Louisiana

MICHAEL N. CASTLE, Delaware

EDWARD R. ROYCE, California

FRANK D. LUCAS, Oklahoma

BOB BARR, Georgia

SUE W. KELLY, New York

PAUL E. GILLMOR, Ohio

JIM RYUN, Kansas

BOB RILEY, Alabama

STEVEN C. LATOURETTE, Ohio

DONALD A. MANZULLO, Illinois

WALTER B. JONES, North Carolina

JUDY BIGGERT, Illinois

PATRICK J. TOOMEY, Pennsylvania

ERIC CANTOR, Virginia

FELIX J. GRUCCI, JR, New York

MELISSA A. HART, Pennsylvania

SHELLEY MOORE CAPITO, West Virginia

MIKE FERGUSON, New Jersey

MIKE ROGERS, Michigan

PATRICK J. TIBERI, Ohio

MAXINE WATERS, California

CAROLYN B. MALONEY, New York

MELVIN L. WATT, North Carolina

GARY L. ACKERMAN, New York

KEN BENTSEN, Texas

BRAD SHERMAN, California

MAX SANDLIN, Texas

GREGORY W. MEEKS, New York

LUIS V. GUTIERREZ, Illinois

FRANK MASCARA, Pennsylvania

DENNIS MOORE, Kansas

CHARLES A. GONZALEZ, Texas

PAUL E. KANJORSKI, Pennsylvania

JAMES H. MALONEY, Connecticut

DARLENE HOOLEY, Oregon

JULIA CARSON, Indiana

BARBARA LEE, California

HAROLD E. FORD, JR., Tennessee

RUBE ́ N HINOJOSA, Texas

KEN LUCAS, Kentucky

RONNIE SHOWS, Mississippi

JOSEPH CROWLEY, New York

(V)

C O N T E N T S

Page

Hearing held on:

August 2, 2001 .................................................................................................. 1

Appendix:

August 2, 2001 .................................................................................................. 49

WITNESSES

THURSDAY, AUGUST 2, 2001

Broadman, Ellen, Director, Securities and Corporate Practices Division, Office

of the Comptroller of the Currency ..................................................................... 19

Higgins, Edward D., Executive Vice President, U.S. Bancorp, on behalf of

the American Bankers Association and the ABA Securities Association ........ 32

Kroener, William F., III, General Counsel, Federal Deposit Insurance

Corporation ........................................................................................................... 17

Kurucza, Robert M., Partner, Morrison & Foerster LLP, General Counsel,

Bank Securities Association ................................................................................ 34

Maloney, Eugene F., Executive Vice President and Corporate Counsel,

Federated Investors, Inc. ..................................................................................... 38

Meyer, Hon. Laurence H., Member, Board of Governors, Federal Reserve

System ................................................................................................................... 15

Patterson, Michael E., Vice Chairman, J.P. Morgan Chase & Co. ...................... 31

Pollard, K. Reid, President and CEO, Randolph Bank & Trust, Asheboro,

NC, on behalf of the Independent Community Bankers of America ............... 36

Unger, Hon. Laura S., Acting Chairwoman, U.S. Securities and Exchange

Commission ........................................................................................................... 4

APPENDIX

Prepared statements:

Oxley, Hon. Michael G. .................................................................................... 50

Bachus, Hon. Spencer ...................................................................................... 52

LaFalce, Hon. John J. ...................................................................................... 55

Broadman, Ellen (with attachments) .............................................................. 116

Higgins, Edward D. .......................................................................................... 179

Kroener, William F., III ................................................................................... 99

Kurucza, Robert M. (with attachments) ......................................................... 198

Maloney, Eugene F. (with attachments) ......................................................... 262

Meyer, Hon. Laurence H. ................................................................................. 81

Patterson, Michael E. ....................................................................................... 168

Pollard, K. Reid (with attachments) ............................................................... 230

Unger, Hon. Laura S. ....................................................................................... 59

ADDITIONAL MATERIAL SUBMITTED FOR THE RECORD

Watt, Hon. Melvin L.:

Federated Investors, Inc., letter, Aug. 9, 2001 ............................................... 56

(1)

PUSHING BACK THE PUSHOUTS:

THE SEC’s BROKER-DEALER RULES

THURSDAY, AUGUST 2, 2001

U.S. HOUSE OF REPRESENTATIVES, SUBCOMMITTEE ON CAPITAL MARKETS, INSURANCE

AND GOVERNMENT SPONSORED ENTERPRISES, JOINT WITH THE

SUBCOMMITTEE ON FINANCIAL INSTITUTIONS

AND CONSUMER CREDIT, COMMITTEE ON FINANCIAL SERVICES, Washington, DC.

The joint subcommittees met, pursuant to call, at 10:05 a.m., in

room 2128, Rayburn House Office Building, Hon. Michael G. Oxley,

[chairman of the Committee on Financial Services], Hon. Richard

H. Baker, [chairman of the Subcommittee on Capital Markets, Insurance and Government Sponsored Enterprises], and Hon.

Spencer Bachus, [chairman of the Subcommittee on Financial Institutions and Consumer Credit], presiding.

Present from the Committee on Financial Services: Chairman

Oxley.

Present from the Subcommittee on Capital Markets, Insurance

and Government Sponsored Enterprises: Chairman Baker; Representatives Bachus, Hart, Cox, Weldon, Ackerman, Bentsen, Sherman, Inslee, Capuano, K. Lucas of Kentucky, Israel, and S. Jones

of Ohio.

Present from the Subcommittee on Financial Institutions and

Consumer Credit: Chairman Bachus; Representatives Baker, Kelly,

Cantor, Grucci, Capito, C. Maloney of New York, Manzullo, Hart,

Ackerman, Bentsen, Sherman, K. Lucas of Kentucky, Waters,

Tiberi, and Watt.

Chairman BAKER. Good morning. I just wanted to make an announcement for those interested in the hearing this morning. I am

advised that we will have a minimum of two votes which just were

called. It appears that because of the timing of the votes we would

probably have a likely start time of about 10:30. I know how it

feels to be on the tarmac in the plane wondering what’s going on.

Our on-time departure will now be probably 10:35. We hope to

make up for that in the air, and we will be back soon. Thank you.

[Laughter.]

[Recess.]

Chairman BAKER. Due to the time constraints of not only our

panelists, but Members this morning, there are numerous activities

ongoing this morning, I’m going to call our meeting to order. I do

expect Members’ participation as they return from the vote cur-
2

rently pending. To facilitate important testimony, I’d like to recognize Chairman Oxley at this time for his opening statement.

Mr. OXLEY. Thank you, Chairman Baker and also to Chairman

Bachus for calling this hearing on the Securities and Exchange

Commission’s interim final rules. One of the important duties of

these subommittees is not only to make law, but also ensure that

the laws are correctly understood and implemented by agencies

under our jurisdiction. Today’s hearing provides us an opportunity

to demonstrate why this second rule is so important.

When Gramm-Leach-Bliley became law in November of 1999, the

regulatory landscape for the American financial services industry

was fundamentally changed. The Gramm-Leach-Bliley Act replaced

Depression-era laws with a comprehensive framework for banking,

securities and insurance geared for the 21st century. The old financial services laws were not designed for a world where technology

would give consumers almost limitless investment options. But in

order for consumers to exercise that freedom, artificial barriers to

providing banking, insurance and securities services needed to be

removed, and that’s exactly what Gramm-Leach-Bliley did.

Functional regulation has taken the place of the inflexible onesize-fits-all approach that existed before the Act. The ‘‘push-out’’ provisions were designed to allow banks to continue to perform

such traditional activities as providing investment advice and acting as trustees without having to register under the securities

laws. At the same time, banks would not be given limitless authority to engage in the securities business.

Functional regulation means that banking activities will be regulated by the banking authorities and securities activities will be

regulated, of course, by the SEC.

The SEC’s interim final rules raise troubling questions as to

whether that agency has upheld the letter and the spirit of the law.

GLB was never meant to make banks disrupt their customer relationships and force traditional banking activities into broker-dealer

affiliates. But the SEC’s rules, were they to become final as written, would do just that. I’m encouraged that the SEC has extended

both the comment period and the effective date of its rules, and I

hope this hearing will provide the SEC with an opportunity to receive valuable input on how the law was meant to be implemented.

I want to say I look forward to hearing from all of our witnesses

today and exploring this topic further. The great strides made by

Gramm-Leach-Bliley are too important to be undone by misguided

attempts to implement the law, no matter how well intentioned.

And I want to emphasize that GLB, in particular, the functional

regulation provisions of Title II, was negotiated over a very long

period of time. Boy, was it long.

[Laughter.]

And the Congress gave consideration to concerns raised by not

only every witness represented here today, but every other affected

party and the public, and I’m proud of our work on that historic

piece of legislation and have no intention of reopening debates that

were so carefully and fairly resolved.

The SEC’s interim final rules, however, clearly need substantial

revision to accurately reflect Congress’ intent in that statute, and

this hearing is an important step in that process.
3

And let me pay a special welcome to Chairwoman Unger for

being here two days in a row. You’ll get combat pay. And in your

final appearance as Acting Chairwoman, we’ve been proud of the

work that you’ve done there and hope you continue on as a Commissioner there doing the fine work that you’ve done over a number of years. And with that, Mr. Chairman, I yield back.

[The prepared statement of Hon. Michael G. Oxley can be found

on page 50 in the appendix.]

Chairman BAKER. Thank you, Mr. Chairman. I, too, would like

to add my expression of appreciation, Ms. Unger, for your work. We

certainly have enjoyed having your opinions and professional guidance in matters before the committee and certainly wish you well

in all future endeavors.

Ms. UNGER. Thank you.

Chairman BAKER. Our hearing here this morning is a joint hearing, which I am acting as Chair for Panel I. Chairman Bachus will

chair Panel II. The Financial Institutions Subcommittee and the

Capital Markets Subcommittee both have expressed concern about

the pending rules which were pursuant to Title II of GrammLeach-Bliley. The Commission, on May 11th issued an interim final

rule concerning definitions and exemptions for banks, savings associations pursuant to Sections 3(a)(4) and 3(a)(5) of the Act of 1934.

Initially, the implementation date was October of this year. Now

as a result of the Commission’s actions, the date has been pushed

back to May 2002 to give affected parties and the Congress the opportunity to make comment.

Without doubt, the rule has generated controversy not only from

market participants’ perspective, but also among almost all financial regulatory interests.

The intent of Gramm-Leach-Bliley was, to the best of our ability,

to the field not only from a market, but a regulatory perspective,

among banking, insurance and securities participants. And certainly that was aimed at fairness in regulatory constraints. I would

only add at this point that I feel it is important from here forward

that all financial regulators given the consolidated business structures which are now commonplace in the market, should to the extent practicable discuss and consider from all perspectives rules

which will have effect on your respective market participants.

The lines which historically divided business practice was clearly

eroded by market practice and by statute, and this creates additional burdens, understandably, on the regulators to consult and

understand the consequences. But I think it very important that

the development of this rule perhaps could have had an easier road

had such preliminary discussions been engaged in.

At this time, to facilitate, I’m going to ask the Members’ permission. Chairman Bachus has an opening statement. I don’t know if

a Member on the other side would have an opening statement. Ms.

Unger has some time constraints, and for Members to facilitate

questions of Ms. Unger, I would suggest, with your permission,

that Mr. Bachus be recognized for an opening statement, and to go

directly to Chairwoman Unger so Members may have an opportunity for questions.

Without objection, Chairman Bachus.
4

Chairman BACHUS. Thank you. I have a written statement. I’m

going to introduce it into the record and in the interest of time depart from that and just make two points.

The first point is that when Chairman Baker says there’s been

concern expressed, ‘‘concern’’ is too mild a word. Hysteria may be

more——

Chairman BAKER. I’m always a person of understatement. You

know that.

[Laughter.]

Chairman BACHUS. This rule would cause changes that I think

our financial institutions—that they’re not necessary and unwise

and would cause many of the traditional functions that they’ve

done, done well, and done safely to unnecessary changes in how

they do it and pushing those out.

The other point that I would emphasize is that with the blending

of securities, insurance and banking, the regulators have got to

work together. You’ve got to rely on each other for expertise. Not

talk at each other, but talk with each other. Sit down and have serious discussions I think before some of these rules are released.

It undermines I think the faith in the regulatory system when we

have rules that come out that are then—well, they come out and

there are flaws and I think significant, fundamental problems with

them. And you can tell that in this instance we have that case, because you can read what the Federal Reserve and other bank regulators say about it, what the industry says about it, and see the

profound differences in opinion. And I think some of these can be

avoided. And I’m not criticizing any one agency. I think we could

have that happen by any agency.

But I would hope that there would be much more cooperation

and discussions and reviews among the agencies before these

things are announced to the public.

And those are my two points, Mr. Chairman.

Chairman BAKER. Thank you, Chairman.

Chairman BACHUS. And I appreciate you convening this hearing.

[The prepared statement of Hon. Spencer Bachus can be found

on page 52 in the appendix.]

Chairman BAKER. Thank you very much for your interest and

leadership in this matter as well.

At this time I’d like to recognize our first witness, which we will

depart a little bit from customary practice. We would receive Ms.

Unger’s testimony and then have subcommittee questions in order

to facilitate her departure time.

It’s a pleasure to have you back, Chairwoman Laura Unger, of

the Securities and Exchange Commission. Welcome.

STATEMENT OF HON. LAURA S. UNGER, ACTING

CHAIRWOMAN, SECURITIES AND EXCHANGE COMMISSION

Ms. UNGER. Thank you very much, Chairman Baker and Chairman Bachus. And I appreciate your kind words, Chairman Baker,

as to my tenure as Acting Chairwoman. This may be the last time

you get to call me Chairwoman, so feel free to use it as many times

as you like.

[Laughter.]
5

I am actually pleased to be here today to talk about GrammLeach-Bliley and the historic legislation and the implementation of

the functional regulation provisions in Title II of this legislation.

We recognize, as has already been indicated today, that there are

a number of significant issues that have been raised about the

Commission’s rulemaking in this area, and I want to assure you

that we are listening very closely to these concerns.

I thought I would just touch on a couple of general issues today

rather than the more specific and technical parts of our rules since

the comment period is still open on those rules.

Most importantly, I do want to emphasize to you our commitment to implement Title II of Gramm-Leach-Bliley Act in a manner

that faithfully upholds the plain meaning of the Act and Congress’s

intent in enacting the legislation. We are eager to work with the

banks and the bank regulators to reach the appropriate balance in

the rules consistent with our mandate to protect investors. We also

are committed to easing the transition process for banks in implementing this historic legislation.

In enacting the Gramm-Leach-Bliley Act, Congress determined

that functional regulation was necessary. That is, any bank that

conducts a full-scale securities business has to do so through a registered broker-dealer. Without functional regulations, some investors would have different rights and protections than others, depending on where they did business. And we at the Commission

strongly believe that investors deserve the same protection, regardless of where they buy and sell securities.

In preserving some of the exemptions to the definitions of

‘‘broker’’ and ‘‘dealer’’, however, Congress determined that certain

traditional bank activities should not be disturbed. This creates a

tension in the statute between the objective of having the full-scale

brokerage activities occur in a registered broker-dealer, and the

goal that certain traditional bank activities, such as trust activities, would not be disrupted.

The Commission, as you know, is statutorily charged with interpreting the functional regulation provisions of the Act, and the

rules that we issued represent our judgment as to how to effectively implement the statute consistent with Congress’s intent. The

rules were intended to provide legal certainty about some issues of

concern that the banking community actually brought to our attention as creating some ambiguity.

