U.S. GOVERNMENT PRINTING OFFICE

WASHINGTON : 

58–493CC 1999

RISKY BUSINESS IN THE OPERATING SUBSIDIARY:

HOW THE OCC DROPPED THE BALL

HEARING

BEFORE THE

SUBCOMMITTEE ON

OVERSIGHT AND INVESTIGATIONS

OF THE

COMMITTEE ON COMMERCE

HOUSE OF REPRESENTATIVES

ONE HUNDRED SIXTH CONGRESS

FIRST SESSION

JUNE 25, 1999

Serial No. 106–37

Printed for the use of the Committee on Commerce

(
2

COMMITTEE ON COMMERCE

TOM BLILEY, Virginia, Chairman

W.J. ‘‘BILLY’’ TAUZIN, Louisiana

MICHAEL G. OXLEY, Ohio

MICHAEL BILIRAKIS, Florida

JOE BARTON, Texas

FRED UPTON, Michigan

CLIFF STEARNS, Florida

PAUL E. GILLMOR, Ohio

Vice Chairman

JAMES C. GREENWOOD, Pennsylvania

CHRISTOPHER COX, California

NATHAN DEAL, Georgia

STEVE LARGENT, Oklahoma

RICHARD BURR, North Carolina

BRIAN P. BILBRAY, California

ED WHITFIELD, Kentucky

GREG GANSKE, Iowa

CHARLIE NORWOOD, Georgia

TOM A. COBURN, Oklahoma

RICK LAZIO, New York

BARBARA CUBIN, Wyoming

JAMES E. ROGAN, California

JOHN SHIMKUS, Illinois

HEATHER WILSON, New Mexico

JOHN B. SHADEGG, Arizona

CHARLES W. ‘‘CHIP’’ PICKERING,

Mississippi

VITO FOSSELLA, New York

ROY BLUNT, Missouri

ED BRYANT, Tennessee

ROBERT L. EHRLICH, Jr., Maryland

JOHN D. DINGELL, Michigan

HENRY A. WAXMAN, California

EDWARD J. MARKEY, Massachusetts

RALPH M. HALL, Texas

RICK BOUCHER, Virginia

EDOLPHUS TOWNS, New York

FRANK PALLONE, Jr., New Jersey

SHERROD BROWN, Ohio

BART GORDON, Tennessee

PETER DEUTSCH, Florida

BOBBY L. RUSH, Illinois

ANNA G. ESHOO, California

RON KLINK, Pennsylvania

BART STUPAK, Michigan

ELIOT L. ENGEL, New York

THOMAS C. SAWYER, Ohio

ALBERT R. WYNN, Maryland

GENE GREEN, Texas

KAREN MCCARTHY, Missouri

TED STRICKLAND, Ohio

DIANA DEGETTE, Colorado

THOMAS M. BARRETT, Wisconsin

BILL LUTHER, Minnesota

LOIS CAPPS, California

JAMES E. DERDERIAN, Chief of Staff

JAMES D. BARNETTE, General Counsel

REID P.F. STUNTZ, Minority Staff Director and Chief Counsel

SUBCOMMITTEE ON OVERSIGHT AND INVESTIGATIONS

FRED UPTON, Michigan, Chairman

JOE BARTON, Texas

CHRISTOPHER COX, California

RICHARD BURR, North Carolina

Vice Chairman

BRIAN P. BILBRAY, California

ED WHITFIELD, Kentucky

GREG GANSKE, Iowa

ROY BLUNT, Missouri

ED BRYANT, Tennessee

TOM BLILEY, Virginia,

(Ex Officio)

RON KLINK, Pennsylvania

HENRY A. WAXMAN, California

BART STUPAK, Michigan

GENE GREEN, Texas

KAREN MCCARTHY, Missouri

TED STRICKLAND, Ohio

DIANA DEGETTE, Colorado

JOHN D. DINGELL, Michigan,

(Ex Officio)

(II)
3

C O N T E N T S

Page

Testimony of:

Alpert, Jonathan L., Senior Partner, Alpert, Barker, and Rodems .............. 13

Crawford, Denise Voigt, Securities Commissioner, Texas State Securities

Board on behalf of North American Securities Administrators Association ................................................................................................................. 4

Griffin, Mary, Insurance Counsel, Consumers Union ................................... 8

Williams, Julie L., Chief Counsel, Office of the Comptroller of the Currency ............................................................................................................... 76

Material submitted for the record by:

Securities and Exchange Commission, prepared statement of ..................... 86

Williams, Julie L., Chief Counsel, Office of the Comptroller of the Currency, letter dated July 8, 1999, to Hon. Tom Bliley, enclosing response

for the record ................................................................................................. 95

(III)
(1)

RISKY BUSINESS IN THE OPERATING SUBSIDIARY: HOW THE OCC DROPPED THE

BALL

FRIDAY, JUNE 25, 1999

HOUSE OF REPRESENTATIVES,

COMMITTEE ON COMMERCE,

SUBCOMMITTEE ON OVERSIGHT AND INVESTIGATIONS,

Washington, DC.

The subcommittee met, pursuant to notice, at 10 a.m., in room

2322, Rayburn House Office Building, Hon. Fred Upton (chairman)

presiding.

Members present: Representatives Upton, Burr, Bilbray,

Whitfield, and Green.

Staff present: Duncan Wood, professional staff member; David

Cavicke, majority counsel; Amy Davidge, legislative clerk; and

Chris Knauer, minority investigator.

Mr. UPTON. Good morning everyone, and we are today holding a

hearing on crucial consumer protection issues raised by the Office

of the Comptroller of the Currency, the OCC’s role, in overseeing

securities-related activities in banks. This subcommittee is a strong

supporter of the investor protections provided to the public by the

securities laws and has serious concerns about OCC’s supervision

of bank operating subsidiaries that sell securities to bank customers.

The primary mission of the securities regulators is to enforce the

securities laws which are designed to ensure that investors receive

adequate disclosure and information from the brokers, and to safeguard against consumer, customer confusion.

In contrast, the OCC’s primary mission is not investor protection,

but rather ensuring the safety and soundness of national banks.

Today’s hearing is particularly timely because probably next week

the House will vote on H.R. 10, otherwise known as the Financial

Services Act of 1999, and unless the bill is amended on the floor

or in the Rules Committee, it will allow banks to conduct the full

range of securities activities within an operating subsidiary from

retail sales of mutual funds to securities underwriting, and even

merchant banking.

Given the track record of the OCC’s supervision of operating subsidiaries, aspects of which we will discuss today, Members of Congress should question the wisdom of any bank bill, that allows

bank operating subsidiaries to expand their securities activity and

undercut the long standing principles of fully functional regulation
2

of securities and regulatory protection against the intermingling of

commercial banking and securities.

The OCC’s mission is to promote the safety and soundness of the

national banking system. According to the comptroller’s hand book,

the OCC’s philosophy is to provide high-quality bank supervision

based on a nonintrusive cooperative process between bankers and

examiners which adds value to the supervised institution.

In today’s hearing, we will review whether the bank regulators’

mission and philosophy offers investors the same level of protection

as the security regulators provide. We also look at cases where securities fraud has occurred in the bank operating subsidiary in

order to find out whether OCC’s guidelines, examinations and ratings constitute an adequate substitute for fully functional regulation of securities by the SEC and the State Securities Commissioners.

There are three issues with which I’m concerned. The first is

that the OCC didn’t interview any victims of the Op. Sub. fraud

from whom they received complaints. Their investigation was limited to talking to the folks who supervised the fraud. Second is

NationsBank received a rating of two, or satisfactory, the year the

Op. Sub. committed this fraud.

Hundreds of elderly investors were bilked out of their savings out

of the Op. Sub. The OCC found the strongest levels of compliance

were noted at Nation’s Securities in a December 2, 1993, report by

OCC examiners when the Op. Sub. was engaging in fraud. If an

Op. Sub. is defrauding hundreds of elderly people and your rating

is satisfactory, what do you have to do to get a bad grade?

And third, the OCC fined NationsBank $750,000 for a failure to

supervise the Op. Sub. In the context of a fraud that bilked so

many folks of more than $100 million, there is little deterrent if the

fine is so small.

For today’s hearing, the first panel will consist of a State securities’ regulator, a spokesperson from the Consumers Union, a civil

attorney involved in the NationsBank case and other cases regarding security violations in operating subsidiaries. The second panel

features Julie Williams, chief counsel and former acting comptroller of the OCC.

I welcome all of our witnesses, and thank you for your contribution to this timely hearing on investor protection issues. And I

yield to the vice chairman of this subcommittee, Mr. Burr, for an

opening statement.

Mr. BURR. Thank you, Mr. Chairman. I would really like to take

this opportunity to raise questions about the purpose and direction

of this morning’s hearing, as well as the relevance of what I understand to be the purpose of today’s witnesses. I’m also concerned

that there are no banks, particularly NationsBank, here and neither were they invited to testify before the subcommittee.

I’ve been told they weren’t invited because there was a desire on

the part of the committee to prevent this hearing from becoming

an inquisition into the past activities of banks that sell securities

and other financial instruments.

However, based on our witnesses’ testimony this morning, this is

not an inquisition; it is a sentencing trial. If this hearing is meant

to examine the role of the OCC in regulating the activities of banks
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as it operates in regards to operating subsidiaries, why hold the

hearing now?

If questions remain about potential problems in operating subsidiaries, they should have been addressed by this committee before we proceeded with the markup and before we voice voted H.R.

10 out of committee, because I understand from the legislative language of the committee report on H.R. 10, operating subsidiaries

were addressed.

Most of today’s testimony, however, seems to center around questionable sales practices that took place years ago for a short period

of time in a joint venture that no longer exists. Settlement in that

case was reached over a year ago to resolve the matter.

I’m also concerned about our new interest in the operations of

the OCC and potential criticism based on the title of this hearing

that they dropped the ball.

Does that title refer simply to one case, or are they in the process

of continually dropping the ball? Based on OCC’s written testimony

as well as the SEC, they’re doing a fine job in their efforts to regulate the activities of operating subsidiaries today, which leaves us

with one review of one incident. Are we going to criticize the OCC

for moving too slowly in the NationsBank case? Based on their testimony, I get the impression they moved along pretty well in that

investigation.