I thought I would take a few minutes to talk about the process

that we used to interpret the terms in the statute. The GrammLeach-Bliley Act does not specifically mandate or require the Commission to engage in rulemaking in this area. And initially, we

didn’t think that we would engage in rulemaking in this area, and

that, in fact, we would act on a case-by-case basis and provide exemptions and interpretive relief. At the time, the banking community did not bring any particular concerns to our attention, so we

assumed this was the correct approach.

As we moved closer to the effective date for implementation of

the Act, however, the banking community became more vocal about

the nature and degree of uncertainty regarding the scope of the

statutory exceptions.
6

As we gradually heard from more banks and their representatives, we realized that more general guidance was necessary. Unfortunately, at the point that this occurred, we were bumping up

against the effective date of the functional regulation provisions. So

we issued these rules as interim final rules, a procedure the Commission does not often use, but that our banking regulators do use,

and we thought maybe this was the appropriate time to try them

in the context of banking legislation. By issuing interim final rules,

we were able to provide quick and definitive guidance to the industry in the short time remaining before the effective date.

We determined that the interim final rules would grant immediate relief to banks from certain of the statutory provisions while

affording opportunity to get substantive comments by delaying the

effectiveness of the other provisions. We have definitely gotten

some substantive comment.

But I want to underscore that the rules were interim in nature

and that we have sought public comment on these rules. Our interim final rules extended the May 12, 2001 effective date for the

functional regulation provisions so that we could meaningfully respond to the comments. On July 18th, as you know, we extended

the comment period for the interim final rules until September 4th

of this year, and the effective date for the rules even further, to

May 12th, 2002. As a result of this extension, banks have another

year to conform their securities activities to the requirements of

the Gramm-Leach-Bliley Act.

We also indicated that we intend to amend the interim final

rules. And we do not expect the banks to adjust their internal compliance systems until after the amendments are adopted. And we

will extend the compliance date once again for the rules once the

amended rules are issued.

Our expectation is that these extensions of time should provide

ample opportunity for the Commission to continue what we believe

have become constructive dialogues with the banking industry and

the bank regulators to craft rules that will implement the functional regulation provisions in the most reasonable, cost-effective

possible manner consistent with investor protection.

I want to stress, as Chairman Oxley pointed out, that the statutory exemptions are extremely complex and that it did take a long

time to adopt the legislation. In fact, it took 20 years, to the best

of my knowledge. So our goal in this rulemaking is not to extend

our jurisdiction, but to adopt rules that are consistent with the language and Congressional intent of the Gramm-Leach-Bliley Act,

and with the Commission’s primary mandate to protect investors.

We welcome your continuing interest in this issue, and we commend you all for your important role that you have played in modernizing the Nation’s financial services industry.

Thank you very much for the opportunity to testify, and I look

forward to any questions.

[The prepared statement of Hon. Laura S. Unger can be found

on page 59 in the appendix.]

Chairman BAKER. Thank you very much, Ms. Unger. To try to

put a fine point on this, in my view the Gramm-Leach-Bliley provisions relative to broker-dealer matters was constructed to facilitate

certain activities in which banks traditionally engaged, which in-
7

cluded trust and fiduciary activities, the offering of investment advice, custody and safekeeping activities, the use of sweep accounts,

and transactions and asset-backed securities.

The concern I have in the operational consequence of the rule as

promulgated is that activities historically engaged in by financial

institutions, particularly in communities where financial services

providers are limited in many rural areas of the Nation, the consequences of the Act where an institution does not deem it advisable financially to create the structure necessary to provide the

services outside its own bank lobby will in net effect result in a

public consequence of services simply not being provided.

Is there a view at the Commission that the consequence of the

rule would, in fact, result in that, or was this something that was

not foreseen when the rule was ultimately promulgated?

Ms. UNGER. If you’re asking about small banks and what the

Commission’s—— Chairman BAKER. Trust activities.

Ms. UNGER.——has been with respect to that, there are two

parts to that answer. One is the trust activity generally and the

other is small bank trust activity. With respect to small banks, the

Commission has always been concerned about small entities, including broker-dealers and other institutions that we regulate on

an ongoing basis. We have reached out to the small bank community, and in fact we are instituting a number of meetings that are

upcoming to really find out from them how the interim final rules

impact the way they do business and how we can preserve their

ability to carry on these traditional bank activities without them

crossing the line into wholesale brokerage.

As far as trust activities, I think the interim final rules don’t preclude certain trust activities such as custody. When you get into

order-taking—and areas where we traditionally have regulated

order-taking—it really depends on what the activity is by the institution. Order-taking with a de minimis payment for order-taking is

different than commission-based order-taking. Once you move toward a commission-based order-taking, to me that looks like brokerage activity.

This is why a dialogue is very important. We wouldn’t want to

preclude order-taking for a de minimis cover-your-cost kind of fee,

but once a bank has a salesman’s stake in that transaction, then

that is securities activity. And so we start with that concept and

that belief, and we want to hear why it’s not.

Chairman BAKER. I just want to express the view that the more,

how shall I say it, generous terms of defining appropriate conduct,

particularly in the area of trust activities in the community bank

environment, would be very, very helpful I think in the overall receptivity of the rule as currently constructed.

Now there are other issues, and I’m sure other Members will

speak to those. But that is one around which I had particular interest.

Ms. Waters, did you have questions?

Ms. WATERS. Thank you very much, Mr. Chairman, and thanks

to our panelists for being here today. I would like to ask you about

certain parts of your testimony. As you note in your statement, you

reference the fact that Congress directed the SEC not to disturb
8

the traditional trust activities of banks. The rules that your agency

adopted for trust activities, however, appeared to create a great

deal of disturbance in the trust departments of banks, inserting the

SEC far into the relationship of the banks and their customers in

particular.

The rules your agency has adopted may require many banks to

renegotiate trust compensation agreements with customers that

were designed to comply with the requirements of the trust and fiduciary laws. Could you comment as to why you thought it was

necessary to impose very detailed, account-by-account requirements

even though trust compensation arrangements must comply with

the bank’s fiduciary obligations?

Ms. UNGER. Well, my testimony noted that we were charged with

interpreting what the exemptions meant and that, in doing so,

Congress charged us to make sure that banks don’t engage in

wholesale brokerage inside the bank yet enable banks to keep intact their traditional bank activities.

The account-by-account interpretation was intended to prevent

wholesale brokerage from occurring within the institution. If we

were to say, OK, 51 percent of your activity is banking and 49 percent could be wholesale brokerage or could be brokerage, then

there could be a number of accounts in the trust department that

were, in fact, wholesale brokerage. So we determined that an account-by-account calculation would prevent wholesale brokerage activity from occurring in the trust department.

Now we did say that a bank would not have to engage in an account-by-account calculation if its sales compensation from the

trust activities is less than 10 percent of the total compensation

coming from these activities. So our understanding was that the 10

percent exception would allow banks that have just traditional

trust activities to continue those activities. If that 10 percent level

is too low, then of course we would like to consider what would be

the appropriate level. But that 10 percent threshold would mean

you would not have to keep track on an account-by-account basis.

Ms. WATERS. Could you refer to the part of my question that

asked whether or not the rules your agency adopted may require

banks to renegotiate trust compensation agreements with customers that were designed to comply with the requirements of the

trust and fiduciary laws?

Ms. UNGER. I might not know enough of the specifics to answer

this fully, but I will get you a more fulsome answer. My understanding is that we will look not just at the label of the relationship, but the actual nature of the relationship. And as in my answer to Chairman Baker, the more there is a salesman’s stake in

the outcome of the account, the more it looks like brokerage activity.

So to the extent you’re advising the clients and managing their

trust account, that would probably not come under traditional brokerage. But we can’t just say, well, because you say it’s a fiduciary

relationship, that’s enough to satisfy us that it’s not brokerage activity.

Ms. WATERS. OK. So, I guess we are at this point because the

Act itself did not specifically require you to do rulemaking and you

decided that you didn’t have to do it, and you came up with some
9

new rules that kind of say, well, the 10 percent rule and some

other things and case-by-case, and you think that that is good

enough, that that takes care of any concerns that one may have

about the intent of the Act?

Ms. UNGER. No. I think we’re trying to balance what Congress

told us to do, and that is to maintain the traditional bank activities

without allowing wholesale brokerage in the bank. We sought input

from the banking industry who told us they wanted more guidance,

and that is what led to the rules, and to the timing of the rules.

We continue to seek input on this provision. It was our best judgment that, based on the information we had at the time, the 10

percent was sufficient to allow banks to continue traditional trust

activity without having to account for it on an account-by-account

basis.

Ms. WATERS. Do you still think that you made the correct decision not to do rulemaking, but rather the way that you are doing

it is going to work out?

Ms. UNGER. Well, this is a rulemaking. It’s not the way the Commission traditionally proposes its rules. But again, we had the time

pressure that led us to conclude this was the best.

Ms. WATERS. Well, of course, you know this is not the rulemaking, the traditional rulemaking that we’re referencing. You

know this is different.

Ms. UNGER. This is different for us, too. It’s not different for the

bank regulators. So we’re trying to emulate the bank regulators,

but maybe not to your satisfaction.

Ms. WATERS. You’re right about that.

Ms. UNGER. I suspected. The reason that we extended the time

period, though, is that we heard a lot from the banking industry

and from the bank regulators that we didn’t get it exactly right. So

we’re going to continue to work to get it exactly right.

Ms. WATERS. That’s right. You didn’t get it right and we’re glad

to hear you say that, and you’re right. We’ve got to get it right.

Thank you.

Ms. UNGER. You’re welcome. Thank you.

Chairman BAKER. Before recognizing Mr. Bachus, I think I want

to take just 30 seconds to make the expression of my position more

clear. And as I am understanding it, if you get to the activities of

a trust—and let’s assume for the moment now we’re not talking

about a small bank, we’re talking about a complicated trust—

where there may be various accounts within the construct of that

trust, the presumption under the rule as constructed would be

you’d have to go to each account activity to determine the appropriate regulatory constraint as opposed to what I would view as the

historic presumption that the trust itself—that any activity performed by a bank in the capacity of trustee is covered by the trust

exemption, unless there is a specific finding by the Commission

that a particular activity should not.

So I think the view is a reversal of the presumptions here, not

necessarily the applicability of the regulatory oversight. Thank you,

Mr. Bachus. Mr. Bachus?

Chairman BACHUS. Thank you. Looking at Gramm-Leach-Bliley

in its entirety, does the SEC maintain that it was Congress’s intent
10

to require traditional bank practices such as trust and fiduciary

services to be moved from the bank to a broker-dealer?

Ms. UNGER. Well, you know, what is interesting, Chairman

Bachus, is the fact that what people might consider to be traditional bank activities has really evolved in the 20 years of talking

about financial modernization. And I think there has always been

some concern about securities activities being conducted in the

banks.

So now that we are supposed to functionally regulate banks’ securities activities, I think the fact that the banks have been conducting these activities for a long period of time doesn’t make them

any less securities activities. And so we’re trying to balance our

urge to regulate securities activities with the business practices of

banks.

So, we want to fulfill our mandate of protecting investors and

regulating securities activities, as we think you want us to, while

preserving the ability of the bank to conduct what they consider to

be traditional bank activities.

Chairman BACHUS. But, I guess my question was, are you contending that these trusts and fiduciary activities should be moved

from the bank to a broker-dealer? Or do you think that that’s what

the Congress intended?

Ms. UNGER. You mean wholesale? It would probably make it a

lot easier.

Chairman BACHUS. Any move. Any change in the present status

quo?

Ms. UNGER. No, I don’t. I think it’s something that we really

need to work with the bank regulators and the banking industry

on to figure out where to draw the lines.

Chairman BACHUS. All right. How can Congress be assured that

the Commission will amend their interim final rules in a way that

meaningfully addresses the concerns that the other regulators on

our panel expressed in their opening statements that I’ve read and

have raised regarding bank trust activities, custodial activities, investment advisory activities? In other words, can we get some assurance?

Ms. UNGER. That we’ll get it right the second time.

Chairman BACHUS. Can we get some commitment?

Ms. UNGER. I can absolutely commit to you that I would not

want to come back and testify after our final rules are adopted

about why we didn’t get it right the second time. We are committed

to working with the bank regulators and the industry to balance

the two competing interests, which are very difficult to balance. I

think, given the time extension, that we can do that.

Chairman BACHUS. And substantial changes will be made?

Ms. UNGER. I don’t know if your definition of ‘‘substantial’’ would

be the same as mine, but I can assure you that we absolutely intend to amend the rules that were proposed.

Chairman BACHUS. I don’t know if I still have some time. I’ll ask

the bank regulators. Have there been any problems in the areas of

trust and fiduciary services that would lead to the need for an SEC

oversight in addition to the oversight that Federal and State banking regulators supply today?
11

Mr. MEYER. Mr. Chairman, I don’t believe so. But as the Chairwoman has indicated, there is an urge on the part of the SEC to

oversee and to regulate all securities activities wherever they lie.

Banking agencies for a long time before there was an SEC were supervising security activities that are going on in banks. We have

a process of doing so. We operate under the fiduciary and trust law.

We have bank examinations that effectively assure compliance

with those laws. No, we don’t think there’s any necessity to have

another regulator duplicate and oversee those activities.

Mr. KROENER. Let me just add to that, I think a fair reading of

the legislative history and the intent here of the Congress indicates

an awareness that there had not been significant securities-related

problems arising out of these traditional activities, and that was

the fundamental basis on which Congress created these exemptions.

Chairman BACHUS. I would agree.

Ms. BROADMAN. I’ll agree with both of those statements. We’re

not aware of reasons to push these activities out of the bank. And

in fact, we will note that bank fiduciary and trust activities are

subject to a comprehensive regulatory scheme. They are closely examined by bank regulators. Trustees have the highest duties that

they owe to their customers, higher in many respects than brokerdealers.

Chairman BACHUS. Thank you. And let me just close by saying

Chairwoman Unger, I am very impressed with your willingness to

work and to promise cooperation and to make a commitment to go

forward with an upside-down look and review of these rules. I

mean that sincerely. I thank you.

Ms. UNGER. Well, thank you, Chairman. I think you just heard

the dilemma that we face, which is how we accomplish functional

regulation of ‘‘traditional’’ bank securities activities.

Chairman BACHUS. I don’t think Congress intended another layer

of regulation over what has been in place.

Ms. UNGER. No. Nor do we want to provide another layer.

Chairman BACHUS. And I think what’s been in place has worked

well. But I sincerely appreciate your willingness to work with us

and with the industry and with the other regulators. I mean that.

Ms. UNGER. Thank you.

Chairman BAKER. Thank you, Chairman Bachus.

To restate where we are for Members since folks are busy this

morning, in and out, we recognized Ms. Unger for her opening remarks and we have not yet heard the testimony from our other

three witnesses in order to facilitate an early departure for Ms.

Unger. Mr. Watt, you would be next for questions. I would ask that

Members, if you do not feel the need to pursue questions of Ms.

Unger at this time, because we will have further discussions from

the other witnesses as well, but, Mr. Watt, you’re up next in regular order.

Mr. WATT. Thank you, Mr. Chairman. I assume your encouragement not to ask questions doesn’t extend to an encouragement not

to praise the Chairman. So I want to start by praising the Chairman, both Chairs, for convening this hearing quickly and helping

to kind of create some momentum here for a discussion, public discussion, about what I think is an extremely difficult issue.
12

My initial reaction, and I continue to have this reaction, is that

the SEC clearly probably overstepped. And my initial inclination

was to do a letter expressing that as a number of people on the

subcommittees have done. But once a hearing was scheduled, it

seemed to me to be an appropriate step to have the benefit of the

testimony and discussion before getting too far out there.

And I want to join with Chairman Bachus in expressing my feeling that your response appears to me to be a very, very appropriate

response and balanced response. That you put something out there,

you probably realized that it would provoke some discussion, probably not as much as it has provoked, and you want to now proceed

with caution and try to work out what the appropriate balance is.

I think we should resist the temptation to get into a battle between the regulators, though, just on the question of whose turf is

here and remember that our objective is to create a set of rules

going forward that work for the new world that we have created

and sanctioned under Gramm-Leach-Bliley. So it can’t always be

business as usual, because Gramm-Leach-Bliley is not business as

usual. And I think inherently, we are going to have these kinds of

tensions being raised, and it is good to have an aggressive public

discussion about them. And while I don’t want to leave any impression that I think the balance that you achieved in the initial rulemaking was the appropriate balance, I think it’s good to have this

discussion, and I think it’s good that this discussion has been provoked by the rules or the proposals that you have come forward

with.

So, in that context, I think we’ve got some difficult times ahead

not only on this set of issues, but on a number of issues that I

think we’re going to have to work out between historical patterns

of regulation. And I do think it’s important for us as Members of

these subcommittees to keep in mind that the overwhelming responsibility of the SEC is to assure the protection of the public and

customers. And while that is not adverse to any of the other regulators, they have exercised that jurisdiction historically in an aggressive fashion, and I hope they will continue to exercise it in an

aggressive fashion. And I hope the regulators won’t get to the point

where you are just kind of jockeying for power and position here,

but that all of the regulators will keep in mind that this is about

protecting the public and consumers and customers at the end of

the day.

I didn’t ask a single a question.

Ms. UNGER. I could pretend you did.

Chairman BAKER. You started out very well, though.

Mr. WATT. But I praised the Chairmen and I praised the SEC

representative, so I guess I’m doing all right.

Chairman BAKER. I won’t forget that. Thank you, Mr. Watt.

Ms. UNGER. Thank you.

Chairman BAKER. Mr. Manzullo, you’re next by time of arrival,

but I have to advise the subcommittees that the Chairwoman needs

to be out of here by 11:20, so Mr. Manzullo, proceed accordingly,

but we have to excuse our witness timely.

Mr. MANZULLO. I just have a comment. In addition to being on

the panel here, I’m the Chairman of the Small Business Committee. And you’re in a very difficult position. I think you did a
13

great job of defending the interim final regulations, whatever those

are called. But my question would be on behalf of the small banks

in this country and also of the tons of small banks that are in the

Congressional district that I represent, which has a lot of rural

areas, did you seek any comment prior to issuing the interim final

rules from the small banks or small bank organizations or Congressional panels?

Ms. UNGER. We did, but we are making a much more concerted

effort to reach out to the small bank community. We have scheduled a number of meetings, and are in the process of scheduling

more meetings to make sure that we do address the particular concerns of small banks. The Commission has always expressed concern about small institutions. We’re always mindful in any regulation of the cost and benefit and burdens to the smaller institutions,

and we routinely grant exemptions to smaller institutions.

Mr. MANZULLO. I guess the other question would be with regard

to whether or not the SEC should have even promulgated rules

into traditional bank activities where the area there was gray and

you went ahead and issued the rules. Did you confer with any Congressional panels or Members of the Banking Committee for further elucidation on that issue?

Ms. UNGER. We did not reach out to the Members. I believe we

worked with the staff, we worked with the banking community, the

bank regulators and really it was the banking community that led

us to believe that the interim final rules were necessary and that

there was more general guidance needed than what we were intending to provide, given our statutory obligation under GrammLeach-Bliley, which was through granting exemptions and providing interpretive relief.

Mr. MANZULLO. Thank you. I yield the balance of my time to

Mrs. Kelly.

Mrs. KELLY. Thank you. Thank you very much, Mr. Manzullo.

Ms. Unger, an interim final rule sounds to me like an oxymoron.

I don’t see that that’s something—I mean, if you’re going to amend

an interim final rule, how is it final?

My concern with regard to what is happening here is twofold.

Normally when an agency issues a major rule in a final form without having any kind of a comment period, no area, no time period

for notice and comment, that’s very, very unusual. And taking the

form of an interim final rule, I’d like to know why the SEC took

that stand.

Ms. UNGER. That’s a very fair question, because the Commission

does not usually issue interim final rules. I had said in my testimony that what happened was, we had initially intended to issue

interpretive relief and guidance on a case-by-case basis, and we encouraged the industry to let us know if there was confusion and a

need for guidance.

It wasn’t until we bumped up to the time where the statute was

going to take effect that we found out there was general confusion

and the need for more general guidance. We actually looked to the

bank regulators practice in issuing the interim final rules. They do

this type of rulemaking routinely. It’s unusual for our agency.

There is a comment period, however, even with interim final rules.
14

We even extended that comment period. The comment period had

originally expired on July 18th.

We extended it to September 4th in response to the numerous

comments and letters that we received with respect to the interim

final rules. We’ve been using the time in the interim to meet with

the interested groups, to reach out to small banks, to really try to

get together with the constituencies who expressed concern about

our interim final rules. We also have plans to sit down with the

bank regulators. I think we’re in the process of scheduling something so that we may resume our conversations with them as well.

But what’s interesting about this is what Congressman Watt was

talking about. We don’t want to duplicate regulation. We want efficient, effective regulation. We want a seamless web of regulation,

and that’s what we’re trying to achieve with the bank regulators.

You hear them talk about them regulating bank securities activities, and yet we’re told to regulate bank securities activities. So we

just need to figure out how we can do the best job consistent with

the business practices of banks and make it work.

Mrs. KELLY. Well, I guess what I find disappointing here is the

fact that when we worked so hard to craft the Gramm-Leach-Bliley

bill, we were very clear that we expected the regulators to work together. And what I feel here I’m really disappointed that the SEC

didn’t work with the other regulators before they did this interim

final rule.

I just think that this has created a tremendous legal uncertainty

for the banks that are trying to figure out what their obligations

are under this new rule and by extending a comment period and

by doing the issue of an interim final rule prior to having enough

period for comment and workout, I think that this has the potential

for allowing the banks and the bank customer relations to deteriorate during this timeframe. I would hope that you would address

that. And I would hope that you would be very specific and very

clear when you’re dealing with the banks. They need some guidelines. And I feel that this may unfairly affect their relationship

with the general public. I don’t know how you feel about that, if

you want to respond to that.

Ms. UNGER. Well, I think the fact that we didn’t know they wanted more general guidance was maybe the first misstep in what may

be viewed as a series of missteps. We’re trying to have a relationship with the bank regulators—but this is really the first time

we’re charged with coming up with a seamless web or system of

regulation.

We sat down with them. I think they didn’t like what we said

and maybe we didn’t agree with some of what they said. I think

now it’s clear we came up with our best judgment about how to

make sure banks don’t engage in wholesale brokerage activity

within the institution, yet preserve the traditional bank activities.

I think a certain amount of it reflects a learning curve. I think

we’re continuing to learn, we’re continuing the dialogue, and we

really don’t want to duplicate regulation. But I don’t want to be

called up here in 6 months and have you say that it’s your job to

regulate the securities activities of banks, and you didn’t. So I

think we want to be very careful that we get it right, because this
15

is very big, it’s historic legislation, as you said, and you’re talking

about a substantial part of the financial industry.

Chairman BAKER. Ms. Unger, Mr. Manzullo’s time has expired,

Mrs. Kelly, and I feel an obligation to facilitate Ms. Unger’s departure here. She’s been gracious with her time and we’re past your

departure schedule.

With the subcommittees’ understanding, we will return to regular order and hear the testimony of our other witnesses. I’d like

to at this time excuse Ms. Unger. I am confident there are Members who would like to make further expression or pose further

questions with regard to the testimony. The record remains open,

and we may get back to you in writing.

Ms. UNGER. Thank you very much.

Chairman BAKER. Thank you for your participation this morning.

Ms. UNGER. I appreciate that. I hope the Members leave feeling

that we are sincere in our efforts to continue a cooperative dialogue

with everybody who’s interested in having one.

Chairman BAKER. For that, we are appreciative. Thank you very

much for your appearance here today.

Proceeding now in regular order, our next witness this morning

is the Honorable Laurence Meyer, a Member of the Board of Governors of the Federal Reserve System, no stranger to the subcommittees. Welcome, sir.

STATEMENT OF HON. LAURENCE H. MEYER, MEMBER, BOARD

OF GOVERNORS, FEDERAL RESERVE SYSTEM

Mr. MEYER. Thank you. Chairman Baker and Members of the

subcommittees, I appreciate this opportunity to present the views

of the Federal Reserve system on the interim final rules issued by

the SEC to implement the bank securities provisions of the

Gramm-Leach-Bliley Act. The manner in which these provisions

are implemented is extremely important to banks and their customers and well deserves your attention.

As the banking agencies detailed in our official comment to the

Commission, we believe the rules are, in a number of critical areas,

inconsistent with the language and purposes of the GLB Act and

create an overly complex, burdensome, and unnecessary regulatory

regime. The rules as currently drafted would disrupt the traditional operations of banks and impose significant and unwarranted

costs on banks and their customers.

We support the Commission’s recent actions to address important procedural aspects of the rules by providing or promising various extensions to the rules and the underlying statutory provisions. We believe these procedural steps are both necessary and appropriate to ensure there is a meaningful public comment process

and that the SEC receives much needed information regarding the

practical effects of its rules on the traditional activities of banks.

More importantly, we look forward to engaging in a constructive

dialogue with the Commission and its staff and to assisting them

in modifying the substance of the rules in a manner that gives effect to Congress’s intent and does not disrupt the traditional activities of banks.

However, we are concerned that the SEC testimony today—and

I refer specifically to their more detailed written testimony—sug-
16

gests that the SEC is not prepared to make the substantive

changes needed to make the rules conform to the language of the

GLB Act and the intent of Congress.

Congress worked carefully in designing the securities provisions

so as not to disrupt the traditional activities of banks. It is important to keep in mind that these provisions were not imposed because abuses had occurred in the traditional securities activities of

banks. In fact, banks generally have conducted their securities activities responsibly and in accordance with bank regulatory requirements and other applicable law. Nor was this change undertaken in order to extend regulation to an unsupervised activity.

Banks in the securities activities they conduct as part of their

banking business are supervised, regulated, and examined by the

relevant Federal and State banking agencies.

Rather, the review of the bank exception was undertaken to address a concern that, with Glass-Steagall repeal, security firms

might acquire a bank and move the securities activities of the

broker-dealer into the bank in order to avoid SEC supervision and

regulation.

Some also expressed concern that banks might in the future significantly expand their securities activities beyond the traditional

services provided to bank customers. Congress sought to balance

these concerns with a desire to ensure that banks could continue

to provide their customers the securities services that they had traditionally provided as part of their customary banking activities,

without significant problems, and subject to the effective supervision and regulation of the banking agencies.

The end result—the GLB Act—replaced the blanket exception for

banks from the definitions of ‘‘broker’’ and ‘‘dealer’’ with 15 exceptions tailored to allow the continuation of key bank security activities.

While we differ with the Commission on a number of aspects of

the rules, we are most concerned with the provisions that implement the statutory exception for the trust and fiduciary activities

of banks. Trust and fiduciary activities are part of the core functions of banks, and banks have long bought and sold securities for

their trust and fiduciary customers, under the strong protections

afforded by fiduciary laws and under the supervision and examination of the banking agencies. In fact, the Conference Report for the

GLB Act specifically states that, I quote: ‘‘the conferees expect that

the SEC will not disturb the traditional bank trust activities’’

under this exception.

The interim final rules, however, impose compensation requirements on an account-by-account basis that are unworkable, overly

burdensome, and at odds with both the language and the purposes

of the exception. Under the rules as written, many customers that

have chosen to establish trust and fiduciary relationships with

banks will be forced to terminate these relationships or have duplicate accounts at the bank and a broker-dealer resulting in increased costs and burden. This was very clearly not the result intended by Congress.

Another of the exceptions included by Congress in the GLB Act

was designed to protect the custodial and safekeeping services that

banks have long provided as part of their customary banking ac-
17

tivities. Bank-offered custodial IRAs provide consumers throughout

America a convenient and economical way of investing for retirement on a tax-deferred basis, and banks have long executed securities transactions for these accounts, subject to IRS requirements

and the supervision and regulation of banking agencies.

Banks, as part of their customary banking activities, also provide

benefit plans with security execution services and execute securities transactions on an accommodation basis for other custodial

customers. The Commission has stated, however, that the custody

exception does not allow a bank to effect security transactions for

its custodial IRA accounts, for benefit plan accounts, or as an accommodation for custodial accounts. This position essentially reads

the explicit authorization adopted by Congress out of the statute,

is completely contrary to the purposes of the Act, and would disrupt longstanding relationships between banks and their customers.

The interim final rules also impose unworkable or overly broad

restrictions on the networking arrangements a bank may have with

a third-party broker.

In addition, we strongly believe that the rules should provide a

cure or leeway period to banks that are attempting in good faith

to comply with the exceptions, particularly given the complexity of

the rules. Indeed, in some cases, banks will not even be able to confirm that their security transactions will comply with an exception

at the time they are conducted.

The Board stands ready to work with the SEC and the banking

industry to make sure the significant extent of changes to the rules

that are needed to ensure that any final rules reflect the words of

the statute and the intention of Congress.

Thank you.

[The prepared statement of Hon. Laurence H. Meyer can be

found on page 81 in the appendix.]

Chairman BAKER. Thank you very much, Governor Meyer.

Our next witness is the General Counsel for the Federal Deposit

Insurance Corporation, Mr. William Kroener. Welcome, sir.

STATEMENT OF WILLIAM F. KROENER III, GENERAL COUNSEL,

FEDERAL DEPOSIT INSURANCE CORPORATION

Mr. KROENER. Thank you. Chairman Baker, Chairman Bachus,

Members of the subcommittees, I appreciate the opportunity to testify on behalf of the FDIC regarding the implementation by the

Federal Deposit Insurance Corporation and other Federal banking

agencies of Title II of the Gramm-Leach-Bliley Act.

My testimony today will discuss our view of the Securities and

Exchange Commission’s interim final rules that seek to implement

the bank broker-dealer exceptions set forth in Title II. Those views

are also set out very completely in the official comment letter of the

banking agencies to the SEC.

We are concerned that the burden on banks resulting from the

SEC’s interim final rules would force the push-out of various lines

of business by banks that meet the statutory exceptions in Title II

of the Gramm-Leach-Bliley Act. As you know, Title II was a carefully crafted compromise intended to allow these lines of business
18

to be offered by banks. The SEC’s interim rules would effectively

overturn this compromise.

The adverse impact of the interim final rules would be especially

painful for hundreds of community banks that do not have SECregistered broker-dealer affiliates. These banks provide important

trust and custody services to their communities. If the SEC’s interim final rules stand as currently drafted, customers of community banks would lose these important services.

As published in the Federal Register of May 18th, the interim

final rules are intended to clarify the SEC’s interpretation of various bank exceptions from the definition of ‘‘broker’’ and ‘‘dealer’’ in

the Exchange Act. However, instead, the rules in effect significantly revise the statutory language in Title II and disregard Congressional intent regarding the various statutory exceptions.