If speed is an issue in these investigations, Mr. Chairman, perhaps it’s time we turn the efforts of this subcommittee to turning

up the heat as it relates to the Department of Energy’s labs and

not on legislation we’ve already passed. I thank the Chair.

[Additional statement submitted for the record follows:]

PREPARED STATEMENT OF HON. TOM BLILEY, CHAIRMAN, COMMITTEE ON COMMERCE

In our work modernizing financial services laws, we have encountered one truly

bad idea—the Administration’s demand to expand the power of operating subsidiaries, giving the Treasury control over the financial markets.

Our financial markets have thrived because of their independence. Unlike Asia

with its crony capitalism and conflicts of interest, America has avoided expansion

of taxpayer subsidy from banking to the capital markets.

Alan Greenspan has indicated that operating subsidiaries pose serious risks to

banks and to their deposit insurance funds. Op-Subs threaten to infect America with

this crony capitalism. Op-Subs expand taxpayer subsidiary from banks to securities

and merchant banking. Securities firms are not in need of a taxpayer handout.

Still, the Administration persists in its turf grab against the interests of efficient

free markets.

Today the O&I subcommittee will take a look at the OCC’s supervision of existing

Op-Subs. The Treasury wants more power for op-subs. Today we pose a simple questions—How are they doing with the one’s they have?

The answer is disturbing. In the wake of massive fraud in an operating subsidiary

of NationsBank, the OCC rated NationsBank’s compliance with its guidance as satisfactory.

The OCC did not investigate customer complaints arising out of the fraud. They

limited their discussions to the persons who perpetrated the fraud.

When approached by elderly investors who had been defrauded by the op sub, the

Comptroller indicated that it could be of no assistance because the matter was the

subject of private litigation.

Hundreds of elderly people were defrauded by the NationsBank op sub. Over $40

million was paid to settle private claims. The OCC gave NationsBank a satisfactory

rating the year of this fraud. An operating subsidiary is part of a bank. Its profits

are the bank’s, its losses are the bank’s. The OCC apparently did not think that

this fraud merited a lower rating for the bank. I wonder what they would have had

to do to fail their exam.
4

The Subcommittee has found evidence that the OCC is failing to oversee the limited Op-Subs that exist today. Given this record, expanding Op-Subs would be reckless.

I commend Chairman Upton for this hearing, and yield back the balance of my

time.

Mr. UPTON. Thank you. We welcome the witnesses. Before us we

have a ruling in the subcommittee that we swear in our witnesses.

Do any of you have any objection to that? We also have a standard

rule that you’re welcome to have counsel if you so desire. Do any

of you need counsel? I didn’t think so. If you would stand and raise

your hand.

[Witnesses sworn.]

Mr. UPTON. Ms. Crawford, we will start with you. We have your

testimony, which will be made a full part of the record. And we

would like you to limit your oral testimony to 5 minutes, if you can.

And this little fancy smanchy timer will keep track of that for us.

Go ahead.

TESTIMONY OF DENISE VOIGT CRAWFORD, SECURITIES COMMISSIONER, TEXAS STATE SECURITIES BOARD ON BEHALF

OF NORTH AMERICAN SECURITIES ADMINISTRATORS ASSOCIATION; MARY GRIFFIN, INSURANCE COUNSEL, CONSUMERS UNION; AND JONATHAN L. ALPERT, SENIOR PARTNER, ALPERT, BARKER, AND RODEMS

Ms. CRAWFORD. Good morning, Mr. Chairman and members of

the subcommittee. My name is Denise Voigt Crawford. I am the

Texas securities commissioner and the immediate past president of

the North American Securities Administrators Association, which

is the entity that is the national voice of State securities regulators.

By way of background, NASAA has testified on a number of occasions regarding financial services modernization.

State securities regulators have welcomed banks and insurance

companies into the securities business; however, we believe that

modernization efforts should be congressionally dictated rather

than accomplished via regulatory fiat. And to that end, we commend you, Chairman Upton, as well as your colleague, Congressman Klink, for holding this hearing.

Back in 1996, the Texas State Securities Board brought a very

important and unprecedented enforcement case in the

NationsBank’s matter. Our investigation and subsequent enforcement action exposed numerous violations of State securities laws,

including among others the following.

First, fraudulent misrepresentations. Bank customers were told

that their highly volatile investments were FDIC insured, risk-free

alternatives to certificates of deposit. This was absolutely false.

Second, lack of suitability. The securities were aggressively marketed to elderly customers of the bank and to those whose risk tolerance clearly indicated that they were unsuited for such risky investments.

Third, an appalling lack of supervision in an atmosphere particularly conducive to confusion, customers could not even determine

who they were dealing with. Were they dealing with an agent of

the broker/dealer subsidiary, or were they dealing with an employee of the bank? They simply could not tell.
5

1The oldest international organization devoted to investor protection, the North American Securities Administrators Association, Inc., was organized in 1919. It is a voluntary association

with a membership consisting of the 65 state, provincial and territorial securities administrators

in the 50 states, the District of Columbia, Canada, Mexico and Puerto Rico. In the United

States, NASAA is the voice of the 50 state securities agencies responsible for grass-roots investor protection and efficient capital formation.

And particularly disturbing, especially in view of events that have occurred over the last few days, is the sharing of private customer information with the broker/dealer subsidiary on the part of

the bank and simply to increase sales. This was done in connection with a so-called bank referral incentive program, whereby bank personnel were compensated to turn

certain identified customers over to the broker/dealer subsidiary.

For example, customers whose CDs were about to mature or customers who had made recently large deposits in their accounts

were referred over pursuant to this program and referral fees were

paid.

There’s no question that banking regulators do a great job in as- suring the safety and soundness of the institutions. However, banking regulations do not mandate the screening, testing or licensing

of bank employees. Banking regulations do not mandate that banks

and their employees make full and fair disclosure of all material

facts regarding a bank-sponsored investment product. Banking regulations do not provide wrong purchasers with private rights of action. And these are but some of the failings of the banking regulatory system as it relates to bank sales of securities. To dispense with these protections is clearly a recipe for disaster. To try to duplicate within the banking regulatory structure of the

framework of securities regulation is unnecessarily duplicative and

extremely costly. Fortunately, it’s unnecessary to do this. Functional regulation where the expert regulator oversees the activities

that fall within the area of that regulator’s expertise is the best

and least expensive approach.

In conclusion, NASAA’s position is that the SEC and State security regulators should be the only primary regulators of the bank

securities activities regardless of where or how security sales take

place. The experts should be the ones in charge. Thank you for your kind attention, and I would be happy to an- swer any questions that you might have. [The prepared statement of Denise Voigt Crawford follows:]

PREPARED STATEMENT OF DENISE VOIGT CRAWFORD, SECURITIES COMMISSIONER, TEXAS STATE SECURITIES BOARD ON BEHALF OF NORTH AMERICAN SECURITIES ADMINISTRATORS ASSOCIATION, INC.

Chairman Upton and Members of the Subcommittee: I am Denise Voigt Crawford,

the Texas Securities Commissioner and Past-President of the North American Securities Administrators Association (‘‘NASAA’’).1 I commend you and Congressman

Klink for conducting these hearings, and I appreciate the opportunity to discuss several important issues associated with the regulatory oversight of securities activities

at banks.

NASAA has testified before Congress over the years to support congressionally directed financial services modernization that will protect investors and preserve faith

in the integrity of our securities markets.

With a record number of households investing in the securities markets, investor

protection, the basis for confidence in the securities markets, should be a top priority as Congress moves forward with legislation that reforms our financial services

markets. We hope our expertise and experience as state securities regulators will

be useful to you.
6

Our federal counterparts at the Securities and Exchange Commission (‘‘SEC’’) tend to focus on the oversight of large corporate offerings and the globalization of

the marketplace. State securities regulators, on the other hand, are closest to the

investing public and serve as the local cops on the beat.

FUNCTIONAL REGULATION

NASAA strongly supports and upholds the ideals of functional regulation of secu- rities activities and products. We believe it is a core element of investor protection.

We welcome banks, as well as insurance companies, into the securities business,

but under the same complementary state/federal securities oversight system. We believe it neither rational nor plausible to adopt a course calling for federal banking

regulators to recreate within their ranks and walls the essential enforcement culture, regulatory schemes and systems essential to monitor securities activities and,

more specifically, police abusive securities sales practices. It is completely impractical to expect them to do so in the near term and to the extent provided by the

NASDR and other SROs, the SEC and the states. Even an attempt would be unnecessary, constituting a wasteful duplication of resources and money, and the dismissal of decades of proven securities regulatory experience. Residents of our states investing in securities should receive the same disclosures and have the same investor protections whether they invest through a broker-dealer, a bank, an insurance company or a mutual fund. Those who sell securities

should be subject to the same licensing qualifications and oversight whether their

employer is a bank, an insurance company, a securities firm, or something else.

THE NATIONSSECURITIES CASE

Actions taken by state securities regulators in Texas in 1996 and Florida in 1997

exemplify the unique problems and risks to consumers posed by retail securities

sales operations affiliated with and operating on the premises of banks. These actions also underscore the benefits of functional regulation of these affiliates or subsidiaries by state securities regulators.

Texas and Florida securities authorities received numerous investor complaints

regarding securities sales activities of NationsSecurities, a registered broker-dealer

subsidiary of NationsBank. As a result of their investigations, Texas and Florida securities regulators brought enforcement actions in which they alleged

NationsSecurities misrepresented the safety and risks associated with a particular

investment vehicle.

In the Texas action, among the investors involved were NationsBank depositors

who had been targeted because they wanted higher returns on their money than

what was provided by certificates of deposit. NationsBank proprietary investment

products (whose title included the words ‘‘Government Income Term Trust’’) were

marketed to them, in some cases with the misrepresentations that investments were

safe, conservative, low risk, and high yield, backed by AAA-rated government securities. In fact, the investments were risky and volatile, involving derivatives based on

collateralized mortgage obligations. Shortly after these products were sold to

unsuspecting investors, their value declined sharply.

In a settlement reached with the Texas State Securities Board, NationsSecurities

was required to make offers of rescission to investors and undertake significant compliance enhancements. The firm also provided $275,000 in funding for an extensive

Texas investor education program. Subsequent settlements were reached with Florida securities authorities ($250,000) and with the SEC ($4 million fine), National

Association of Securities Dealers—Regulation, Inc. (‘‘NASDR’’) ($2 million fine, three

individuals fined, suspended and censured) and the Office of the Comptroller of the

Currency (‘‘OCC’’) ($750,000 fine) on related issues. Private class action suits were

settled as well, according to press reports, for nearly $40 million.

In his Business Week Commentary of May 18, 1998, David Greising discussed

both the NationsBank settlements and the need for functional regulation of securities activities at banks.

The abusive atmosphere at the securities division of NationsBank Corp. in

the early 1990s was shocking even for veteran stockbrokers. Working at the

bank’s branches, they were told to hawk NationsBank’s investment products to

bank customers without explaining that they were brokers, not bankers.

. . .The case shows how difficult is it to regulate stockbrokers working for

banks, in part because bank regulators usually lack the skills or the inclination

to root out securities fraud.

. . . Banks have pushed to stay under the umbrella of banking regulators, who

have precious little experience with brokerage derring-do. But in an era when

every ambitious bank is copying the playbook of Merrill Lynch & Co., not J.P.
7

2 2David Greising, ‘‘Commentary,’’ Business Week, May 18, 1998, p. 154

Morgan & Co., that’s a recipe for regulatory undersight. It leaves regulators unable to stop sleazy selling practices by stockbrokers dressed in bankers’ pinstripes.2

It is well known and often repeated that the essential goals of banking regulation are safety and soundness of the banks, while the essence of securities regulation is

protection of the investor. These are very different premises; and as distinct as the

systems and skills required to achieve them. Banking regulation imposes broad financial reporting requirements and limita- tions, and relies upon auditors and examiners to review both the adequacy of the

finances and the level of regulatory compliance. It is very much geared to accounting and analysis. To avoid the worst of all banking nightmares, a run on the bank,

secrecy and confidentiality are paramount concerns. The regulators make sure that

depositors’ confidence in the solvency of their institutions is maintained. Traditional banking regulation does not include any concept of the screening, test- ing or licensing of banker employees. Traditional banking did not include the concept of selling investment products on a commission basis. Banking regulation contains no direct mandate that banks must make—and see to it that their employees

make—full and fair disclosure of all material facts regarding a bank-sponsored securities product or risk regulatory sanction. Banking regulators do not have a system

in place to track bank employees who may move from one bank to another, perhaps

without disclosing past customer-related problems. They cannot track such people,

nor is there a database available for the public to access to make inquiry on their

own. Banking regulation does not provide private rights of action for wronged purchasers of investments, nor is there established any means of alternative dispute

resolution. Sanctions imposed on banks for banking law and regulatory violations

are generally not publicized, probably because to do so could or would undermine

the safety and soundness of the institution.

The complementary state/federal securities oversight system, in conjunction with

the self-regulatory organizations, provides all of those features in its regulation of

securities sales activity.

Finally, as the NationsSecurities and subsequent enforcement actions make clear,

banking customers remain confused and highly susceptible to believing that securities investments offered and sold to them at banks are somehow insured against

loss by federal deposit insurance. This potential for misunderstanding means that

it is even more important for bank-sited brokerage personnel to provide potential

investors with clear disclosure relating to the investment products they consider

purchasing from the bank rather than at more traditional broker-dealers.

Another issue of concern relating to bank sales of securities involves bank customers’ rights to privacy and cross marketing practices. For example, a securities

customer phoning or visiting the office of his or her securities broker-dealer does not

expect to be referred to a desk where products federally insured against loss are

available. Can the same be said for a bank depositor visiting his or her bank branch

to make a deposit or renew a CD who is directed to a salesperson located on the

bank floor and offered a ‘‘government backed fund?’’

PENDING FEDERAL LEGISLATION

Most retail securities activity currently conducted on bank premises is conducted

through broker-dealers registered with and regulated by state and federal securities

authorities. We believe this should remain the norm. As the bills before both Houses

of Congress are given further consideration, NASAA would request that certain key

concepts be included to maintain the current level of investor confidence in the U.S.

securities markets. There has been significant and consistent support to preserve

and give full force and effect to state securities enforcement authority in any final

legislation under consideration to become law. In addition, full functional regulation

should be required of securities products as well as securities personnel in any entity where securities sales occur. Also important, any modernized financial services

law should require the functional regulation of all entities or persons performing

similar, if not almost identical, services in order to protect all investors equally.

In conclusion, it is undeniable that financial markets and services are blending.

Regulators have met and will continue to meet the challenges of coordinating efforts

to achieve the greatest good at the lowest cost. But as securities regulators, our

prime directive remains investor protection, not cutting costs. Synergies will continue to develop among corporations and regulators in dealing with macro issues of

major conglomerates and international mergers. Retail investment consumers need

the protection not so much from conglomerates and global mergers, but from over8

aggressive and abusive salespeople who would take advantage of their confusion

and concerns; protections that state securities regulation, functional regulation, afford.

Thank you for your kind attention.

Mr. UPTON. Thank you very much.

Mrs. Griffin.

TESTIMONY OF MARY GRIFFIN

Mrs. GRIFFIN. Thank you. Thank you, Mr. Chairman and Mr.

Burr, for the opportunity to present the views of consumers about

consumer and investor protection regulatory issues in today’s financial services marketplace. My name is Mary Griffin, and I am

counsel with Consumers Union. And in our written testimony

which we submit for the record outlines the problems and needed

solutions for consumers facing confusion and risk in the world of

one-stop shopping, but I will just highlight briefly the obstacles

presented by our regulatory system.

As the financial services market has consolidated, huge money

centers peddling an array of products taunt one-stop shopping as

a boom for consumers. As you will hear from Mr. Alpert, this boom

can and has turned into a bust for many consumers. Consumers

mislead and deceived about the nature and risk of products that

they purchased from their once-trusted federally backed banking

institution now face the risk of losing the very savings they were

trying to protect.

The changes in the market have been fostered by Federal regulators expanding bank powers. While studies and cases over the

years provide ample evidence of the need to maintain clear separation between banks’ insured and uninsured activities, strong disclosure of the nature and risk of uninsured products, anticoercion

rules and other safeguards, Federal bank regulators have failed to

provide these protections. Instead, they chose to issue guidelines to

the banks rather than legally enforceable rules.

We believe guidelines send a wink and a nod to the banks as opposed to a strong message of no tolerance for deception and unfair

dealing. We have urged the OCC and other agencies to issue rules,

rules with teeth. Even former Comptroller Ludwig recognized the

need for such rules before he left and urged the interagency task

force, the FFIEC, to move forward on rulemaking; but to date, no

rulemaking has been put forth.

And as you know, banks are currently exempt from investor protection rules, an outdated rule that must be repealed if investors

are to feel safe purchasing securities from banks.

In addition to dropping the ball on issuing needed rules, Federal

regulators have also been meddling in the affairs of States and

their consumer protections. The OCC has issued several opinion

letters over the years that permit banks to ignore State consumer

laws, even where there are no Federal laws providing the protections.

Congress even admonished the Federal banking agencies in the

conference report of the 1994 Riegle-Neal interstate Branching Act,

stating that their application of preemption principals was ‘‘inappropriately aggressive resulting in preemption of State law in situations where the Federal interests did not warrant it.’’
9

One of those preemption actions by the OCC involved New Jer- sey’s lifelong bank account law which the OCC let national banks

ignore. The New Jersey Banking Commission petitioned for review

of that decision in 1996. The OCC to date has failed to take action

on that case to reverse their overly broad preemption substance. The OCC’s latest State activities are in Connecticut and Iowa

where they furthered national bank attempts to overturn authority

of States to enact and enforce ATM surcharge banks. Another area where we feel the OCC and other agencies may drop the ball is financial privacy. While both former acting Comptroller Williams and Comptroller Hawk have made strong statements about the banking institution’s poor performance in the area

of protecting customer’s privacy, we have not heard them get out

and support the privacy protections passed by this committee in

H.R. 10 a few weeks ago. We hope the OCC will do so today, since what was passed by the committee a few weeks ago is consistent with and supported by the

administration’s own financial privacy policy announced last

month. We commend this committee for its action on financial privacy in H.R. 10. As you know, the good progress this committee made by getting consumers some level of control over their financial information

with notice and opt-out for affiliate and third-party sharing is

under an all-out attack by an unusual alliance of banking, insurance, and securities firms. We’re concerned that industry pressure

will even prevent a vote on the issue by the Rules Committee. Wouldn’t it be ironic if the public through its members is denied even a vote on the privacy protections they are demanding, just

like financial firms are refusing to give consumers the vote to say

no to sharing of their information. The first compromised step

taken by your committee toward providing a kind of price and the

protection the public needs and is screaming for must not be held

back and about industry pressure. We hope the House does not succumb to the campaign of misin- formation and bold threats to Members of Congress and make sure

the public through their representatives gets to vote at least on

what the Commerce Committee’s H.R. 10 privacy provisions are.

Consumers have not faired well in the changing financial services

market and the regulators have missed the opportunity to make

sure consumers benefit from the change they helped create. Congress needs to step in to make sure strong retail sales protec- tions are put in place, that the bank exemption from securities

laws is repealed. But States can protect their residents and the

consumers are given back control over the privacy rights they so

cherish.

While H.R. 10 has a long way to go to give consumers these as- surances they need, a strong vote on privacy will prove Congress

still heeds the call of the public and not just special interests. We

thank you very much for allowing us to present our views today. [The prepared statement of Mary Griffin follows:]

PREPARED STATEMENT OF MARY GRIFFIN, INSURANCE COUNSEL, CONSUMERS UNION

Thank you for the opportunity to testify today on consumer, investor protection

and regulatory issues in the current financial services marketplace. Consumers

Union, publisher of Consumer Reports, is dedicated to educating consumers about
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pocketbook issues and helping to ensure a competitive marketplace characterized by

fair and honest dealing. We will focus our remarks today on problems that consumers face in the world of one-stop shopping and the need to update consumer

laws and regulations to keep pace with the rapid changes in the financial services

market that will escalate with the enactment of H.R. 10.