First, the trust and fiduciary exception. Of greatest concern to

the FDIC and the other banking agencies are the provisions of the

final rules that implement the statutory exemption for traditional

trust and fiduciary activities. We believe many of these provisions

conflict with the statutory language of the Gramm-Leach-Bliley Act

and will significantly interfere with the traditional trust and fiduciary activities of banks. These activities are a key component of

the business of banking for many banks, including more than 1,000

community banks. They have long been offered to bank customers

without significant securities-related problems, and are already

regularly examined by bank examiners for compliance with trust

and fiduciary principles that provide strong customer protections.

The trust and fiduciary exception in Title II broadly authorizes

the bank, without registering as a broker-dealer, to effect securities

transactions in a trustee capacity so long as the bank is ‘‘chiefly

compensated’’ for such securities transactions by forms of trustee

compensation and if other statutory conditions are met.

The SEC’s interim final rules provide that a bank meets the Act’s

chiefly compensated requirement only if, on an annual basis, the

amount of the relationship compensation received by the bank from

each trust account exceeds the sales compensation received by the

bank from that account.

The FDIC and the other banking agencies strongly disagree with

the SEC’s position that the Act’s chiefly compensated condition for

the trust and fiduciary exception may be implemented on an account-by-account basis.

Second, the custody and safekeeping exception. We also disagree

with the SEC’s treatment of the Act’s custody and safekeeping exception. That statutory exception permits a bank, without registering as a ‘‘broker’’ under the Exchange Act, to engage in various

custodial and safekeeping-related activities, ‘‘as part of its customary banking activities.’’ This exception also allows banks to engage in other activities as part of their customary safekeeping and

custody operations, including facilitating transfer of funds or securities as a custodian or clearing agency, effecting securities lending

and borrowing transactions from customers, and holding securities

pledged by a customer.

We strongly disagree with the SEC’s position that the custody

and safekeeping exception does not permit banks to accept securities orders for their custodial IRA customers, for Section 401(k) and
19

benefit plans that receive custodial and administrative services

from the bank, or as an accommodation to custodial customers. We

understand that one of the changes made in the Conference Committee in enacting the Gramm-Leach-Bliley Act was intended to

address precisely this. Although the SEC’s interim final rules include two SEC-granted exemptions for custodial-related transactions, including a small bank exemption, these exemptions are

subject to numerous burdensome conditions so that the result is little benefit to banks and enormous disruption.

Third and finally, the networking exception. We are concerned

with respect to that exception that the SEC’s interpretation of the

term, ‘‘nominal one-time cash fee of a fixed dollar amount’’, imposes

unnecessary limitations on the securities referral programs of

banks that are not required by the statute. Prior SEC precedents

regarding networking arranged by banks and savings associations

did not involve such restrictions on bonus programs and referral

fees as are contained in the interim final rules.

To conclude, the FDIC commends the subcommittees for focusing

attention on the significant impact of the SEC’s interim final rules

on the banking industry.

Given the profound impact of the interim final rules on the functional regulation of securities activities of banks, we hope that the

SEC will engage in a meaningful dialogue with the banking agencies to produce a final rule that significantly limits unnecessary

termination of traditional banking services or, in the alternative,

does not force customers to have to seek duplicative account arrangements.

Thank you.

[The prepared statement of William F. Kroener can be found on

page 99 in the appendix.]

Chairman BAKER. Thank you very much, Mr. Kroener.

Our final witness on this panel is Ms. Ellen Broadman, Director

of Securities and Corporate Practices, Office of the Comptroller of

the Currency. Welcome, Ms. Broadman.

STATEMENT OF ELLEN BROADMAN, DIRECTOR OF SECURITIES AND CORPORATE PRACTICES, OFFICE OF THE COMPTROLLER OF THE CURRENCY

Ms. BROADMAN. Thank you. Chairman Baker, Chairman Bachus,

Members of the subcommittee——

Chairman BAKER. And you need to pull that mike. They’re not

very sensitive. You have to just pull it close.

Ms. BROADMAN. Can you hear me now?

Chairman BAKER. Absolutely.

Ms. BROADMAN. Oh, good. OK. Chairman Baker, Chairman Bachus, Members of the subcommittees, thank you for this opportunity

to discuss the SEC’s interim final rules. We appreciate the subcommittees’ efforts to review the significant issues that the rules

raise.

To begin, I would like to commend the Commission for its recent

actions on the rules. The Commission’s recent decision to extend

the time for banks to comply with the rules was a constructive first

step.
20

We also welcome and view as essential its commitment to further

extend the compliance time once final rules are adopted so banks

have sufficient time to bring their operations into compliance with

the rules. And we are especially pleased that the Commission recognizes the importance of and anticipates amending the rules.

The banking agencies are currently working together to develop

for the Commission suggested approaches for revising the rules. We

look forward to working with the Commission in developing rules

that are workable for banks and that are consistent with the statutory language and Congressional intent behind the rules.

We especially appreciate the subcommittees’ support for this collaborative effort. The Office of the Comptroller of the Currency and

the other banking agencies provided the Commission with comprehensive and detailed comments on the rules because of the significant issues they raise. We are concerned that the rules create

unworkable requirements that would force banks to discontinue

traditional banking activities that Congress specifically intended to

preserve under the Gramm-Leach-Bliley Act.

We are concerned that the rules would significantly disrupt longstanding relationships between banks and their customers, would

restrict customer choices and increase customer costs. This result

is unnecessary and inconsistent with the intent expressed by Congress in enacting these provisions.

One particularly troubling area is how the rules would treat

trust and fiduciary activities subject to the exemption. Congress

adopted this exemption to permit banks to continue offering traditional trust and fiduciary services. To qualify for this exemption,

the rules require banks to conduct account-by-account reviews and

establish for each individual account that the account meets very

complicated compensation requirements. This provision and other

provisions in the rules are so burdensome for banks and so impractical that they will effectively force banks of all sizes, large and

small, to discontinue significant aspects of their traditional trust

and fiduciary business.

Another area of concern is the treatment of custody and safekeeping activities. These activities, like trust and fiduciary activities, are part of the core business of banking. Congress created a

custody and safekeeping exemption to allow banks to continue providing the full range of customary custody and safekeeping services. Bank custodians have a long history of providing to customers

order transfers to registered broker-dealers. Despite this longstanding history, the rules do not include customary custodial

order-taking within the exemption. Instead, the rules create an exemption that permits bank custodians to continue taking orders if

they do not charge any fees for the service.

To the extent that the rules force banks to stop offering ordertaking as a convenience, customers will no longer have the choice

of using their selected custodian to submit their orders. We believe

this is contrary to both the language and the Congressional intent

of the statute.

We have a number of other areas of concern that are detailed in

our comment letter that also are very important and that need to

be addressed by the Commission in revising its rules.
21

Our comment letter also expressed concerns with the process

that was employed in adopting the rules. Final rules were issued

prior to a notice and public comment period. This is not the normal

way that the banking agencies issue their rules. This placed banks

in an untenable position. Without knowing how the rules would be

changed, banks were required to take immediate steps to comply

with the rules without knowing how the rules would be changed

prior to the effective date. Our letter urged the Commission to review public comments before establishing final rules and then

grant banks sufficient time to bring their operations into compliance.

We appreciate the Commission’s response in which it pledged to

address these problems. We believe the Commission has taken a

positive step by extending the dates for compliance and acknowledging that the rules must be changed after consideration of the

public comments.

We stand ready to provide the Commission assistance in this

process. And again, we appreciate the attention the subcommittees

have given to the significant issues raised by the Commission’s

rules and appreciate this opportunity to express our views.

[The prepared statement of Ms. Ellen Broadman can be found on

page 116 in the appendix.]

Chairman BAKER. Thank you very much, Ms. Broadman. I would

quickly add to your comment, it’s apparent Members of the subcommittees have a very keen interest in resolution of the matter.

And as you and the other panelists reach conclusions about remedies that would be appropriate, we would be very appreciative of

being engaged in that discussion.

I was visiting with Chairman Bachus during the course of the

hearing this morning—and we’ve pretty much, at least on our behalf, reached a conclusion that we’d like to have those remedies— so in the event the remaining months ahead don’t bring appropriate resolution, we might have an approach that might be helpful. And Chairman Bachus may wish to address that at a later

time.

Mr. Kroener, I want to understand it from a consumer perspective here for a minute. You’re my banker. I come in to see you and

I want to set up a trust for the kids. And pre-Gramm-Leach-Bliley,

as long as your compensation package didn’t trigger certain things,

you could in your capacity as the trustee get all of it done and tell

me where to sign. Today if the SEC rule would go into effect, depending on account-by-account how your income is derived, not

with regard to my business, but generally in the banking practice,

you may in order to facilitate the distribution of my investment

strategy, have to go to a broker-dealer.

Now beyond the disruptive effect of that new arrangement, there

is a potential to increase the cost to me as the consumer for those

services, because in your capacity as a trustee, you’re going to be

compensated because of those arrangements. And now we have to

add on the broker-dealer for whatever it is he’s going to do. Is that

a fair assumption.

Mr. KROENER. Yes. I think it’s fair. Let me expand on that a little. Right now if you come to me to set up a trust account for your

family and others, the bank will act as trustee, agree to set up the
22

trust account, look at the asset composition and decide, given the

objectives of your trust and the needs, the various transactions

needed to be performed to set the portfolio correctly. And the bank

will then charge you fees, and it may also do transactions through

a registered broker-dealer and charge the account amounts for

those transactions.

Under the new rule as proposed, the process of initially setting

up the portfolio will incur fees through the broker-dealer that will

count as the bad type of compensation that banks cannot receive— not relationship compensation. So if the bank actually has the misfortune that you’ve come to them to set up the portfolio in December of a year and the bank goes ahead and executes the transactions in December of that year, the compensation to the brokerdealer for setting up the portfolio the way it needs to be in the

bank’s view as trustee will be much higher than the other fees that

the trustee would receive for the year. So that account would not

be exempt, even on an account-by-account basis. And it would be

necessary for the bank in that circumstance to require you not only

to open the trust account, but also for you to open a separate brokerage account with a broker-dealer and for the customer to actually go to the broker-dealer to arrange these transactions, as I understand it.

Now that’s an extreme example, because I’ve picked December of

a year. But that’s a single account. And that one account may

cause the bank to not avail itself of the exemptions in the Act for

these traditional trust services. The bank has to track it in a very

different way than it would have prior to the Act. And it may not

even be possible for the account to be done at all.

Chairman BAKER. Well I take that as a yes.

[Laughter.]

Chairman BAKER. And secondarily, my point is, this is not just

a matter of which regulator gets to look at the books, nor a matter

of which industry makes the fees, there is an operative consequence to a consumer as a result of the implementation of these

rules, and my concern is that we are, in fact, layering a regulatory

oversight, increasing the net cost to the consumer of fiduciary services. And I think that is the principal focus which I hope the subcommittees will take.

I’m just about to expire my time.

Mr. Watt.

Mr. WATT. Thank you, Mr. Chairman.

Mr. Meyer, let me understand whether your position is that if a

bank were engaging in an activity before Gramm-Leach-Bliley,

would there be any circumstance under which you would think that

the SEC would come in and do regulation of that activity as opposed to the banking regulators?

Mr. MEYER. I think the issue here is: are there activities that

should be legitimately pushed out of banks under these rules?

Mr. WATT. All right. So you’re saying if there is such an activity,

it ought to be pushed out of the bank and not be retained in the

bank and therefore there is no activity that should be retained in

the bank—— Mr. MEYER. And double-regulated.

Mr. WATT.——that the SEC should have any jurisdiction over?
23

Mr. MEYER. No. Not double regulation, not double oversight, no.

But I think the tension here is that the SEC may have concerns

that banks would try to become engaged in a general retail brokerage business not related to their trust accounts, not related to their

custodial accounts. And it seems to me that’s what this whole

push-out was about—to prevent banks from moving in directions

beyond their customary ones.

Mr. WATT. OK. Let me go back to not a trust account, but an IRA

account. Maybe there’s no difference between the two technically,

but in my mind—I’m directing my own IRA account. Are banks

doing that inside the bank now?

Mr. MEYER. Absolutely.

Mr. WATT. OK. And when there is a transaction of securities, I

call and I say I want to transfer——

Mr. MEYER. You want to make a change.

Mr. WATT. I want to sell IBM and buy something else. Does the

bank get a separate commission there?

Mr. MEYER. It can. It takes the order, and it can get paid for taking that order, although it is effected and actually executed ultimately through a broker-dealer.

Mr. WATT. OK. Does the bank get a commission, or does the commission go to the broker-dealer?

Mr. MEYER. Well, the bank can charge for that.

Mr. WATT. I think you’re sidestepping my question. Does the

bank get a commission? Do they get a commission, or have they

been paid a separate fee for just being the administrator of my

IRA?

Mr. MEYER. Well, no, they can get a fee for administering, but

they get a fee that has to cover any fee charged by the broker-dealer for executing the commission, and they can also charge a fee for

taking that order.

Mr. WATT. OK. But they can’t get a commission on the sale

itself?

Mr. MEYER. They get a commission for taking the order, if you

like. The actual execution is done ultimately by the broker-dealer.

But they pass that through to the customer.

Mr. WATT. Well, I’m assuming they pass all this through to the

customer.

Mr. MEYER. Right.

Mr. WATT. The question is whether that person—well, let’s cut

the broker-dealer out. Let’s say they did it online. They can’t do

that?

Mr. MEYER. They always do it and they have to do it through a

broker-dealer.

Mr. WATT. OK. So you can’t do it online. They can’t just sit in

the office and do it online and take a commission there. But they

can charge a fee and then charge the broker-dealer’s commission

back to the customer, right?

Mr. MEYER. Of course.

Mr. WATT. OK. All right. I don’t have a position on this. I’m just

trying to figure out what the appropriate response is. And you’re

saying the broker-dealer part of that has got to be pushed out?
24

Mr. MEYER. What the SEC says is that the bank can hold as a

custodian the securities, but can’t be involved in any activities related to order-taking.

Mr. WATT. OK. If they have a securities subsidiary or affiliate,

can they go to their own affiliate and use them as the broker-dealer?

Mr. MEYER. Well, of course, they could do that, certainly. They

could use a broker-dealer, including an affiliate.

Mr. WATT. OK. I’m just—— Mr. MEYER. But the issue here is that customers are used to

working with banks who administer their IRA accounts and doing

their customary business. If I want to make a change in my IRA

account, I can do it through the bank. I call up the bank. I tell

them exactly what I want to do. I don’t have to set up two accounts, one with my bank and another with a separate broker-dealer in order to get that transaction done. That would be burdensome, break the normal relationships, and be added cost for the

bank customer.

Mr. WATT. Thank you, Mr. Chairman. This is enlightening. I

think more educational than—— Mr. MEYER. Could I make another point about this, because this

was an issue that came up during the Conference Committee, as

Members of the subcommittees I’m sure are aware. At that time,

we thought there was no problem with these transactions and this

order-taking as part of custodial IRA accounts, but the banking

agencies got wind that the SEC was taking a different interpretation, and we included a specific provision, or the Conference Committee added a provision to the bill that clarified, we thought, that

these kinds of order-taking and securities transactions could be undertaken as part of custodial IRA accounts, and we thought the

issue was settled.

Chairman BAKER. Mr. Watt, if I may jump in just for a moment.

I recall the confusion in the Conference about the disposition of

these accounts, and there was an affirmative line inserted which

said traditional trust activities would not be affected by the adoption of the Act, and at issue is the SEC rule affecting those historic

traditional services being provided by the bank. I’m told that about

90 percent of the securities activities that result in commissions

are done through broker-dealers anyway. So this is not about diverting order flow from broker-dealers to banks, who are going to

take the commissions from the SEC certified broker-dealer. It is

more a question of how the customer engages with the bank and

gets a product delivered by his bank to him. Either way you go, the

customer is going to pay. You’re absolutely right. My concern is

that just with a different layer of authority, you could have the potential for higher cost assessments on the consumer.

Mr. WATT. I appreciate the Chairman giving me a little extra

time. And I guess my concern is in that 10 percent. I think the 90

percent, there’s a clear understanding of that.

Chairman BAKER. And my understanding is, and Governor

Meyer may want to jump in, is that in that remaining area where

the trustee is compensated in his capacity as a trustee and administration official of the trust activities, he is compensated in that

fashion and not as a commission as a broker-dealer would be com-
25

pensated. So as long as he’s engaging in his administrative responsibilities to facilitate the order or the instructions for the trust, I

think that’s sort of the catch-all here. And when you get beyond

that pale, then you do have to have a broker-dealer. I think.

Mr. Bachus.

Mr. BACHUS. Thank you. I’m not going to ask any questions of

the panel, because everything you said I agreed with.

[Laughter.]

I don’t want to elicit a negative response. Let me simply say this.

I am going to yield to the gentlewoman from Pennsylvania for

questions. But I will tell you, picking up on what Chairman Baker

said, that there is sentiment on both sides of the aisle. I’ve talked

to my counterpart in the Senate. I think we’ve got a commitment

here this morning for substantial changes in the rules by the SEC.

I know Chairman Pitt will be on the Hill in discussions. We hope

to get the same commitment from him.

If there are not substantial changes in the rules by the SEC,

then substantial changes will be made legislatively, and I hope we

can avoid that. But there will be substantial changes to the rules

one way or the other.

Chairman BAKER. Thank you.

Chairman BACHUS. Thank you.

Chairman BAKER. Thank you, Mr. Bachus.

Ms. Jones.

The gentleman has yielded his time to Ms. Hart. Thank you.

Ms. HART. Thank you, Mr. Bachus, I appreciate that. And thank

you, Mr. Chairman. I won’t take too much time either. Listening

to the testimony actually from the SEC and now from the three of

you, I still don’t know if before these rules were issued there was

some contact or conference among the four of you or your organizations. Could you sort of enlighten me a little bit more about exactly

what type of contact there was prior to these rules actually being

issued?

Mr. KROENER. Let me try to respond to that. I, as FDIC General

Counsel, was involved with the general counsels of the other banking agencies in overseeing and monitoring the implementation of

Gramm-Leach-Bliley generally, including these rules. There came a

time when speeches were made by SEC staff members, with the

disclaimer they did not represent the official position of the SEC,

that gave us great concern. And we, the banking agency general

counsels, sought to schedule, did schedule and had a meeting with

the SEC staff to discuss our concerns about the rules, our view of

how the rules ought to be—our views of the legislative history.

That occurred, I think, in March of this year. It did take a long

time, and it was late in the game.

In the course of that meeting, I think we did give them a letter

that had been received by one of the banks that one of us regulates

saying that one of the big mutual fund groups was actually going

to discontinue business with that bank because of continuing uncertainties. But we did express our views. We did make our views

known about the legislative history. As I say, I think that meeting

was March 7th of this year. And the next thing that really happened was the interim final rules came out.
26

Ms. HART. Which was something that you didn’t actually expect

to see?

Mr. KROENER. That is correct.

Ms. HART. Mr. Meyer.

Mr. MEYER. I would just point out that the SEC did not reach

out to the banking agencies as they were beginning their thinking

about formulating the rules. The banking agencies had to initiate

the meeting when we understood they were going into this process,

and we had an idea from their speeches that they were going to

be very contrary to what our view was of the intent of Congress

in the provisions of GLB.

That meeting was not, shall we say, interactive and collaborative, but it was an opportunity to voice our concerns. But we got

very little from that effort by the time those rules were actually released.

Ms. HART. And there was no contact? OK. And I guess we have

a vote. But I just quickly also wanted to ask one question as well.

Did you foresee after Gramm-Leach-Bliley that the regulation of

the traditional securities-related activities would be overseen more

by the SEC?

Mr. MEYER. No. Actually, we thought the plain language of the

Act in this case was very clear. And for a time, we didn’t think

there would be any rule writing and that it might not be necessary.

So the rules were a surprise and the content was a major surprise.

Ms. HART. Is that pretty fair to assume that all of you agree?

Mr. KROENER. Yes.

Ms. BROADMAN. We agree with that.

Ms. HART. OK. Thank you. Thank you, Mr. Chairman.

Chairman BAKER. Thank you, Ms. Hart.

Just as sort of announcement of schedule here, Mr. Bachus has

departed for the floor to vote, so we can continue with our hearing.

Those who wish to leave and come right back, I would encourage

you. Ms. Jones is next for questions, and you’re recognized.

Ms. JONES. Thank you, Mr. Chairman. I’m sitting here smiling

only because last year when I came to Congress, last year, last

term, and Gramm-Leach-Bliley was on our plate, I can’t believe

that none of us or you did not contemplate the possibility of the situation that you find yourselves in right now. Now that’s not to say

I don’t support or that I do support the position.

But let’s look at it from this perspective just for a moment. If

we’re talking about the consumer and we’re talking about you acting in trust, I’m saying a banker acting in trust for a consumer,

assume, just for example, that something goes wrong with the

transaction. Assume that the consumer then tries to figure out who

is responsible for the problem with the transaction with their trust.

Should not they be able to come back to you or to the broker-dealer

or to understand the obligation or who’s regulating that conduct if

you are, in fact, engaging in conduct that traditionally had not

been the conduct you had engaged in prior to Gramm-Leach-Bliley?

Mr. Meyer.

Mr. MEYER. No. But we’re talking about activities that were engaged in prior to Gramm-Leach-Bliley and that banks have sought

to retain after Gramm-Leach-Bliley. So those activities were cus-
27

tomary. Should the customer have a place to go to? Absolutely. It

can complain to the bank and its supervisors that oversee this, and

we look at those complaints. We have that responsibility to protect

the investor’s interest. Absolutely. It is not a question that the SEC

is the only supervisor out there that is capable of protecting investors’ interests. Bank supervisors have acted in this capacity for a

long time.

Ms. JONES. But in the course of your discussion—— Ms. BROADMAN. May I add something?

Ms. JONES. I only have 5 minutes, so I don’t want two answers

to the same question, unfortunately. I’m sorry. In the course of our

whole discussion are 20 years of trying to decide whether we were

going to let banks and securities and everybody do each other’s

business. Surely you contemplated down the line that there would

be a point where you would cross over and there would have to be

some type of interagency regulation. Mr. Kroener, are you confused

by my question? You had a frown on your face. So if you are, I

want to clear it up for you.

Mr. KROENER. Let me try. Sorry. No, I wasn’t confused by the

question. It has been clear for decades that a bank acting as trustee has responsibilities to the customer, is fully answerable to the

customer. It is one of the highest duties in the law.

Ms. JONES. And can receive compensation for the work that they

do?

Mr. KROENER. The trustee receives compensation. And a trustee

may be surcharged for mishandling the trust. That had been long

established. Banks have executed security transactions in their capacity as trustee for decades, without major problems having arisen. And so when the legislation was passed, there were discussions

about whether it was necessary for those traditional activities that

banks were doing to be swept into the push-out provisions that

would subject them to—— Ms. JONES. Let me just stop you for a moment. Assuming I agree

with you for purposes of this short discussion that we had that

these are traditional conduct or business that you’ve previously engaged in, none of you are saying then that if you operate outside

of the traditional trust conduct that you should not be regulated by

the SEC? If your bank decides to sell securities or whatever, right?

Question? In other words, you act outside of the traditional trust

relationships. That’s what you were just saying, what you traditionally do as a trustee. If you act outside of that and you begin

to engage in conduct that is that of a broker-dealer that you should

not be regulated by the SEC.

Maybe I’ll go to Ms. Broadman. Maybe she understands my question.

Ms. BROADMAN. I understand. I think that Congress recognized

that nobody wanted to put full-scale brokerage operations in banks.

And in fact, that was the intent of the Gramm-Leach-Bliley Act.

Our concern is that the way the Commission has implemented the

Act. They’re doing it a way that is not needed to to make sure that

full-scale brokerage activities are pushed out.

If you look at the trust area, there are enormous regulations, fiduciary duties. There are customer protections. I think you’re right

to be looking at is the customer protected. Where a bank is acting
28

as a trustee, they have the highest duties. Consumers can sue

them if they don’t act in the best interest of the customers. They

can recover costs. There is customer protection there.

Ms. JONES. I’m almost running out of time, Ms. Broadman. Let

me just ask you this question. But there is nothing in GrammLeach-Bliley that keeps a bank from deciding that now I want to

be a broker-dealer and creating a broker-dealer within the bank?

That’s what the purpose—— Ms. BROADMAN. There are. There are advertising restrictions. A

bank can’t run a full-scale brokerage operation such as—— Ms. JONES. Stephanie Tubbs Jones Incorporated Bank could create Stephanie Tubbs Jones, a broker and agency separate and

apart from the bank, right?

Mr. MEYER. No. But that is not one of the exceptions. There are

specific exceptions that are tailored—— Ms. JONES. But my question is not whether that’s one of the exceptions. I’m just saying that you could, in fact, create a broker.

Someone else could create it and call it Stephanie Tubbs Jones Inc.

Mr. MEYER. Could not.

Ms. BROADMAN. Banks can create subsidiaries that are brokers.

They’re separate. But they can’t put it in the bank.

Ms. JONES. Right. So the answer is yes?

Mr. MEYER. No, not inside the bank.

Ms. BROADMAN. It’s a separate entity.

Ms. JONES. A separate entity. That’s what I just said.

Ms. BROADMAN. But Gramm-Leach-Bliley doesn’t permit that to

take place within the bank.

Ms. JONES. I should not have said within the bank. Because really you’re just engaging in the same shell game that you engaged

in before Gramm-Leach-Bliley, that there was another company

that you could use to do what you couldn’t do under Gramm-LeachBliley. Are you with me?

Mr. KROENER. Absolutely.

Chairman BAKER. Ms. Jones, your time has expired.

Ms. JONES. Thank you very, very much.

Chairman BAKER. I would clarify it as a pot plant rule. This one

you can’t do behind the pot plant, you’ve got to have it down the

hall in another room.

Ms. JONES. Exactly. Thank you.

Chairman BAKER. And the question is, if the bank doesn’t have

the money to do that, are we depriving customers of services they

are otherwise provided? I’d like to recognize Mr. Tiberi at this time.

Mr. TIBERI. Thank you, Chairman Baker.

Kind of following up on my colleague from Ohio’s comments, having now established that we all agree that there’s differences between bank trust departments and the way the oversight is and

the oversight on brokerage firms. Would you all agree—could you

explain, I guess, first, the oversight that a bank trust has, and

would you all agree that the need for additional SEC oversight is

unnecessary?

Mr. MEYER. Yes. I think there are two major areas. One, the

bank trust departments operate under trust and fiduciary law. And

bank examiners examine these departments for compliance with

that law. Then they examine to make sure that there are policies
29

and procedures in place that govern that compliance. They make

sure that there are no conflicts of interest, and all the other things

that the SEC could do to protect investors’ interests are being undertaken by the bank regulators and their examination of the trust

departments.

So there is absolutely no need for a duplicative second set of supervisors and oversight of these responsibilities. I mean, the problem here is clearly that the SEC believes that they’re the only ones

that should have the authority to supervise those activities.

Mr. TIBERI. Thank you.

Ms. BROADMAN. I think it’s important, too, just to add to that,

to look at it from the customer perspective. There are customers

who would prefer to do business with a bank than with a registered broker-dealer. And to the extent that the rules force activities out into broker-dealers, they are denying customers that

choice.

Also, some people feel that the regulation in the banks, the fiduciary or the trust requirements, impose higher duties than those

that are imposed on broker-dealers, so they would rather do business there. But in any case, we agree fully with Governor Meyer’s

comment that in the trust and fiduciary area, there are extensive

regulations both under State law, under Federal law, and under

our regulations.

We have examiners that are in the banks. In the largest banks,

we have examiners that are there on a full-time basis constantly

reviewing what’s going on, and in the smaller banks on a regular

basis looking at their activities, so that you do have a pervasive

legal regulatory scheme as well as pervasive oversight by the bank

examiners.

Mr. KROENER. I don’t have anything to add to the prior answers

of the other two witnesses.

Mr. TIBERI. Thank you, Mr. Chairman.

Chairman BAKER. Thank you, Mr. Tiberi. We’re down to about

two-and-a-half minutes. I’m going to have to run to the vote. Mr.

Bachus, I understand, is on his way back. So we would stand in

recess for just a few minutes until Chairman Bachus returns.

I would just make the observation, it appears to me just from a

casual reading of the papers that the SEC has a lot of responsibilities to conduct in other areas, and it would seem pursuing inappropriate conduct within the bank that’s already subject to banking

regulators’ oversight might not be an effective use of resources. So

we have some concerns that I think need to be addressed.

We stand in recess.

[Recess.]

Chairman BACHUS. The Capital Markets and the Financial Services Joint Committee hearing is called to order. When we recessed,

we had anticipated—two Members had requested that we return

and allow them to ask questions. They have not returned. I’m going

to ask one final question. Once you answer that, if they’re not back,

we will adjourn the first panel.

My question—and this for the record—in defending their rulemaking process on the push-out proposal, the SEC testified earlier

that the banking agencies routinely issue, ‘‘interim final rules.’’ Is
30

that true? Under what circumstances have your agencies issued

such interim final rules in the past?

Mr. MEYER. We occasionally issue interim final rules, and I’ll

give you an example. Under Gramm-Leach-Bliley, we were operating under very short timeframes for when new activities in the

statute were becoming effective. And so we had interim rules to

open up access to the new activities for banks so they wouldn’t be

delayed. So when it came to qualifications for financial holding

companies, that was an interim final rule to get that going so that

banks could immediately have access to it. When it came to new

activities that banks could engage in, in affiliates, and so forth,

those were interim final rules.

When we had a controversial case that would impose a new burden on a bank, we did not use interim final rules. The capital

under merchant banking is a perfect example. We put out a proposal. We knew it would be contentious. After all of the discussion,

we didn’t put out then a final rule, but we issued it again as a proposal to allow further comment on it. And I think that’s the model

that we feel is the appropriate one in this context.

Chairman BACHUS. And ‘‘routine’’ would be that you all don’t

routinely issue?

Mr. MEYER. Right.

Ms. BROADMAN. We are the same. We would not routinely use

the interim final rule approach. We’ve used it in unusual circumstances to relieve burden. We would not use it in a case like

this where we’re imposing new burdens on banks that are going to

be very controversial. So we take a similar approach to the Federal

Reserve Board.

Mr. KROENER. And the same is true, Congressman, of the FDIC.

We have used interim final rules where it expands authority of

banking organizations, but not for the first time to restrict or prohibit or significantly affect existing activities.

Chairman BACHUS. I appreciate your answers. If there are no

further questions, the first panel is discharged. And we’ll go right

to the second panel. We certainly appreciate your testimony and

appreciate you being here, and apologize for the delay.

I want to welcome the second panel and look forward to your testimony. The second panel is consisted from my left to right of Mr.

Michael Patterson, Vice Chairman, J.P. Morgan Chase & Company;

Mr. Edward Higgins, Executive Vice President, U.S. Bancorp.