Protecting Consumers in the World of One-Stop Shopping

When consumers walk into a bank, they are faced with a wide array of choices ranging from mutual funds to stocks to life insurance. Notwithstanding the changes

that will be brought about by H.R. 10, retail sales of insurance and investment

products has been a rapid growth business for banks over the past few years. According to the Association of Banks-in-Insurance (ABI) survey, 96% of all banks

with assets greater than $10 billion are in the insurance business. Banks produced

$27.8 billion in insurance premium in 1997, a huge increase from the $16.5 billion

reported in 1996, with annuities accounting for 68% of the premium. And, 68% of

banks selling insurance market other products, including individual life, commercial

property/casualty and personal property/casualty. Investment services of banks is also huge business. According to the FDIC, banks reported more than $2.4 billion in fee income from their mutual fund and annuity

business in the first three quarters of 1997 and a 46% increase from the previous

year in their sales of these products. The ABA Securities Association reported profit

margins on retail investment sales averaged 28% of revenues in 1997, up from 25%

in 1996. And the number of full-time investment representatives at the companies

continues to increase at a fairly rapid rate, indicating the continuing expansion of

this business for banks.

This expansion in sales activities by banks is not due to changes in legislation

but from a changing marketplace aided by a series of decisions of Federal banking

agencies authorizing banks to expand their insurance and investment activities.

This growth business, however, has not been accompanied by an expansion or updating of consumer protections, which has added confusion and risk for consumers.

And, banks still don’t have to comply with the full panoply of investor protection

rules that apply to registered securities brokers, including the ability to recover

losses through the securities arbitration process.

What are some of the Risks to Consumers with Money Centers and One-Stop Shopping?

Banks tout their entry into the insurance and investment world as a boon for consumers but studies and cases over the years indicate it could just as easily be a bust

for consumers who are misled about whether the products banks sell are FDIC-insured or otherwise guaranteed. They also show that banks recommend products that

are inappropriate. For example, consumers who need a steady stream of income are

recommended products that are subject to huge market fluctuations that could place

their entire investment at risk. And banks, as providers of credit, are in a powerful

position to coerce loan applicants into purchasing other products that they do not

need or want, as they have with credit insurance.

• A survey conducted for AARP and the North American Securities Administrators

Association (NASAA) in 1994 found that fewer than one in five bank customers

understood that products such as mutual funds and annuities are uninsured

and over one-third who purchased mutual funds had not spoken with anyone

at the bank about the appropriateness of the investment.

• In our March 1994 issue of Consumer Reports, we reported on the results of an

undercover investigation we conducted of 40 bank salespeople from different

parts of the country. Only 16 of the 40 salespersons contacted even bothered

to ask questions that would have indicated what products were suitable for the

investigator.

• A May 1996 study initiated by the FDIC to assess bank compliance with the

guidelines issued by the Federal bank agencies found that more than one-fourth

of the banks surveyed failed to tell on-site customers that products are not insured and 55 percent failed to inform telephone customers. Some banks even

told consumers that investment products were FDIC-insured.

• In a 1996 survey, Prophet Market Research found that one in four bank brokers

failed to follow the guidelines. For example, even though the guidelines direct

that reasonable efforts be made to obtain information about a customer’s financial status and investment objectives in order to make the appropriate recommendation, 23% of those surveyed failed to adequately complete a customer

profile before pitching a product.

What harm can come to consumers if banks mislead and deceive them about uninsured products? The oft-cited case of NationsBank/NationsSecurities provides one of
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the most glaring examples of the risks consumers face. After NationsBank shared

lists of its expiring CD holders, NationsSecurities allegedly misled the predominantly retired customers into purchasing various funds, some of which included derivatives. Consumers, who thought their principal was secure, lost money when the

values dropped. It’s not hard to understand why customers believed their investment was secure. In documents announcing some of these products ‘‘managed by

NationsBank,’’ Worthen Investments in Arkansas, for example, promised a full return on the investments and recommended it to people who want high quality with

a ‘‘government guarantee.’’ And NationsBank is not alone. Others such as First

Union were allegedly involved in similar schemes. Other examples? Justine, a 92 year old retiree whose retirement home has a bank

branch downstairs, lost about $3,700 before she was made aware that she had purchased an uninsured stock investment and her bank was selling off principal to pay

her a monthly amount. A teller urged her to get better returns on her sizable savings account balance, recommending that she meet with a bank sales representative. She purchased what turned out to be stocks based on the representative’s recommendation and her belief that the bank-backed investment would be safe and

provide sufficient earnings. She was ‘‘dumbfounded when [later her] broker told her

what they were doing,’’ which was selling off the stock to pay her monthly payments.

Rick’s mother-in-law, a Michigan resident, an elderly woman with limited English

skills, was luckier than Justine. She was referred to a bank sales agent when she

wanted to put some cash into an FDIC-insured product. Not knowing that it was

uninsured, she purchased an annuity based on the recommendation of the sales rep.

Rick cancelled the sales transaction at his mother-in-law’s request after he informed

her the bank sold her an uninsured annuity instead of an insured CD.

Why Current Laws Fail to Meet the Challenges Consumers Face in Today’s Marketplace

Although Federal bank regulators have expanded the authority of banks to conduct insurance and investment activities, including allowing the merger of Citibank

and Travelers without clear authority, and paved the way for banks to ignore state

consumer laws, they have failed to implement strong measures to help prevent the

problems consumers face.

• Lack of Enforceable Regulations Addressing Sales Practice Problems: Despite studies and cases documenting problems with bank sales, the federal banking agencies have not responded forcefully and effectively to address these problems.

The banking agencies jointly issued non-binding guidelines for retail sales of

nondeposit investment products in 1994 and the Office of the Comptroller of the

Currency (′′OCC′′) issued ′′guidance′′ to banks on their insurance sales in 1996.

But guidelines are not legally enforceable and have not been effective in preventing misleading and deceptive practices. After repeated efforts to get the

bank agencies to issue enforceable rules and a letter to the FFIEC from former

Comptroller Ludwig in January of 1998 recognizing the need to move forward

with such rules, the FFIEC was supposed to initiate a rulemaking process.

However, no action by the banking agencies has been taken to date.

Banks are Exempt from Investor Protection Rules: Under current law, banks are exempt from the definition of broker-dealer which means the investor protection

rules issued by the Securities and Exchange Commission (′′SEC′′), including the

ability to receive compensation through arbitration from unscrupulous sellers who

violate SEC rules, do not apply. Had consumers been purchasing directly from

bank employees in the NationsBank/NationsSecurities case rather than a registered broker affiliate, they would not have been able to seek recovery for violation of investor protection rules. Regardless of where consumers purchase their securities, they should have the same protections available to them.

• Lack of Privacy Protections: Current law is woefully inadequate in the area of financial privacy. Affiliates and third parties have easy access to financial information of customers—customers have virtually no control over the sharing and

selling of their information. NationsBank’s sharing of lists of expiring CD holders as well as the recent case filed by the Minnesota attorney general against

US Bancorp exemplifies the risks posed to consumers from the disclosure of

their information without their knowledge or consent.

• Tying the Hands of States to Protect their Residents—the Preemption Problem: The

OCC has run roughshod over state consumer laws, allowing national banks to

ignore important state consumer protections. Over the past few years, the OCC

has issued opinion letters telling national banks that they do not have to com12

ply with such essential protections as state lifeline banking laws that protect

consumers from price gouging on checking accounts and laws that prohibit prepayment penalties when consumers sell their homes and pay off their mortgages. And, with the passage last Congress of the ‘‘Riegle-Neal Clarification

Act’’ (H.R. 1306), state banks can ignore state consumer protection laws whenever a national bank may do so, making it even more important to rein in preemption activities. Despite repeated attempts to have the OCC reconsider its

overly broad ‘‘preemption’’ standard, the agency continues to give national

banks special treatment vis-a`-vis state laws. We believe Congress needs to step

in to preserve the traditional authority of states and ensure state laws are preempted only when they are in clear conflict with federal law.

Updating Consumer Laws: What Consumers Need to Help Ensure they Benefit from

‘‘One-Stop’’ Shopping

The bank regulators have not taken action to protect consumers. It is time for

Congress to act with strong and effective legislation. As Congress ‘‘modernizes’’ laws

through H.R. 10 to allow the various financial firms to merge and diversify, it

should also update consumer laws to make sure modernization does not become a

code word for consumer rip-offs. The need for legislation to protect consumers is urgent and clear—Congress must take the action to ensure a fair and honest marketplace. Here are some of the actions Congress can and should take:

• Enact Strong and Effective Retail Sales Protections: These include:

• Disclosure that products they sell are not FDIC-insured or guaranteed and

subject to risk of loss;

• Anti-coercion rules that prohibit a financial institution from peddling to loan

applicants uninsured products until after the loan has been made:

• Suitability requirements to make sure sales are based on consumers’ financial

needs, not solely the commissions and fees paid to the seller;

• Requirement that sales activities be conducted in an area separate from

where they take deposits and make loans and limitation on compensation for

referrals by nonqualified personnel;

• A process for consumers who lose money when banks violate these rules to

recover their losses.

While H.R. 10 includes a package of consumer protections that provide some of

the measures, it needs to be strengthened to protect against bad practices.

• Repeal Exemption of Banks from Investor Protection Rules: The outdated and unfair exemption of banks from securities laws must be repealed. The Committee’s

action on HR10 goes a long way to close this gaping loophole in the law but

we want to be sure that any bank sales are subject to the protections afforded

by securities laws as well as strong investor protection rules that take into account the unique nature of sales from a federally insured institution.

• Give Consumers Control over their Financial Data: While we commend this Committee for taking a big step forward for financial privacy in H.R. 10, more needs

to be done. Information should not be disclosed for any other purpose than for

which it is given without the prior consent of the consumer; consumers should

have meaningful notice and access to all their financial data; and consumers

should be able to hold institutions that violate their privacy accountable. We

look forward to working with the Committee to improve on its progress on privacy in its recent consideration of H.R. 10.

• Preserve the Authority of States to Protect their Residents: The continuing wave

of preemption of state consumer laws must be stopped. Congress should restate

the authority of states to regulate businesses operating within their borders, including national banks, and allow states to protect their residents. While H.R.

10 presents an opportunity to preserve and clarify state authority, broad preemption standards in the bill not only tie the hands of states to enact consumers laws in the area of insurance but also for other activities of banks such

as deposit taking or lending laws, e.g., ATM surcharge laws, check cashing or

predatory lending laws. We believe the OCC and other agencies will be given

broader, not narrower, authority under H.R. 10 to let banks ignore state consumer laws.

• Improved Disclosure of Costs and Fees: To help promote comparison shopping and

competition, it is essential that consumers know and understand the costs of

the products they are considering. The Committee’s version of H.R. 10 bill includes a provision requiring all financial services regulatory agencies to prescribe or revise rules to improve disclosure of fees, commissions and other costs

of financial products.
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Conclusion

Consumers have not fared well in the changing financial services marketplace

that federal regulators have helped create. Congress needs to step in and demonstrate a commitment to the public, not just the special, interest. While H.R. 10

provides some of the protections consumers need, it has a ways to go to ensure a

competitive, fair and honest marketplace for consumers. We look forward to working

with you to enact legislation that meets the needs of consumers, not just the financial industries vying for greater access to consumers’ pocketbooks.

Mr. UPTON. Thank you, Mrs. Griffin.

Mr. Alpert.

TESTIMONY OF JONATHAN L. ALPERT

Mr. ALPERT. Mr. Chairman, members of the subcommittee, I appreciate the invitation to be here today. I’m Jonathan Alpert from

Tampa, Florida; and I am speaking, I hope, to the best possible on

behalf of my clients, the little people, the average American, that

is the target of and the recipient of both the laws and the activities

of this Congress and of the banks.

There are serious privacy concerns that the folks have. In my

written testimony, we discuss how NationsBank secretly pirated

customer information and turned it over to its brokers allowing

brokers to access the master customer information file; how First

Union had scripts for their bankers to use to call people up and say

I am calling from the branch of First Union, and, of course, the customer’s first reaction was is there something wrong with my account?

And then the banker or broker would go on to say, I am calling

because we notice your CD is about to mature and we’re working

late tonight. Yes, they were working late tonight on blitz nights

and boiler room nights where they were engaged in activities more

characteristic of a penny operated stock boiler room than a national

bank.

NationsBank, now Bank of America, as an invasion of the body

snatchers kind of thing, where it takes over the mantle of a respected bank, used its customers to enrich the bank and the brokerage. I made an investment of $56,000 and lost $20,000 in the

NationsBank here in my neighborhood. I bought the investment in

the bank building thinking it was federally insured. I wasn’t told

all the facts that I might lose. Larry, my husband, passed away.

I went to the bank to try to get a proper investment, and I found

now that my 130,000 investment has lost 11 percent. I now find

that there is an early withdrawal penalty.

I went to the NationsBank, I specifically explained to him that

I was a recent widower, and I was interested in depositing my

money in a plan that would have absolutely no risk. I have lost my

money. When I arrived in Florida, I asked the bank teller to refer

me to someone who could tell me where I could put my money to

draw monthly interest. She referred me to a man with the bank

in charge of investments. I told him I would like to put my money

in a savings account or a CD. I am 62 years old and retired. And

all the money I had was the $50,000 that the man took away from

me.

In May 1993, my certificate of deposit at NationsBank was maturing, to quote Mr. Schultz, the only way that I would lose money
14

would be for the U.S. Government to collapse; of course, every bank

would be gone, too. This is what the bankers are telling their customers: invest in our risky securities, and the only way you would lose money is if

all the banks collapse. NationsBank, here are three cards, one is

from a banker, one is from a broker, and one is from a mutual

fund. You can’t tell the difference. The same thing with First

Union, one is from a banker, one is from a broker. You cannot tell

the difference.

The banks have engaged in a practice of deceptively mining their customers’ accounts. They have done it with the blessing and encouragement of the banking regulators who at every opportunity,

rather than protecting the customer, protecting the American people, have turned a silent stony face to the customers, to the American people, and to this Congress, because, gentlemen, GlassSteagall has been repealed, not by Congress, but by the OCC. And when we turn to the OCC and ask the OCC for help, the

OCC, instead of helping the American people, says this information

is confidential, so you have the Department of Treasury hiding information on deception and deceit from the American people, while

the Department of Energy is dumping nuclear secrets on the red

Chinese. This is not right.

Thank you.

[The prepared statement of Jonathan L. Alpert follows:]

PREPARED STATEMENT OF JONATHAN L. ALPERT, SENIOR PARTNER, ALPERT, BARKER

& RODEMS, P.A.

INTRODUCTION

Mr. Chairman and Members of the Subcommittee, my name is Jonathan Alpert.

I am a lawyer from Tampa, Florida. Our law firm, Alpert, Barker & Rodems, represents injured investors, consumers, and elderly and retired people. Twenty years

ago, I was a Florida Judge of Industrial Claims and I have been on a Florida Bar

Grievance Committee, as well as an Associate Professor of Law at Stetson University College of Law in St. Petersburg, Florida. I have written seven books on Florida

law and articles in publications ranging from the American Bar Association Journal

to the Journal of Legal History to Harvest Years, a magazine for retirees.

Our firm has represented elderly investors and brokers in cases against some of

the largest and most powerful banks and brokerages, including Bank of America

(formerly known as NationsBank), First Union, Amsouth, Barnett Bank (Florida’s

largest bank until it was acquired by NationsBank at the end of 1997), Smith Barney, Dean Witter, Raymond James, MetLife, and PaineWebber, among others.

The problems with the national banks were brought to our attention in mid-1994

when customers and brokers began telling us stories which, frankly, at first we did

not believe. A NationsBank customer, Leilani DeMint, for example, was sold a risky

government bond fund, even though she thought she was purchasing series EE

bonds. Ms. DeMint, a retired toll taker, had her entire life savings put at risk. Another NationsBank customer, Max Wells, who has bought securities in the past and

who is a retired Air Force policeman, was sold a mutual fund when he thought he

was investing in a CD. Other elderly and retired bank customers who came to us

reported that, unknown to them, their life savings were put into risky mutual funds

when all they wanted were certificates of deposit.

In August of 1994, when we first began bringing these problems to public attention, we had a meeting in our office with various bank securities regulators. We

were told then that ‘‘Congress does not care if elderly people are being swindled in

bank lobbies.’’ This hearing today says that Congress does care.

PROFITABLE (FOR THE BANKS) RISKY BUSINESS

In the early 1990’s, the banks began to develop and market brokerage services.

Characteristic of these retail securities activities were sales activities in bank lobbies by tellers and customer service representatives and by brokers disguised as
15

bankers. Often those activities took place in unlicensed facilities so that the risky

business was for a time concealed from both the regulators and the customers.

Banks did this for one reason . . . profit. The profitability of bank brokerage operations is illustrated by an internal First Union 1993 comparison between the profit

from a one year $10,000.00 CD and a mutual fund sale of $10,000.00. According to

the comparison, the CD yields pre-tax income of only $11.53; the mutual fund yields

pre-tax income of $313.54, which is, of course, fee income to the bank—almost thirty

times the CD income in one year. [Attachment 45]

CUSTOMERS ARE TARGETED

Customers were targeted by the banks and their brokerage affiliates and subsidiaries. Illustrative of this is the April 14, 1994 Marketing Bulletin [Attachment 1]

to the employees of NationsBank which advised the employees that, in obtaining information from customers, they should tell customers that only their banker would

have access to their personal account. When asked, bankers were instructed by the

Bulletin to say ‘‘No, only your banker can access your account.’’ [Attachment 2] Despite this, on August 17, 1994, NationsSecurities, the brokerage operating subsidiary of NationsBank, sent to one of our clients a letter in response to our client’s

complaint at having his private banking information shared with a broker: ‘‘It is our

understanding, however, that the agreement covering your relationship with the

bank authorizes it to share such information with its affiliates, including

NationsSecurities.’’ [Attachment 3]

Similarly, First Union targeted its bank customers for the sale of risky investment

products. First Union’s computer system was designed to provide ‘‘Automated Prospects Functions’’ identifying ‘‘current users of First Union services who have been

recognized, based on several criteria, as candidates for additional services.’’ [Attachment 4] In addition, there was a ‘‘Personal Prospects Function’’ which advised the

First Union teller to share with the First Union broker the fact that a customer had

deposited checks drawn on a Merrill Lynch asset management account. [Attachment

5]

Blurring the line between the bank and the brokerage, First Union advised its

bankers and brokers to send out a form letter which said in part, ‘‘First Union investment specialists have an objective view . . . Our knowledgeable investment specialists look out for your best interest because they represent First Union and our

broad range of services.’’ [Attachment 6] Nowhere is it disclosed that there is a big

difference between a bank product and a securities product; one involves significant

risk and the other involves government guarantees of safety and soundness.

First Union, as did NationsBank, had ‘‘Nonlicensed Employee Calling’’ scripts [Attachment 7] which establish that First Union knew both that its customers thought

it was the bank calling and that it was pirating secret account information:

BANKER: Good evening. I’m ————— from the ————— branch of First

Union. Do you have a minute to talk?

CUSTOMER: Is there anything wrong with my account?

BANKER: No, not at all. It’s just that some of us are staying late tonight to

review the relationships of our most important customers. As I studied your accounts with us, I noticed that you have a CD scheduled to mature on [date]. . . ’’

[Attachment 7]

The script goes on to compare investment products with bank products. It technically, but not meaningfully, reveals the non-existence of FDIC insurance for investments. First Union targeted its customers in these types of scripts. NationsBank

also targeted its bank customers for risky securities, secretly disclosing private data

to its stockbrokers. [Attachment 11 (a)&(b)]

CUSTOMER CONFUSION

First Union National Bank blurred the differences between government guaranteed or backed bank products and securities. Illustrative of this is a letter to one

of our clients on January 25, 1993, on the stationary of First Union National Bank.

The letter discusses a government agency guaranteed security which, although

guaranteed against default, has no guarantees as to interest rate risk, market risk

or other risks. [Attachment 8]

First Union trained its brokers to make sure not to set up two brokerage accounts

because some of its customers did not even know they had one [Attachment 12]; to

conceal the risk of loss by not answering ‘‘Yes,’’ to the question, ‘‘Can I lose money

in this?’’. A training video which we obtained states, ‘‘You didn’t say yes, you could

lose money. What I don’t want you to say is [yes, you could lose money.] Negative.