You’re testifying on behalf of the American Banking Association?

Mr. HIGGINS. Yes, Mr. Chairman.

Chairman BACHUS. I see. And Mr. Robert Kurucza, General

Counsel of the Bank Securities Association. Mr. Reid Polland,

President and Chief Executive Officer, Randolph Bank & Trust

Company, also testifying on behalf of the Independent Community

Bankers. And finally, Mr. Eugene F. Maloney, Executive Vice

President and Corporate Counsel, Federated Investors. Welcome to

you all. We have a mix of veterans before the subcommittees and

first-time witnesses. At this time, Mr. Patterson, we’ll start with

you. Thank you.
31

STATEMENT OF MICHAEL E. PATTERSON, VICE CHAIRMAN.

J.P. MORGAN CHASE & CO.

Mr. PATTERSON. Thank you, Chairman Bachus. I very much appreciate the opportunity to be with you today to comment on the

SEC’s interim final rules. My brief remarks will touch only on a

few specific aspects of the rules that are illustrative of our broader

concerns. And my written statement addresses additional issues

which have been part of an ongoing dialogue between banking organizations and the Commission’s staff.

At the outset, let me emphasize that we are not opposed to functional regulation or to full compliance with Title II of the GrammLeach-Bliley Act. Quite the contrary. Congress made a clear determination that certain activities once conducted by banks should

now be conducted by SEC-registered broker-dealers, and at J.P.

Morgan we are moving various activities into our broker-dealers

and, indeed, over 1,000 of our bank employees have qualified to become SEC-registered representatives.

Our basic concern is that the interim final rules impose detailed,

complex requirements on activities that Congress decided to leave

in banks. The cost of complying with these requirements would be

very substantial, and in some cases, the rules would make it virtually impossible for banks to continue those activities.

The rules evince a suspicion on the part of the Commission that

without the straitjacket of the rules, banks would conduct a wholesale brokerage operation under the guise of a trust or a custody department. Given the conditions in the statute itself, we don’t think

that suspicion has any basis that would justify the burdens imposed by the rules. These bank activities are subject to extensive

fiduciary and other legal duties and potential liabilities and are intensively supervised by bank regulators. Given these constraints,

we don’t believe it would be rational or possible for a bank to try

to provide a full service brokerage in disguise.

Several of our concerns with the interim final rules relate to compensation. Under the Act, transactions in a trustee or fiduciary capacity are exempt only if the bank is ‘‘chiefly compensated’’ on the

basis of administration or certain other fees. The SEC rules propose that the chiefly compensated test, which has very complex

definitions of different categories of compensation, be applied to

every single account. For J.P. Morgan, this would require a periodic

review of more than 50,000 trust and fiduciary accounts to determine and document their compliance. Our firm’s existing management information systems—and we suspect those of most other

banks—do not provide data using all the categories required by the

SEC’s test. We could, of course, create new systems given enough

time and money. In fact, I believe one bank has estimated that

doing so will cost it at least $15 million.

But we do not believe that Congress could possibly have intended

banks to assume a burden of this magnitude in order to demonstrate that a traditional banking business should not be pushed

out of the bank. Instead of an account-by-account approach, we

agree with the banking regulators that the Commission should

adopt a test that measures chiefly compensated ‘‘on an aggregate

basis,’’ and hopefully, with simplified compensation calculations.
32

We’re also concerned about the provisions related to employee

compensation, including the SEC’s discussion of bonus plans.

Bonus plans are not mentioned in the Act. However, the Commission seems to take the view that unregistered bank employees may

not receive bonuses based in any part on securities transactions

unless the bonuses are based on the overall profitability of the

bank. But few if any bonus plans are based on the stand-alone

profitability of a bank as opposed to the profitability of the overall

financial institution or a business unit within it. This requirement

would effectively regulate the structure of bank bonus compensation plans and we think is another example of the SEC’s unnecessarily broad approach to eliminate the perceived, but we think unsubstantiated, risk of evasion.

One final example of overreaching intervention in traditional

bank activities is the interim rules’ treatment of bank employees

who also have been registered as employees of a broker-dealer affiliate, of whom, as I mentioned, we have over 1,000. When performing in the latter role, these dual employees would quite properly be subject to the supervision of the broker-dealer. However,

the SEC’s release indicates that it believes that the bank securities

activities of the employees should also be subject to broker-dealer

supervision, including approval and recordkeeping requirements.

This duplicative supervision is not only unnecessary and burdensome, but in our view flies in the face of the principal of functional

regulation underlying Title II.

Thank you for your attention, and I’d be pleased to answer any

questions.

[The prepared statement of Michael E. Patterson can be found on

page 168 in the appendix.]

Chairman BACHUS. Thank you.

Mr. Higgins.

STATEMENT OF EDWARD D. HIGGINS, EXECUTIVE VICE PRESIDENT, U.S. BANCORP, ON BEHALF OF THE AMERICAN BANKERS ASSOCIATION AND THE ABA SECURITIES ASSOCIATION

Mr. HIGGINS. Mr. Chairman, I’m Ed Higgins, Managing Director

of the Private Client Group at Firstar, a subsidiary of US Bancorp.

We operate in 25 States, primarily in the Midwest, West, and in

Florida. I am here today on behalf of the American Bankers Association and the ABA Securities Association.

As you have heard, the issues raised by these rules are of great

concern to all banks, large and small. Many services offered to

bank clients, including self-directed IRA account holders and Section 401(k) plan participants will be significantly and negatively

impacted if the SEC’s interim final rules are not amended. Brokerage services offered to retail customers from the bank lobby

through registered broker-dealers and sweep services offered deposit account holders are two other products that will suffer under

the SEC’s rules.

Before I discuss these issues in greater detail——

Chairman BACHUS. Could you slide that mike up a little closer?

Mr. HIGGINS. Before I discuss these issues in greater detail, however, I wish to go on record regarding the recent initiatives undertaken by the SEC. We are grateful that the SEC has moved the
33

compliance date to next May and has indicated further additional

time to comply will be given once the SEC issues amended final

rules. Industry discussions held since the SEC first issued its interim final rules have been helpful, and we hope that they will continue as the SEC continues to learn more about our banking industry.

One of the industry’s top concerns with the final rules is the

trust and fiduciary exemption’s chiefly compensated requirement as

interpreted by the SEC. We believe that the SEC has interpreted

the statute in such a way that banks will be forced to push out

many of the traditional trust and fiduciary activities in direct contravention of Congressional intent, or alternatively, expend millions of dollars to develop the requisite technology to comply.

The SEC’s narrow interpretation also harms consumers. For example, employers who sponsor retirement plans for employees often

negotiate for bank trustees of Section 401(k) plans to be compensated through the use of Section 12(b)(1) shareholder servicing

fees and other fees paid by the mutual funds in which the plan assets are invested. Although this process and practice has been allowed for years by the Department of Labor, the agency charged

under the Employee Retirement Income Security Act with regulating Section 401(k) plans, accounts earning these fees would not

pass the chiefly compensated test. Many small employers can only

afford to offer their employees’ Section 401(k) plans through these

fee arrangements. At a time when we are encouraging consumers

to save for their retirement, it just does not seem right to eliminate

options that would allow consumers to do just that.

Order taking is another service offered by the banks where SEC

has taken an exceedingly narrow position with regard to the pushout provisions that effectively prohibit banks from taking orders

from Section 401(k) participants, self-directed IRA customers and

many other consumers. The Act provides without limitations that

banks as part of their customary banking activities, that offer safekeeping and custody services with respect to securities, will be exempted from the brokerage registration.

Order taking and buying or selling securities at customer direction, and as an adjunct to custody relationships, has long been a

traditional bank service. The Department of the Treasury, bank

regulators and well-known trust authorities dating back as early as

the 1930s have all recognized that order taking is a customary custody service.

The SEC disagrees, despite the fact that Members of the subcommittees specifically added self-directed IRAs to the statute to

make clear that these accounts were adequately protected under

the legislation.

Broker-dealer firms do not want to assume order execution responsibility for bank custody accounts. Thousands of accounts

would have to be opened under individual customer account names.

Records for these accounts would have to be established and maintained, compliance responsibilities would be expanded by adding

these accounts to the broker’s book. Yet no assets would be held

in the account as the actual custodial account and assets would remain in the bank. Consequently, not even our members’ brokerdealer affiliates wish to assume a business that significantly in-
34

creases compliance costs and regulatory burdens for very little compensation.

For the first time ever, the SEC has defined the term ‘‘nominal

one-time cash fee of a fixed dollar amount’’ to mean a payment that

does not exceed one hour of the gross cash wages of the unregistered bank employee making the referral. In addition, the SEC interpretation requires all points paid under a referral fee program

to be the same for all products.

Our members, banks and broker-dealers alike, have long operated their referral fee programs in compliance with all applicable

guidance, including guidance previously issued by the Securities

and Exchange Commission. In fact, the requirements that formed

the framework for the development of many bank referral fee programs involving products and other services rather than just securities are based on these SEC guidelines.

Finally, the Gramm-Leach-Bliley Act provides an exemption from

push-out for bank sweep services. I know that other members of

this panel will also discuss this issue, so I’ll merely close by suggesting that before the SEC takes any action that might encourage

consumers to move their sweep deposit accounts from banks to

broker-dealers, consideration should be given as to what impact

such movement would have on the availability of deposits to fund

loans in our local communities. It would be prudent for the SEC

and the bank regulators to consider this issue jointly before any

regulatory action is taken that could cause significant

disintermediation of bank deposits.

Thank you for your time.

[The prepared statement of Edward D. Higgins can be found on

page 179 in the appendix.]

Chairman BACHUS. Thank you.

Mr. Kurucza.

STATEMENT OF ROBERT M. KURUCZA, GENERAL COUNSEL,

BANK SECURITIES ASSOCIATION

Mr. KURUCZA. Thank you, Chairman Bachus. My name is Bob

Kurucza. I am a partner in the law firm of Morrison & Foerster

and serve as General Counsel to the Bank Securities Association

(BSA). Prior to joining Morrison & Foerster, I served as Director

of the Securities and Corporate Practices Division at the OCC, and

as an Assistant Director in the Division of Investment Management at the SEC. Accordingly, I have been involved in bank securities matters for over 20 years, both as a regulator and as a private

practitioner.

I am pleased to have the opportunity to appear today to discuss

the SEC’s ‘‘push-out’’ rules. As you know, these rules relate to the

bank broker-dealer exceptions in Title II of the Gramm-Leach-Bliley Act, the so-called Title II Exceptions. This is a vitally important

matter for the banking industry, and we commend your leadership

in holding this hearing. We clearly need your help.

The Gramm-Leach-Bliley Act was intended to modernize the regulatory scheme for the financial services industry. There is no

question that functional regulation is a key component of the new

regulatory regime. However, Congress recognized the limits of functional regulation. This is why it provided the Title II Exceptions.
35

There was no need to subject activities that had been conducted

safely and soundly by banks—in many cases for over 100 years— such as trust, fiduciary and sweep account services—to redundant

broker-dealer regulation. These activities have and continue to be

effectively regulated by Federal and State banking authorities

without any history of significant problems.

The Title II Exceptions were clearly intended to allow banks to

continue to conduct traditional securities-related activities undisturbed, without having to register as broker-dealers. The SEC

seems to have missed this fundamental point.

It is not surprising that the push-out rules, which in effect nullify many of the Title II Exceptions, have met with almost universal criticism. The BSA has been a loud voice in this chorus of

critics. It believes the rules are fundamentally flawed from both a

procedural and substantive perspective.

As to process, the BSA believes that a substantial doubt exists,

from a legal standpoint, as to whether the SEC in issuing the rules

as ‘‘final rules’’ has met the stringent standards imposed under the

Administrative Procedures Act. There clearly was no urgent need

to adopt definitive rules. The only thing that had to happen immediately was the deferral of the May 12th effective date.

By issuing final rules without providing prior notice or the opportunity for public comment, the SEC placed banks in a Catch–22 position. To its credit, the SEC recognized the quandary in which it

had put banks, and recently extended the Title II compliance dates

until May of next year. This is a welcome first step in the right direction. However, no amount of time delay will cure the substantive defects in the rules.

In this regard, the BSA believes that most of the rules will greatly diminish the ability of banks to provide longstanding services to

their customers. Accordingly, they clearly contravene Congressional

intent and reflect a basic lack of understanding as to the nature,

structure and pricing of these services. The rules are replete with

departures from Congressional intent. This is the case with almost

all of the Title II Exceptions. Even in cases where the SEC ostensibly is attempting to provide relief or flexibility, it conditions the

availability of the relief on such onerous and unworkable conditions

that it is rendered meaningless.

As the SEC has acknowledged, banks now conduct most of their

core securities activities, such as full service brokerage, through

registered broker-dealers. Nonetheless, the SEC somehow believes

that banks will use the Title II Exceptions to evade broker-dealer

regulation. This is pure sophistry of the highest degree. Banks

have been conducting most of their securities activities through

registered broker-dealers for many years. They have done so voluntarily even though a blanket exemption from regulation was available.

Where does this leave us? There is no question that the rules

must be rebuilt from the ground up. We would hope that the SEC

would heed the concerns expressed by your subcommittees and

other interested parties. Based on this input, we would urge the

SEC to start afresh and republish the rules as proposed rules that

follow Congress’s mandate and conform to a normal rulemaking

process.
36

Thank you again for the opportunity to appear. We greatly appreciate it. I would be happy to answer any questions that you may

have.

[The prepared statement of Robert M. Kurucza can be found on

page 198 in the appendix.]

Chairman BACHUS. I appreciate that.

Mr. Pollard.

STATEMENT OF K. REID POLLARD, PRESIDENT AND CHIEF EXECUTIVE OFFICER, RANDOLPH BANK & TRUST COMPANY,

ON BEHALF OF THE INDEPENDENT COMMUNITY BANKERS

OF AMERICA

Mr. POLLARD. Chairman Bachus, Members of the subcommittees,

my name is Reid Pollard, and I am President and CEO of Randolph

Bank & Trust Company, a $186 million community bank in

Asheboro, North Carolina. I also serve on the Federal Legislation

Committee of the Independent Community Bankers of America

(ICBA), on whose behalf I am testifying today.

Thank you for this opportunity to express our views on the effect

the SEC’s proposed broker-dealer rule would have on community

banks. We believe the SEC’s rule in its present form is incompatible with Congressional intent. To quote from your letter of July 19

by Chairman Oxley and every subcommittee chair: ‘‘We are troubled that the rules do not reflect the statutory intent of Congress

to allow certain traditional banking activities involving securities,

such as trust and custody services, to remain in the bank and outside SEC regulation.’’ A separate letter sent by Ranking Member LaFalce expressed

similar concerns. Clearly, this subcommittee, the subcommittee of

primary jurisdiction, knows what Congress intended when it

passed the Gramm-Leach-Bliley Act. We encourage the SEC to develop a regulatory scheme that meets this intent.

We are greatly concerned that the SEC’s proposal in its present

form would impose unworkable and burdensome requirements on

small banks.

Indeed, we believe that in some cases the additional requirements placed on banks to comply with the rule would essentially

nullify the exceptions that Congress wisely wrote into the law.

These exceptions are extremely important for community banks

and our customers. Registering as broker-dealers is simply not an

option for most small banks.

It appears that the SEC has failed to take into account the extensive fiduciary requirements that other laws impose on bank

trust and fiduciary activities as well as the existing supervisory

framework that Federal banking agencies have established to supervise these activities.

Nullifying the exceptions or rendering them useless because of

unnecessarily restrictive regulations would have a damaging effect

on our banks and our communities.

If community banks lose these exceptions, customers in many

rural areas might not have anywhere else to turn for these services. That is why it is so important to get this rule right, to adhere

to the intent of Congress as closely as possible to allow banks to

continue to do the things we have been doing for many years with-
37

out any problems. And many banks have been doing it for quite

some time. Our bank has been offering securities and other nondeposit products and services for over 9 years. We are very pleased

with how we have assisted our customers and grown to become a

total financial services center in our community.

Like you, Mr. Chairman, we have a number of substantive concerns which we have spelled out in detail in our comment letter.

We feel the interim final rule would be very disruptive for custodial

services, retirement plans, and many other products and services

that include security services that banks have offered their customers for many years without problems. These products and services were and should be exempted by statute. Unfortunately, the

existing SEC approach goes in a very different direction, and in

some instances what is supposed to be investor protection would

actually be investor exclusion.

Like you, Mr. Chairman, we very much welcome and appreciate

the SEC’s announcement on July 17 that the compliance date and

comment period for this rule would be extended and that the rule

would be amended. But we ask the SEC to take it a step further.

We believe the SEC should issue a substantially revised proposal

for public comment. We believe it would be an error for the SEC

to try to fix this rule based on comments on the existing flawed interim final rules. Rather, a new proposal is needed that takes into

account the comments the agency has already received, and it is

extremely important that the public have a further opportunity to

comment on a revised proposal.

We believe the SEC should work closely with the Federal banking agencies as it drafts a proposal that would impact the banking

industry.

Finally, we believe that the SEC should defer compliance for at

least 12 months after a final rule is published. This is critical to

allow banks the time to adopt systems, procedures and products

and services.

Mr. Chairman, we want to thank you and the other Members on

the subcommittees who have brought critical attention and focus to

this issue. You have provided the leadership necessary to get the

bank broker-dealer exceptions back on the right track, the track

that you intended in adopting the Gramm-Leach-Bliley Act some

20 years ago.

Thank you again for this opportunity to testify. I will be happy

to answer any questions you may have.

[The prepared statement of K. Reid Pollard can be found on page

230 in the appendix.]

Chairman BACHUS. Mr. Maloney, I noticed from reading your

written testimony that you are also a faculty member at Boston

University.

Mr. MALONEY. I had the misfortune of being trained as a lawyer,

yes, Mr. Chairman.

Chairman BACHUS. But you teach trust and securities activities.

Mr. MALONEY. Yes, sir.

Chairman BACHUS. So we’re very much looking forward to your

testimony.
38

STATEMENT OF EUGENE F. MALONEY, EXECUTIVE VICE

PRESIDENT AND CORPORATE COUNSEL, FEDERATED INVESTORS, INC.

Mr. MALONEY. I have two roles, Mr. Chairman. I’m a senior officer in my company, and for the last 13 years, I have been a member of the faculty of Boston University Law School. And I teach a

course on the trust and securities activities of banks. So this is an

issue that I’ve been involved in both corporately, but academically

as well.

My company is involved in Gramm-Leach-Bliley primarily because of the $160 billion in the mutual funds that we manage. Easily 50 percent comes from the 1,400 bank trust departments

throughout the country that we do business with. And I’m really

not here today in behalf of my company. I’m here in behalf of our

clients. And they aren’t just clients, they’re friends.

I got involved in H.R. 10 when to our surprise it made it through

the House by one vote. We looked at Title II and the 11 Exceptions

from broker-dealer status, and we superimposed those 11 Exceptions on the typical book of business of a community bank trust department, and were very, very concerned that between 10 and 15

percent of the traditional products and services offered by a community bank trust department would have to be pushed out to a

broker-dealer.

We came down here and spoke to folks on the Senate side. And

we had two questions. One, here’s an examination procedures

checklist. And every time a bank examiner goes into a bank trust

department, he or she is required to make sure that the bank employee has the requisite level of training, supervision and education

to perform their role. We don’t see the need for SEC supervision

and a securities license for those kinds of people. And I guess we

were interested in hearing what had come to the attention of Congress that would somehow warrant the involvement of the SEC in

an industry that certainly in my 29 years has largely been problem-free.

We were told that our arguments had merit, but we were simply

too late. Congress, as you know, time ran out. We knew there

would be a son of H.R. 10. And we were here first at the table in

the spring of 1999. We again worked with the folks on the Senate

side of the table. And again, our concern was that the overly broad

language in Title II would cause our clients to have to discontinue

services which they had been offering problem-free for decades.

Participant-directed Section 401(k) was one that we were particularly concerned about. We were told that again our arguments

had merit. The Senate would certainly consider them. The Senate

version of Title II, as you know, was not passed, and Title II in the

House version was, in fact, passed. I gave my first speech on

Gramm-Leach-Bliley in Chicago in January of 2000 to 400 community bankers, and they were in a very celebratory mood. They had

party hats on and noisemakers. And my comments were twofold.

One, if this thing is read wrong, it could take 2,000 community

bank trust departments off the competitive board in a heartbeat.

And number two, anything that takes 50 lawyers two days to explain can’t be all that great. And I sat down.
39

It was clear to us that the SEC was going to make a place for

itself in bank trust departments. My company has a habit of working with the regulatory agencies in behalf of our clients, and I was

dispatched to Washington to really work with the staff of the Securities and Exchange Commission, not to dispute their jurisdiction,

but to rather educate them on what goes on inside a bank trust department. I can tell you personally that I have not had a better,

more positive, constructive experience with a regulatory agency

than we did with the professionals at the Securities and Exchange

Commission. We found them willing to listen. We had access anytime we wished. They were eager to learn. And frankly, the 158-

page effort we feel is extraordinary, given an agency that came

from a standing start.

But there are problems. And I think the problems really stem

from what the SEC is and how they go about the regulatory process. To the SEC, everything is brokerage and everything is a brokerage commission until proven to the contrary. It’s almost like the

French system of justice. We have taken the position—and you’ll

see it in our comment letter, Mr. Chairman—that the assumption

should be that everything that goes on inside of a bank trust department should be fiduciary in nature. And indeed, there’s a pervasive body of State trust law and ERISA at the Federal level that

basically precludes a fiduciary from receiving a commission as a byproduct of an investment decision. So if there is brokerage activity

lurking out there, it certainly escaped our observation.

We’re particularly concerned as banks start to take their rightful

place in the financial services community, they’re starting to price

their products, processes and services the same way their competitors are. And they’re starting to use mutual funds packaged products, if you will, as delivery vehicles for pooled investment management. They’re starting to replace traditional trust delivery vehicles,

common trust funds and collective investment funds.

There are statutes in all 50 States that permit a fiduciary to

make an investment decision to use a mutual fund and at the same

time provide discrete services to those mutual funds for which they

receive additional fund-level compensation. All three bank regulatory agencies have examined these statutes, looked at the practices, and concluded that they’re consistent with the law of trust.

The problem, of course, is it bumps right into the chiefly compensated test.

We were the organization in the spring of 1994, in response to

requests from our very large bank clients, that came up with the

concept of bundled fees for defined contribution plans. Large bank

after large bank would complain to us that in a competitive setting,

the explicit nature of their fees when matched against mutual

funds sponsors or broker-dealers, where their fees were built into

the products and processes, put them at an enormous competitive

advantage. So why can’t you, with all of your legal resources, come

up with a way for us to price our products and process implicitly

as well?

The Department of Labor looked at fund-level compensation in

defined contribution relationships for the better part of two-and-ahalf years, issued two advisory opinions specifically authorizing directed trustees to receive fund-level compensation, and while doing
40

so, not creating a conflict of interest or a prohibited transaction.

That’s what Ed Higgins was referring to in his comments. It was

wonderful for us to see our clients now being able to offer competitive products and processes to that defined contribution marketplace.

And now, of course, you run into the issue of whether or not if

all of the compensation takes place at the fund level, if that’s

deemed to be brokerage, the vast majority of community banks in

this country simply can’t organize broker-dealers. I wish Mrs.

Jones was here to hear this. When the prospect of push-out and

community banks surfaced, we hired a former senior official from

the Securities and Exchange Commission to advise us on the likelihood of community banks being meaningful players if they had to

organize broker-dealers. He said simply, forget it. It’s too expensive. The compliance process is too overbearing.

So there are practical issues at work here as well. The chiefly

compensated test is hopelessly complex. If I was going to give you

a two-word summary of where our clients would be on this, they

won’t do it. It’s very simply. They simply won’t do it. A large bank

client of our firm in anticipation of my appearing today called and

said we have 8,000 separate fee schedules for personal trust. I was

going to bring one fee schedule with me of a large bank client of

ours. It looks like a small suburban telephone book. And if you

read the SEC release, the assumption is that since all clients pay

the same fee, it’s a simple arithmetic calculation to determine if the

chiefly compensated test has been met or exceeded. That simply

isn’t reality.

So it’s a problem. It’s a great problem. And we’re not here today

to suggest solutions. But we are here today to suggest there has

to be a dialogue between the Commission and the bank regulatory

agencies, and the community banks of this country can’t be in the

middle of the problem.

Thank you.

[The prepared statement of Eugene F. Maloney can be found on

page 262 in the appendix.]

Chairman BACHUS. We very much appreciate your testimony.

Mr. Watt, you were so kind to yield to multiple opening statements over here. I would like to return the favor.

Mr. WATT. That’s mighty kind of you, Mr. Chairman. And I want

to thank all of you for being here. I apologize to the first two-anda-half witnesses for missing your testimony. I was trying to get

back, but just couldn’t get here in time, to extend a special welcome

to Mr. Pollard from North Carolina, a well respected and admired

member of our community in North Carolina.

I think we were doing all right until we got to Mr. Maloney, and

all of a sudden, what everybody had been saying, it sounds to me

like he may have exploded. Mr. Pollard—well, I’d have to say, I

leaned over to one of the staff people back here when Mr. Pollard

said if there’s anybody who knows what the intent of GrammLeach-Bliley was, it was Members of this subcommittee, I said ‘‘I

don’t think so.’’ You ask 50-some Members of this subcommittee,

you’d probably get 50-some different intents of what Gramm-LeachBliley was all about. And a lot of uncertainty and a lot of, well, I

didn’t even think about that issue.
41

So then we get to Mr. Maloney and he says, OK, well, we had

a legislative intent. We took it to the U.S. Senate. And the U.S.

Senate put it in their bill, but the U.S. Senate bill was not the bill

that got passed. So if that’s the case, then maybe this clarity about

what the legislative intent was is not nearly as clear as we would

like to think that it is. Because if Mr. Maloney was working with

the Senate and he put what he wanted in the Senate bill and then

the House didn’t pass that version of it and the final bill was the

House version, what does that do to the legislative intent that we

thought was so clear on this issue?

Now, having said that, we’ve got a problem and I think we put

our finger on it. I may have stumbled on the right question in my

question to Mr. Meyer when I asked him whether there were any

things that banks were doing that the SEC ought to be regulating.

He said if banks are doing anything that the SEC ought to be regulating, then that activity has to be pushed out, which presents

some serious, it sounds to me, problems for particularly community

banks, because I thought I heard Mr. Pollard say at least a substantial minority part of what he does—maybe 10, 15 percent, according to Mr. Maloney—is securities services. I’m not sure what

that is. But if those securities services are the things that are typically under the review and jurisdiction of the SEC, Mr. Meyer just

told me on the preceding panel that those services have to be

pushed out, which is something that community banks don’t want.

But if they are securities services that are typically regulated by

SEC, then I hear everybody else saying we don’t want the SEC regulating them if they’re being done inside banks. So we’ve got a real

problem on that 10 to 15 percent of business unless I’m misdefining

the problem.

So I’ve defined the problem. First of all, I guess the question is,

what is your reaction to Mr. Meyer’s position that everything that

banks are doing that SEC ought to have some—may have some jurisdiction over has got to be pushed out of the bank?

Mr. MALONEY. Mr. Watt, let me help you with your problem.

Mr. WATT. All right. Help me.

Mr. MALONEY. Let’s take participant-directed Section 401(k). A

growth area for banks, large, medium and small. This is the way

the product works. Now bear in mind, in Title II, there’s a two-part

test. Part one is the nature of the relationship the bank has with

its customer, the so-called fiduciary relationship.

Now the SEC has given us a specific exemption in their release

for participant-directed Section 401(k). They argued the issue of

whether or not it was a fiduciary relationship, but they conceded

maybe it is. That’s part one of the test. Number two is the chiefly

compensated test. So you could have a fiduciary relationship that

passes part one, but flunks part two because of the nature of the

compensation arrangement you have.

Now in a participant-directed Section 401(k) product, it’s typically a menu of mutual funds. If it’s a large bank, it’s proprietary

funds—FirstUnion would be a good example in your State, sir, or

Bank of America—and a mix of third-party funds, depending on

their investment objectives and policies. It’s almost certain that the

compensation that the bank is going to receive for the various serv-
42

ices it provides in connection with that product is going to come

from payments at the mutual fund level.

The services the bank provides are investment, directed trustee,

reporting and recordkeeping. You probably didn’t notice sales or

commission-driven activities. The mere fact that the bank gets all

of its compensation at the fund level, because that’s the way its

competitors are pricing their services, triggers the chiefly compensated test. That was the point I was making.

Mr. WATT. All right. Let me ask Mr. Pollard whether there are

any things in what you called securities services—that’s the term

you used—that you’re doing in the bank, inside the bank, that

would traditionally be regulated by the SEC, and what your reaction is to the prospect of having to push those things out.

Mr. POLLARD. The prospect of having to push those things out is

very scary.

Mr. WATT. What are they? Just give me a couple of examples.

Mr. POLLARD. Those securities services, they’re the things like

you talked about with the previous panel. A customer may come in

and want a self-directed retirement plan or just funds that they

want to invest for their financial welfare that they do not intend

to put in an insured bank product. That can be mutual funds, that

can be annuities, that can be a basket of stocks. Those activities

we are conducting at the present time in a wholly-owned subsidiary

of the bank.

Our State commissioner’s office has interpreted Gramm-LeachBliley to say that the intent of Gramm-Leach-Bliley is that we

could conduct those activities in the bank without a separate wholly-owned subsidiary in the future. They have told banks in the

State that you no longer have to form that subsidiary to conduct

that per Gramm-Leach-Bliley. So there you have an interpretation

very much different than that of the SEC as to what the intent of

the subcommittees and the Congress was with Gramm-Leach-Bliley.

But we conduct that, have conducted it for 9 years, in a subsidiary of the bank. We have a third-party broker-dealer relationship with a large, established, SEC-regulated broker-dealer. Our

revenue comes from a split of that revenue from the third-party

vendor. We do not charge the customer additional fees. I think that

was the question you were trying to get at with the previous panel.

As Mr. Maloney stated, our revenue comes from our agreement

with the third-party provider out of those products. And it would

be difficult for a $186 million bank to push those out, whatever

they may be. Right now it is very difficult to determine, and it’s

very, I guess you could say, frightening to determine where it could

be pushed out.

Mr. WATT. Mr. Chairman, I’m well over my time. You’ve been

very generous. You all have been very generous with your time.

Could I just ask Mr. Maloney to do one thing? Not a verbal response, but it would be helpful if we knew if you had the ideal that

would have addressed this issue had we adopted that language as

opposed to the language that’s actually in Gramm-Leach-Bliley. Because it may well be that this is sufficiently murky at this point

that we may have to go back and revisit this issue, because from

what I’m hearing, the legislative intent may not be as clear as ev-
43

erybody is saying the legislative intent was. But if we were going

to address this problem and correct it in the way that you would

have had Gramm-Leach-Bliley address it in the first place, it might

be helpful to have that specific language.