You don’t want to be negative.’’ [Attachment 15-16]
16

First Union bankers and brokers were also trained to encourage unsophisticated customers to buy a mutual fund, even if they were risk averse. Brokers were to tell

them, ‘‘and what is important is you are buying them through the bank and look

at the return, 12%.’’ [Attachment 17] The brokers and bankers were trained to make

these representations to their typically elderly and unsophisticated customers. [Attachments 18-20]

Interestingly, both First Union and NationsBank also engaged in what amounted to money laundering, a practice more characteristic of racketeering than banking.

Because of securities prohibitions against paying commissions to unlicensed persons,

the bank brokerages split commissions with the bank and the bank then split the

commissions with its unlicensed banking personnel. The First Union training tape

reveals this: ‘‘Because the capital management group is pooling the money and passing the money [to the bank], the bank is distributing it.’’ [Attachments 21-23] Therefore, both of these banks and presumably others were able to evade the securities

licensing requirements of state and federal securities regulators.

CUSTOMERS SUFFER SEVERE LOSSES

Customers suffered severe losses as a result of these activities. Both First Union

and NationsBank had telemarketing drives, such as the First Union Blitz Night,

which more resembled penny stock boiler rooms than the appropriate activities of

national banks. The July 19, 1994 First Union Blitz Night referred to ‘‘unimaginable

wealth’’ and ‘‘fabulous prizes.’’ [Attachment 24] This wealth and prizes, of course,

were for the bankers and brokers, not for the elderly and unsophisticated customers

of First Union. In point of fact, customer losses became so spectacular that well over

one thousand (1000) customers in just Florida and Texas alone wrote to

NationsBank complaining of the losses. Just one letter, dated March 13, 1995, from

one customer summarizes what happened, ‘‘I made an investment of $56,000.00 and

lost $20,500.00 in the NationsBank here in my neighborhood. I bought the investment in the bank building thinking that it was federally insured. I wasn’t told all

the facts, that I might lose. The stock market should be left to the stockbrokers and

the banking should be left to the banks. What is the procedure? Can you do anything for me?’’ [Attachment 25]

Even though letters like these had been pouring into NationsBank for well over

a year, in June of 1994, NationsBank, in promoting one of its risky mutual funds,

included the language ‘‘I’ve worked my whole life for this money and I can’t afford

to risk it now.’’ [Attachment 26] The return card was addressed, not to the brokerage, not to the mutual fund, but to NationsBank itself in Charlotte, North Carolina.

[Attachment 27] People thought they were dealing with the bank, as they

were . . . until the losses started.

First Union also blurred its brokerage services with banking as is illustrated by

its brochures advertising both bank and brokerage services. [Attachment 28]

THE OCC DROPS THE BALL

One of our clients, Leilani DeMint, turned first to the OCC for help. NationsBank

had sold a risky mutual fund to Leilani, who thought she was purchasing Series

EE savings bonds. The OCC wrote to her that it could not be of any assistance because it understood that there was a lawsuit against NationsBank and, because of

the lawsuit, the OCC would not become involved. The OCC stated in its letter of

November 11, 1994 to Leilani DeMint, ‘‘This office contacted the bank and was advised that NBS previously responded to your concerns. NBS affirmed its position regarding this matter as stated in its letter to you dated March 11, 1994 . . .The office

has been advised that this matter is the subject of litigation pending in U.S. District

Court in Tampa, Florida. Accordingly, the office can provide no further assistance

in this matter.’’ [Attachment 29]

This is not the only instance of the OCC washing its hands. Barnett Bank, then

Florida’s largest bank, was purchased by NationsBank at the end of 1997. Therefore, by mid 1998, Barnett Bank no longer existed. Barnett Bank had sold securities

from unlicensed offices [Attachment 30] using marketing scripts [Attachment 31]

and disguising the risk of loss. [Attachment 29] On April 8, 1998, we wrote to the

OCC requesting certain examination reports and a letter which the OCC had previously sent to the President of Barnett Banks. [Attachments 32-39] On April 10,

1998, the OCC responded, requesting that we return confidential information which

we had received, which we believed might establish Barnett Bank’s illicit activities.

[Attachment 41] Then, the OCC processed our request for information, and, as

might be expected, on June 3, 1998, denied it. [Attachments 42-43]

As mentioned, Barnett Bank did not exist in 1998 and, therefore, there were no

safety or soundness concerns that might justify withholding the information we re17

quested. As a result of the OCC’s refusal to even minimally cooperate, we were hampered in obtaining the evidence to establish the full extent and scope of Barnett’s

noncompliance with both state and federal law.

The OCC stated to Ms. DeMint her remedy was private litigation. Yet it refused

to provide even the most basic assistance through the production of documents in

private litigation involving the Barnett lawsuit. The OCC refused both to take regulatory action and also tried to frustrate private legal action to redress Barnett’s

wrongs. The reaction of the OCC to the request regarding Barnett Bank should be

placed in context: The Comptroller of the Currency is documented to have exchanged 24 phone calls and 27 faxes and letters in the 7 month period between May

14, 1996 and January 13, 1997 with the Chairman of Barnett Bank. [Attachment

44] This raises serious questions.

Unfortunately, the OCC has never taken any action against Barnett Bank; has

never taken any action against First Union; has taken only reluctant and minimal

action against NationsBank, now Bank of America; and, has never taken any action

against even Amsouth Bank, even though state (primarily Florida) or federal security regulators, including the NASD, have taken action against the brokerage subsidiaries of all of these banks. It is our understanding that the OCC has actively

blocked or resisted the actions of securities regulators who have tried to protect the

American people from the predatory activities which we have described. I had the

personal experience of objecting to a bank regulator about the inordinate profits

which the banks were making from their improper securities activities and being

told that some in the banking regulatory community would be in favor of such profits, even though illicit, because, after all, it would positively impact the balance

sheet of the banks.

CONCLUSION

Given the opportunities for abuse, such as the accompanying copies of the advertisements for the NationsBank Tax Deductible Smart Loan [Attachment 46] and the

NationsBank Tax Relief Municipal Bond Fund [Attachment 47], the banks continue

to exploit the government subsidized bank franchise. Whether that exploitation is

a good or bad thing on a macro-economic level is for this Committee and this Congress to determine.

I would point out in closing that, although we believe that bank-brokerage practices have become more sophisticated, the current prosperity has papered over many

of the continuing improper practices. We are told, for example, that customers in

First Union still do not understand that their cap account or money market account

is an uninsured mutual fund, not an FDIC insured depository account. Many

NationsBank supervisors, who were involved in earlier illicit activities, continue to

occupy high positions in the financial services industry, even though NationsBank

has paid $60,000,000.00 (sixty million dollars) in compensation as a result of our

work.

Financial modernization should include meaningful regulatory protection so as to

preserve the independence of the state securities, insurance, and banking regulators

in the interest of federalism. Also, the functional independence of the federal and

state banking and securities regulators should be maintained. Securities functions

belong in holding company affiliates so that they may be properly regulated by securities regulators with protections for both safety and soundness and customers.

A final note: We are unable to share with the Committee some of the worst examples of bank misconduct because of confidentiality orders, legal requirements, and

OCC legal interpretations.
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Mr. UPTON. That’s next week’s hearing.

Mr. Green, would you like to make an opening statement?

Mr. GREEN. No, Mr. Chairman. I’m just surprised that this information is 5 years old and not that the boiler room effect wasn’t

wrong and the penalty may have been too low and my staff suggested maybe from now on we put a scarlet A on the brokers’ business cards. But anyway, I’m anxious to hear and also from other

questions, but I have one question I would like to ask. And I will

do it in my time.

Mr. UPTON. Okay. I would like to note that all members will

have a chance to make a part of their opening statement as part

of the record.

Mrs. Crawford, when the State of Texas has realized that there

are some problems with some of the relationships that are out

there, has there been a pattern or a history of checking with the

OCC to see if they might be helpful as you pursue your own State

regulatory issues within the State when you’ve identified some type

of problem?

Ms. CRAWFORD. Mr. Chairman, as a matter of course, our investigators in the enforcement division of the Texas State Securities

Board always make attempts to contact the banking regulators. In

the case of Nations Securities, that was done. No assistance was

forthcoming in that case.

Mr. UPTON. It sounds a little troubling. Was it made—did you

get a flat no? Did the request just come unanswered?

Ms. CRAWFORD. I would say, Mr. Chairman, that the Office of the

Comptroller of the Currency was unresponsive.

Mr. UPTON. You can’t help us a little more than that?

Ms. CRAWFORD. Well, it basically boiled down to our notifying

that office of the problems, requesting any assistance that they

might provide and then not receiving any assistance in return.

Mr. UPTON. Now, as you might deal with associates from other

States, Michigan in my case, California and other States, is there

some national meetings where that view is also prevalent and, in

fact, they were not helpful in other cases?

Ms. CRAWFORD. Yes, yes, Mr. Chairman. That has been the talk,

if you will, among State securities regulators. And I want to very

quickly disabuse this committee of the notion that there are no continuing problems. That is absolutely untrue. State securities regulators are actively investigating bank securities activities. There

are ongoing enforcement efforts being made. It just so happens that

this particular case has so many elements to it that it makes for

a good example.

Mr. UPTON. Mr. Alpert, you checked off a number of cases. How

did you get access to information like that? Did they come to you

for help?

Mr. ALPERT. Brokers and customers came to me for help. And

what’s interesting is that when we got—and sometimes we got

unanimously people who felt upset. We got an anonymous batch of

documents in the mail about Barnett Bank which was Florida’s

largest bank, and included in those documents was a letter from

the OCC to the chairman of Barnett Banks, which was highly critical. We were not authorized by law to have that letter, so we advised the OCC that we had it.
67

We also asked the OCC for information on Barnett Bank, and

this is in 1998 when Barnett Bank had ceased to exist. And, therefore, there were no safety or soundness concerns. And the OCC, I

would point out in its handbook in section 413, has a supervisory

responsibility of all bank-related activities.

So we asked the OCC if we could have this letter to help some

elderly consumers in a private action and although the OCC in

1995 had told one of our clients that she could not—that the OCC

would not be of any assistance and would do nothing because it

was private litigation, in 1998, the OCC blocked our efforts to obtain information in private litigation.

So it’s almost like, if you will pardon the expression, you’re

dammed if you do and dammed if you don’t. And as a private lawyer trying to get assistance for people, it’s much more difficult for

me to get information than it is for the OCC, which is in there with

examinations.

There is presently ongoing Federal criminal investigations. And

I am obviously not privy to the interworkings of the United States

Attorney’s office, but once again I seriously question whether there

is the cooperation with the United States Attorney and the Department of Justice by the OCC, because that information is being hidden from the American people, and that’s the concern.

Mr. UPTON. Thank you.

Mr. Green.

Mr. GREEN. Thank you, Mr. Chairman. And I would like to ask

each of the witnesses clearly there are massive problems with

NationsBank and Nations Security, and the line between banking

and selling securities was blurred during the early 1980’s. Many

people, in fact, lost a great deal of money because of the deceptive

practices. I see the SEC fined $4 million, securities 2 million, OCC

the 750,000, and the private class-action suits resulted in a—I

guess, judgments of $40 million.

Nevertheless, here we are in 1999. I would like to know what

evidence do we have that shows is there still a continuing problem

with Nations Securities, or NationsBank. If it’s still continuing, can

witnesses point to specific banks, not just Nations but other banks,

and describe the activities which you believe to be the problem?

And if they are continuing, what could this committee do to address this problem, investigations, legislations that you would

make suggestions on.

Ms. CRAWFORD. Congressman Green, as I indicated before, I

think it’s very important for members of the committee to understand and appreciate that the Nations Securities case was not an

isolated incident and that there are ongoing investigations.

Mr. GREEN. Ongoing investigations relating to banks—and I

know there are investigations of SEC and the State agencies on securities issues. But in relation to banks?

Ms. CRAWFORD. In relation to banks. And as a matter of fact, in

the State of Texas, banks are not exempt from being registered as

dealers, so my own office periodically does send teams of examiners

out to banks.

Now, we are uncovering problems. One of the things that happens when you’re a regulator is if you have to make hard decisions

about the utilization of resources. As it so happens, I have been the
68

designated spokesperson for a number of years on financial services

modernization. I have been extremely hopeful, and I communicated

these hopes to my colleagues along the lines of at some point Congress is going to act and take care of some of these problems.

A lot of things have been on hold, frankly, both from the regulator’s side and from the regulated. I believe that banks in many

instances are doing everything in their power to make sure that investors who are bank customers do not complain to regulators.

They are hoping that Congress will not act, that Congress will not

address the problems created by financial services modernization

realities, and that if they can stay out of the press, and if they can

keep these actions from being taken against them, then eventually

they will be okay.

Legislation will protect them, because the banks would really

like to see the banking regulators in charge. They see what’s happening with the OCC and its continuous deregulation that isn’t

even subject to public scrutiny or public comment. And they’re very

hopeful that at the end of the day that process will prevail.

So I guess, Mr. Green, this is a long-winded way of saying that

we’re all on hold; we’ve got actions ready to go. The banks are trying their very best to keep these things from percolating to the attention of the public.

Mr. GREEN. Okay. Miss Griffin.

Mrs. GRIFFIN. Well, in terms of NationsBank specifically, I can’t

speak to anything I’ve heard recently about their specific practices.

I can tell you in the area of privacy, I walked into the NationsBank

last week and asked them for a financial privacy—I asked a manager for their financial privacy policy. Ane he said I don’t know

what you’re talking about, what’s a privacy policy. So you know it’s

how you share information or what you do with the information.

And he said well, we don’t have a privacy policy, but I can tell

you we don’t share information with anyone. I advised him that he

might want to go on-line and look at their Web site to look at their

privacy policy, which does, you know, show that they do share information.

Mr. GREEN. That’s a subject of an amendment that our committee talked about for a long time. I understand.

Mrs. GRIFFIN. Which we appreciate very much and are fully support of and hope the Rules Committee allows it to go forward next

week. But in terms of other—I mean the NationsBank case has

been one case cited. In addition of that, the studies have shown

over the years every time there’s been studies about this, including

FDIC’s own study, that banks are not informing people about the

risk. They are misleading people, in some cases. They even told

people that the products were insured.

And one of the things to highlight about the NationsBank case

is, you were talking about a securities—a registered securities

broker there, and you do have securities regulators, you do have

the investor protection rules there, but banks—if those people were

purchasing directly from bank employees, there’s no investor protection rules that apply. The banks are exempt from those investor

protection rules when they sell directly. And that’s one area where

we really would like to see some changes. And this committee’s
69

version of H.R. 10 goes a long way to close what we think is a huge

loophole in the law.

Mr. GREEN. Mr. Chairman, and not—I know my time is up, but

if somewhere in the other questioning if they could address whether H.R. 10, I know out of this committee, but compare the Banking

Committee’s H.R. 10 as relationship to the SEC still having regulation over securities that even though the OCC may have jurisdiction also, and did H.R. 10—I know our committee didn’t, but as it

came out of the Banking Committee, did it take away regulation

authority over securities in banks from the SEC?

Mrs. GRIFFIN. Well, the banking committee—the exceptions contained in the Banking Committee’s version of H.R. 10 are much

broader and don’t close that loophole. The Commerce Committee’s

version goes much further in terms of making sure that most bank

security activities come under the protections of the securities laws.

But the Banking Committee did not—there are still huge loopholes

in their version, and I’m not sure about their new version.

Mr. GREEN. Thank you very much for your patience.

Mr. UPTON. I would like to add an editorial comment. It’s my understanding that the Rules Committee—Chairman Drier made an

announcement on the floor earlier today about going to Rules and

having that bill on the floor, and it appears as though the Banking

Committee’s version will be part of the base bill that we will consider.

And I know that an amendment is being drafted to bring the

Commerce Committee’s version of this to the floor, and that’s one

of the reasons why we thought we would have the hearing today.

Mr. GREEN. I would hope the Rules Committee will make that

option an order.

Mr. UPTON. I think they will allow that amendment, I hope.

Mr. Burr.

Mr. BURR. Thank you, Mr. Chairman.

Ms. Griffin, let me just show you the documents I’ve got since I

was—they accommodated me better than they did your request.

This is a disclosure statement for NationsBank, application for brokerage account application. I will just point to you above the signatures it says not FDIC insured, may lose value, no bank guarantee.

It doesn’t get to the privacy issue.

Every one of their documents about their products very clearly

stated on the front page in the left bottom says ‘‘not FDIC insured,

may lose value, no bank guarantee.’’

Mrs. GRIFFIN. We wouldn’t dispute the fact that on those disclosures they’ve made progress, definitely.

Mr. BURR. My question would be is that prominently displayed

enough with the suggestion that it is not insured, that a person

might lose money and that the bank does not guarantee it? Does

that meet what you think is sufficient?

Mrs. GRIFFIN. I would say that being a NationsBank’s customer

and receiving a lot of mail from NationsBank and going in there

a lot, a number of those disclosures, yes, are prominent and they’re

very bold. Some however are not. So I cannot say across the board

we’ve given them a high mark. But they’ve definitely improved in

terms of their disclosure about the risk in some areas.
70

Mr. BURR. Ms. Crawford, in the issue that you were talking

about, where you had—you sought the OCC’s help on a securities

issue, was the SEC involved in that investigation?

Ms. CRAWFORD. No, sir, the SEC was not involved at that time.

Mr. BURR. It was a securities issue though, wasn’t it?

Ms. CRAWFORD. It was a securities issue, yes.

Mr. BURR. Would it have been the primary jurisdiction of the

SEC or the OCC there, if you know?

Ms. CRAWFORD. Actually, we have primary jurisdiction, the

Texas State Securities did.

Mr. BURR. Texas State?

Ms. CRAWFORD. Yes, because there were transactions occurring

within our State. Now, the SEC would have also had jurisdiction

over that. But as these matters tend to work out, the local regulator more often than not gets evidence of problems through investor complaints or—as one example of the way that we get that information and will take action first. The SEC, as you know, did

take action against NationsBank last year, and it was exactly the

same case that we brought in Texas.

Mr. BURR. So most of the preliminary investigation would be the

role of the Texas——

Ms. CRAWFORD. In this particular instance, that turned out to be

the case, but it does vary.

Mr. BURR. Mr. Alpert, let me ask you, I looked at your resume.

You have quite a remarkable history of not only cases, but books

published and speeches given on various subjects. You read a number of letters.

Did all of those letters come to you unsolicited?

Mr. ALPERT. Yes, they came unsolicited. There are also a thousand more letters that are hidden because we can’t look at them

under confidentiality orders.

Mr. BURR. How did they know about you? Did they read something like this, that said he’s an expert?

Mr. ALPERT. A lot of them—no, a lot of them came to us—they

sent us old letters that they had sent after they heard about us.

These are letters typically not addressed to us, but addressed to,

quite often to, regulators. The problems of this, by the way, are

continuing.

Mr. BURR. Have you had an opportunity to look at NationsBank

disclosure forms lately?

Mr. ALPERT. Yes.

Mr. BURR. Do you believe they are sufficient now?

Mr. ALPERT. I believe them entirely inadequate, because it is a

positional and situational fraud.

Mr. BURR. Are you currently in litigation with any banks over

disclosure issues?

Mr. ALPERT. No, sir.

Mr. BURR. Have you settled all of the cases that you had, all of

the class actions?

Mr. ALPERT. Yes and no. Most of them were not out—class actions because of the difficulty of establishing class actions and the

impediments to consumers that have been created.

Mr. BURR. But you did have a class action, didn’t you?

Mr. ALPERT. Oh, yes.
71

Mr. BURR. How many people were a party to that class-action

suit?

Mr. ALPERT. There are probably in the thousands.

Mr. BURR. And that’s been settled, hasn’t it?

Mr. ALPERT. That has been resolved.

Mr. BURR. Was it settled sufficiently for your clients?

Mr. ALPERT. It was settled as good as we could get for our clients.

Mr. BURR. How much did you make off of it?

Mr. ALPERT. Well, the total class action—I think everyone is interested in lawyers—the total class action settlements were $60

million.