Mr. MALONEY. Yes, sir. Be happy to.

Mr. KURUCZA. Mr. Watt, may I jump in here?

Mr. WATT. Sure. I’m sorry. I didn’t mean to cut anybody off. My

red light has been on for a good while, so I was just trying to make

a graceful exit.

Mr. KURUCZA. It might be useful to just back up a little bit and

provide a perspective. As I mentioned in my remarks today, while

a general bank exemption still exists, which would have expired on

May 12th without the deferral by the SEC, over 90 percent of all

bank securities activities are today conducted through registered

broker-dealers. And so you have a situation where banks, for safety

and soundness and other reasons, and being very prudent for well

over 15 years, have pushed out voluntarily, their activities into registered broker-dealers. Stated simply, when the banks recognize a

true securities activity without any prompting, without any forcing

from the SEC, they have volunteered registration as broker-dealers.

Mr. WATT. But if we got a State regulator who’s telling community banks all of a sudden you don’t have to push that out anymore, you don’t even have to have a separate subsidiary to do it,

maybe that 10 percent gets bigger over time. But even if it doesn’t,

the gray area is still that 10 percent, which is what I was saying

to Mr. Baker earlier. It’s not the 90 percent that’s causing the problem. I think everybody is in agreement on that. The question is,

who has regulatory authority in that 10 percent area and how does

it get exercised in some responsible way? And how does it get exercised in a nonduplicative way? Because I think we all agree that

you shouldn’t have—maybe you’ve got shared responsibility for the

regulation, but you shouldn’t have one set of regulations by the

banking regulators and a separate set superimposed on top of that

by SEC.

Mr. KURUCZA. Mr. Watt, I believe you’re quite correct. It’s that

10 percent. But I would submit to you that I think we need further

refinement of that 10 percent in terms of what are the nature of

the activities involved? In other words, if in talking about that 10

percent bucket, we’re talking about pure full-service brokerage activities, registration may be appropriate, versus what I think has

been the topic of today, the nature of the activities covered by the

Title II exceptions, which, quite frankly, get into a marginal gray

area of traditional bank activities where registration is not justified. In all cases we must concede there is some securities-related

aspect. It’s almost by definition. There would be no need for the exceptions but for this fact.

If you looked at these activities in isolation, putting on my old

SEC hat, I’d conclude that they were brokerage activities. But the

reason for the exceptions is notwithstanding this, because they’re

traditional activities that have been effectively regulated by the

bank regulators for umpteen years, there’s really no need to superimpose redundant regulation by the SEC on top of that.
44

Chairman BACHUS. I appreciate that. Regulatory oversight of a

bank trust department is significantly different from oversight of

a brokerage firm. Could you briefly describe the oversight that a

bank trust department receives and why additional SEC oversight

would be unnecessary? And Mr. Higgins representing a large bank,

and Mr. Pollard, maybe a smaller institution. Mr. Maloney, your

clients are obviously banks. And either of the other two gentlemen

that would like to offer any comment. If you agree with that.

Mr. HIGGINS. Thank you, Mr. Chairman. The primary regulator

of national banks is the Office of the Comptroller of the Currency.

And with all due respect to Ms. Broadman and her demure presence here today, it is a five-alarm fire when a complaint letter

flows through the OCC to our bank or any national bank. We take

that extremely seriously.

We have OCC regulators who, because of the size of our organization, are resident in the bank. They have offices in the bank 5

days a week, 52 weeks a year, and are almost a part of our management team. Their efforts are supplemented by our outside auditors, in our case, Price-Waterhouse-Coopers. In addition, we have

an audit department that oversees all of our banking activities. We

have a compliance group specifically dedicated to trust, headed in

our case by a former OCC bank examiner. So I think our self-policing is extremely strong.

I also question whether or not the consumer is better served by

having the SEC represent their interests. As I understand it, the

course of action open most often to an aggrieved investor in a brokerage firm is mediation or arbitration I should say. On the other

hand, if you have a grievance against a bank trust department,

you’re free to sue us in State court before a jury with the opportunity perhaps to collect punitive damages. So I’m not so sure that

necessarily pushing out these accounts to a broker-dealer puts the

consumer in a better position.

Chairman BACHUS. Mr. Pollard.

Mr. POLLARD. The FDIC is our primary regulator, and they have

always reviewed thoroughly our activities in the securities business. We have never had any significant problems. In fact, they’re

in there now. In another 3 weeks, I hope to be able to tell you the

same thing.

Our bank compliance officer regularly reviews these types of

transactions. We are audited periodically by the compliance manager of our broker-dealer. A representative of our broker-dealer

that we use, comes into the bank, comes into these offices, and reviews the various transactions for compliance with all the laws and

regulations. We have not had any significant problems from customers because we are trying to look out, we hope, for their best

interest and to develop a full relationship.

We believe that the FDIC, our State office of Commissioner of

Banks, and the regulation from the compliance department of our

broker-dealer, have been very adequate for our activities.

Chairman BACHUS. Thank you. Anyone else who would like to

comment?

Mr. MALONEY. The checklist that a bank examiner is required to

work from, when he or she examines a bank trust department is

very detailed, exquisitely detailed. When we were talking to folks
45

on the Senate side with respect to Gramm-Leach-Bliley, they asked

us to prepare a memorandum of law comparing the standard of

care that exists between a brokerage client and a brokerage representative and a fiduciary and a beneficiary. I had never done

that before, but it was interesting to read the outcome.

The standard to which a bank is held is far higher than that

which exists between a broker and his customer. When we were

talking to the staff, the result of which were the three exemptions

we were granted, I got a sense of how this could go wrong. And I’d

just like to share that anecdote with you.

We were talking about entry-level trust accounts, Mr. Baker’s

question earlier, and how that all works. And you come in the trust

department and there is a variety of options available as to how

they’re going to manage your assets. Common trust funds, individual securities, mutual funds, perhaps a combination thereof, or

one or the other. And the folks from the Commission said aha! Just

like a Reimbursement Account Plan account, which of course in

their calculus is a brokerage relationship. I said it’s not just like

a RAP account. I said there’s this standard to which the bank is

held. It’s called the Uniform Prudent Investor Act, which has been

passed in all 50 States. And that’s the standard to which the bank

is held in managing your wealth. And if there are problems, if the

assets are mismanaged or a conflict of interest, whatever the case

may be, as Ed pointed out, there are remedies available in State

court for misconduct by banks. And those remedies are equally if

not more severe than anything meted out under the various securities laws.

So the idea that there aren’t any protections in place for clients

of bank trust departments is simply not the case.

Chairman BACHUS. All right. Thank you. There have been some

comments made about the intent of Congress. I think what we intended to do was very clear. I think that we, at least in pretty plain

language, I thought expressed our intent. But perhaps what the

Senate language might have is it may be tighter drafted and have

anticipated something that we didn’t anticipate. So I think it would

be helpful to look at that as we move forward.

But I can tell you that it was the fairly unanimous intention of

Congress to let trust departments, fiduciary relationships and for

the oversight of that to remain with the banking regulators. And

I think we all agree. I think I’ve heard nothing on this panel

which—but, you know, obviously sometimes you anticipate problems, and those may have been addressed in the Senate bill.

Mr. Higgins, I’m going to quote something you said. You said

since the SEC first issued the interim final rules in mid-May, members of the SEC staff have conducted a series of meetings with various industry groups in order to get a clearer understanding of the

difficulties that the industry would experience when the interim

final rules went into effect.

I’ll ask all of you this. Did the SEC hold meetings with you or

your groups prior to issuing the final interim rules? That would be

my first question.

Mr. MALONEY. We had extensive contact with the staff of the

SEC, Mr. Chairman. And as I mentioned in my earlier remarks, all

of it was positive.
46

To your question, nobody seems to know the answer yet, but we

hope we can get it. We’ve undertaken to both the SEC and to the

Office of the Comptroller of the Currency, we’re going to have a law firm go in and do a Gramm-Leach-Bliley audit of a $3.2 billion national bank trust department that’s engaged in virtually all of the

activities described in Title II, and we want to get a sense back of

what if any dislocations will be caused as a result of what’s in the

release. I think we all need that kind of practical information.

Chairman BACHUS. So there was contact between you and the

SEC?

Mr. MALONEY. Yes, sir.

Chairman BACHUS. Prior to issuing the final interim rules?

Mr. MALONEY. Yes.

Mr. HIGGINS. Mr. Chairman, I’ve also learned that members of

the American Bankers Association staff contacted the SEC staff

very early on in this process. And once schedules permitted, senior

staffers met in the fall of last year to begin a dialogue.

Mr. KURUCZA. I can also add to that, Mr. Chairman, the Bank

Securities Association did have meetings with the SEC staff and in

one case an individual commissioner. And again, I think they are

to be applauded for that in terms of trying to gather a baseline of

information. But I’d also state that I think there is no substitute

for a public comment period in a normal rulemaking. Quite frankly,

on an informal level, perhaps the candor is better than it would be

in terms of written comments. Perhaps it’s not. But again, the Administrative Procedure Act does require it, and I think qualitatively that was missing from this exercise.

Chairman BACHUS. Right. Many people have pointed out to us

that the provisions of the Administrative Practice Act obviously

were not followed.

Mr. Pollard.

Mr. POLLARD. Yes. Our bank was not contacted. The ICBA received minimal contact, and a meeting was discussed, but it did not

occur prior to the publication of the rule. There has been contact

since, and that effort has improved.

Chairman BACHUS. One pattern that I sometimes see is that the

smaller banks are not contacted and do not participate to the level

that the larger institutions do. And of course, the larger institutions have a more effective, well-paid lobby here in the city. But

that should not account for the lack of an invitation to the table.

My next question, were your concerns addressed in the interim

final rules? And please limit your remarks. And we’ll start with

Mr. Patterson.

Mr. PATTERSON. Well, we participated in conversations with the

Commission staff through trade associations, in particular, the

ABA Securities Association. The areas of concern are addressed in

the rules. But, as you can tell from our testimony and our extensive comments, not to our satisfaction.

Chairman BACHUS. Mr. Higgins, were your concerns addressed in

a constructive way?

Mr. HIGGINS. The SEC staffers we met with appeared to listen,

but I don’t think they quite understood exactly how mechanically

a bank trust department works. And push-out of function is pushout of relationships, and that’s a very big deal for us. We have rela-
47

tionships that are two or three trusts, two or three custody accounts, perhaps a family foundation, and they may have been with

us for 20 years, and now we’ll have to ask that client who chose

us, who chose a bank trust department, to leave.

Chairman BACHUS. They listened, but your concerns were

not——

Mr. HIGGINS. To give them credit, I believe they thought they

were right.

Chairman BACHUS. Thank you.

Mr. Kurucza.

Mr. KURUCZA. I would add, and let me just single out one particular issue that the Bank Securities Association, a number of

members have been keenly interested in, which has not come up

as a specific topic, are the sweep accounts. Again, a very important

product, whether it’s for business customers, small business customers, whether it’s a retail product, whether it’s used in a trust

context, very, very important product Mr. Higgins mentioned earlier. What the SEC has done in the interim final rules was to adopt

from an unrelated disclosure context a National Association of Securities Dealers definition of what is ‘‘load.’’ And again, it’s ironic

that, as you well know, Mr. Chairman, again, the long history of

financial modernization, that definition has been in here for over

15 years going back to legislation, never been changed because of

the compromise that had been reached on it, and they reached back

and decided to select this NASD definition.

You know, we went through all the analysis, we went through

all the arguments. We discussed in detail the terrible impact that

this would have. And really, quite frankly, most importantly, there

was no need for it from an investor protection perspective. We’re

talking about a money market fund. While no securities product is

risk-free, if there ever was one that was risk-free, or relatively riskfree, it’s a money market fund, largely due to the very stringent

and effective SEC regulation of money market funds. Nonetheless,

they chose to do that.

Two named sponsors of the Gramm-Leach-Bliley Act wrote letters on this very point to the SEC, one in the end of December from

Mr. Leach and one on the Senate side from Mr. Gramm indicating

their view on this, which was contrary to the SEC position. These

views were apparently dismissed in the interim final rules. So

that’s a long-winded answer to your question, but I guess in terms

of the satisfaction point, the answer is no.

Chairman BACHUS. Thank you.

Mr. MALONEY. We were satisfied, Mr. Chairman. We put in three

exemption requests and they in large measure were granted.

Chairman BACHUS. OK. Thank you.

Mr. Pollard.

Mr. POLLARD. Really nothing else to add.

Chairman BACHUS. Thank you. I think at this time I want to express to you that your message has reached the Hill. We are as

concerned as you are about these interim final rules. We’re also

concerned about the effect that it’s already had on your institutions

in incurring expenses and reviewing the rules and preparing for

something that we hope won’t happen, but you can’t simply assume

that. So you’ve already had expenses. Your testimony has been
48

helpful. Your representatives I think have done an effective job of

letting us know where the problems are.

The bank regulators have done an exceptionally good job of highlighting the problems with the new rules, and I think the Securities and Exchange Commission as a result of that is responsive and

will be responsive to these concerns. In fact, they made a commitment here today to make substantial changes to those rules. At

least that’s what I heard.

I think it’s the wish of the industry, of the Congress, of your institutions that the Securities and Exchange Commission with the

aid and advice of the Federal bank regulators who have the experience in this field and with your input that they will make the necessary changes. And I’m optimistic that they will.

No one wants to reopen Gramm-Leach-Bliley. That’s not an option that we want to pursue unless absolutely our backs are to the

wall and there’s no other option. If that’s pursued, it will have to

be done I think in a bipartisan way with the agreement of both

Houses to do it in some legislation that is not open to amendment

with other issues coming in that may be problematic, basically an

agreed solution that moves by maybe consent document, something

of that nature.

This concludes our hearing. I appreciate your testimony.

Ms. Hart, I will recognize you at this time, the lady from Pennsylvania. A very valuable Member of our subcommittee.

Ms. HART. Wow. I’m really glad I came now. Thanks for your indulgence, Mr. Chairman. As you know, we had a conference and I

had a lot of conflicts and I really had hoped to be here. One thing

I want to thank the Chairman for indulging our request also to

have Mr. Maloney be one of the witnesses today. My counsel was

here for the testimony, and she just whispered in my ear, and I

wanted to thank him for taking the time to do this. And I understand that you did a nice introduction.

But I also want to let everybody know, and unfortunately, we

don’t have that many colleagues here, and perhaps I’ll send a

memo around to them, to let them know that obviously we know

this is an extremely important issue, but that Mr. Maloney has

been involved for quite a while professionally in working with both

banking and securities industries and I think as well as some other

witnesses has been able to shed some light on this issue for us so

that we kind of push to have it dealt with in a reasonable way, to

come to a conclusion that isn’t going to be burdensome for the industry. And I want to thank you, Mr. Chairman, for completing the

hearing, and I don’t have any questions for the witnesses.

Chairman BACHUS. Thank you. Ms. Hart said this is hopefully

the last day of our session, and we’re dealing with a very important

issue that apparently today finally is working itself out on the

floor. We have various press conferences about it, dueling press

conferences and the like.

Mr. Maloney has given some very valuable testimony, and as

have all you gentlemen. And at this time, the hearing is adjourned.

[Whereupon, at 1:39 p.m., the hearing was adjourned.]
(49)

A P P E N D I X

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