Mr. BURR. How much of that did you get?

Mr. ALPERT. I wish I could say I got 30 percent, which would

have been $18 million or 20 percent which would have been $10

million or 10 percent which would have been $6 million. After you

consider the costs and expenses that we’ve expended, we’ve gotten

less than 2 percent, probably less than 1 percent, because litigation

with the banks you need to understand, they want to drive their

opponents into the dirt, and everything is harder and harder to litigate, because of that, and they make litigation as difficult and as

expensive as possible, because they don’t want to continue to litigate as an example. Case in——

Mr. BURR. I’m not sure whether you made $600,000 or $1.2 million, what did you make?

Mr. ALPERT. I’m not sure either, because of the expenses were

enormous in these cases, and it was—and the problem, for example, in the Barnett Bank case where they have a statutory obligation was not a class action, they’re still litigating and resisting,

paying us for our work, because if you can get rid of the lawyers,

you can—the consumers are as helpless as turtles on their back.

The purpose here is to get rid of the lawyers and everyone, of

course, is of the view that, well, lawyers somehow shouldn’t be

paid, where bankers make $4 or $5 or $10 million a year.

Mr. BURR. I serve with a bunch of lawyers up here, which I am

not, and never have wished to be one, quite honestly.

Mr. ALPERT. I commend you for that, Congressman.

Mr. BURR. I know what thats like.

Mr. ALPERT. I commend you for that, Congressman.

Mr. BURR. Let me ask you—with the Chairman’s indulgence, I

would ask unanimous consent for 2 additional minutes. You said

in your testimony—I want to be accurate—that the scripts that you

referred to by First Union were technically right, but not meaningfully revealing of nonexistence of FDIC insurance.

What do you mean? What’s technically right, but not meaningful?

Mr. ALPERT. Technically right is exactly what you have in your

hand of these so-called disclosures. You give a disclosure like that

to somebody in a bank lobby on a bank platform by a person

who——

Mr. BURR. So these are not sufficient to you?

Mr. ALPERT. As I said to you earlier, in my view, those are not

sufficient, because of the positional and situational confusion that

is created. These people are being told and they’re being told that
72

today, they’re being told that a mile from this capitol building that

they are safe because they are purchasing these things in the bank.

Mr. BURR. Mr. Alpert, according to the Florida Times Union, by

your own accounts you said you’ve sued every big bank in Florida.

Is that an accurate portrayal? Have you sued them?

Mr. ALPERT. I sued First Union, NationsBank, Barnett Bank,

and AMSouth. I believe they were the largest banks in Florida at

the time.

Mr. BURR. And you said that you had sued them for alleged technical infractions. What is a technical infraction?

Mr. ALPERT. Well, the technical infractions are where they do not

disclose there is a security.

Mr. BURR. But is this a technical infraction that you just referred

to? You said it was technically right, but it was meaningfully

wrong?

Mr. ALPERT. No, that is not a technical infraction.

Mr. BURR. What’s a technical infraction?

Mr. ALPERT. A technical infraction—a good example of a technical infraction would be where they call up and say, I am calling

you from the First Union branch and they are not disclosing that

they’re calling from a brokerage. That’s a technical infraction.

Mr. BURR. Even if they did do all the disclosure information

within that script?

Mr. ALPERT. Not necessarily. It depends how they do it and when

they do and where it’s being done. And the problem that you have,

Congressman, is that you—these people rely on the safety and

soundness of the bank that we have encouraged by government

subsidies, saying that we are going to protect our financial system,

and the people feel safe in a national bank, so you take that aura

of safety, that aura of trust and you utilize it, and it’s essentially,

Congressman, like dollars flowing from your pocket, because

they’re your tax dollars just like they’re mine into the hands of the

national banks, to use in selling securities.

If we’re going to have a level playing field, let’s let Smith Barney,

Merrill Lynch, Paine Webber have the same government subsidies

of safety and soundness and trust so they can sell garbage to their

customers too.

Mr. BURR. What’s the status of your class-action suit against

Humana?

Mr. ALPERT. That was certified at the trial level. It was decertified at the second district court of appeal, and it is presently on discriminatory review in the Florida Supreme Court.

Mr. BURR. Have you ever sued the Federal Government?

Mr. ALPERT. Have I ever sued the Federal Government?

Mr. BURR. I was just curious.

Mr. ALPERT. I can’t think of any occasion when I have. I don’t

know any instance where the Federal Government has defrauded

anyone or has injured someone in their medical care.

Mr. BURR. I thank you, and I would yield back. Mr. Chairman.

Mr. ALPERT. If the Federal Government did, it shouldn’t.

Mr. BURR. I feel confident you would.

Mr. ALPERT. I would hope so. There’s an old saying in the law,

by the way, Congressman. It’s from common law that although

some live in the meanest hut in the kingdom and although the door
73

be off the hinges and although the wind goes through the windows,

the king Of England may not enter. And the point of this is that

the law protects the people.

And if we don’t protect the American people, we are sowing the

seeds of our own destruction. Years ago, this committee under the

chairmanship of Congressman Dingell did its best to protect the

people with—this committee has a continuing obligation to do that

as does this Congress.

Mr. BURR. And I assure you, Mr. Alpert, it’s the intent of this

subcommittee, full committee and Congress, to assure that we protect the individuals in this country. We also have a balance, I will

remind you, in policy to protect the rights of businesses, to set

structures that they follow that are understandable, that don’t

move, that are not reinterpreted different than what the congressional meaning was; and hopefully if we do our job right, it’s not

something that’s left up to you or to courts for the interpretation.

It’s in fact to live to the letter of the law of what the congressional

legislation says. We’re here today——

Mr. ALPERT. I couldn’t agree with you more.

Mr. BURR. It’s my time now. We’re today trying to determine

what that balance is, and I think given the fact that the Commerce

Committee addressed it in a different way than Banking, we see

the process at work hopefully for Ms. Griffin and her concerns, Ms.

Crawford and her concerns. We will address this in a way that the

comfort level is higher at the end than it was at the beginning.

To some degree, I resent the fact that banks aren’t here to defend themselves. To some degree I resent the fact that you’re here

and some of the analogies that have been made about issues that

had been resolved, issues that apparently guilt was admitted, or at

least restitution was made and that we would use those examples

to drive policy that is not necessarily the policy of today is, in fact,

misleading to Congress.

Now, it was the decision of this committee to follow this path. I

will follow it, but I will also make sure that we delineate the difference between the past, the present, and the future. And I’m

hopeful we will all be together in the future. And I yield back.

Mr. ALPERT. Congressman, I couldn’t agree with you more. At

the present, the same activities are continuing. They have what are

called ‘‘dual employees.’’

Mr. BURR. Mr. Alpert, I would have suggested that the information that you showed us was not letters from 4 years ago, but the

documents today that don’t meet the technical but—don’t meet the

meaningful, but meet the technical meanings.

Mr. ALPERT. The problem is in 4 years I will be showing you

what’s happening today, because I can assure you, Congressman,

that the NationsBank/Bank America, First Union, and the other

banks don’t come to me and say by the way Mr. Alpert, last week

we defrauded another 10,000 customers. There is a lapse and it

takes a bit of time. It is still going on. And it is still occurring.

Regarding your point on the law and the obligation of Congress,

there’s been some discussion of the 10 commandments, and in some

ways I think maybe if we could just have the 10 Commandments

as a sole statute and wipe out all the other laws, we would cover

everything, because people would ask me when I got started doing
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this, well, what laws did the banks violate, and I was just learning

them; and I said, well, I said, there are two that occur to me right

off the bat. One is thou shalt not steal and the second one is honor

thy father and thy mother.

And those are two of the 10 commandments; and perhaps if we

all honored the 10 commandments, we wouldn’t need lawyers. We

wouldn’t even need bankers, and maybe we wouldn’t need to be in

congressional session.

Mr. BURR. I think that is truly heaven you have just described.

Mr. ALPERT. Thank you, sir.

Mr. UPTON. I would note that the gentleman’s additional 2 minutes is now expired. The gentleman from Kentucky, Mr. Whitfield.

Mr. WHITFIELD. I’m sorry I came in a little late. This seems like

a pretty interesting hearing. Mr. Alpert, what—I am sure that in

your testimony, maybe you did cover this, and it is lengthy, so I

haven’t had the opportunity to review it, but what actually—what

was the total amount of money that was recovered by the victims

of this episode?

Mr. ALPERT. There was a little over $60 million from Bank America. First Union has—I believe those are confidential. I believe that

the other ones are confidential of the past episodes. Publicly, it’s

over $60 million. That’s one of the problems, by the way; we have

to represent our clients, and we sometimes can’t tell everything

that happened.

Mr. WHITFIELD. Okay. So there are settlements in excess of $60

million?

Mr. ALPERT. Yes. And there was some others that I don’t know

about. There were individual cases, for example.

Mr. WHITFIELD. And could you describe what was the actual

basis of the lawsuits. Was it fraud?

Mr. ALPERT. There are several. There’s one—there is was one set

where they committed violations of prospectuses. In other words,

they didn’t have the proper information in their prospectus, nor did

they give it to their customers. What’s interesting about that, and

one of the reasons why I know it’s continuing is, one of the State

managers of Bank America claimed to me under oath that she had

given her brokers word-by-word instruction and instruction on

what the prospectus was. Well, the prospectus contained derivatives. So I asked her what the LIBOR was and she didn’t know.

I asked her what a tranche was and she didn’t know.

I asked her what a PO was, and she didn’t know. I asked her

what an IO was, and she didn’t know. And this person is still in

a high position in Bank America Securities. There was that.

There was then the issue of nondisclosure of the risk of loss aside

from the prospectuses. And these nondisclosures were involved in

a typical securities fraud case. You then have a deception by the

banks. One of them—it is still continuing, First Union, where they

have dual employees where the same person is wearing the hat of

the banker and the broker. So the customer doesn’t know what

they’re talking to that person for at that particular time.

And these people, many of them series 6—and we’re getting technical—they’re not supervised; there’s no one to supervise them. So

you have those kinds of issues, some of the First Union cases, by

the way, there are individual cases filed. They were lost, because
75

the lawyers on an individual basis could not afford to litigate

against the bank, and only in the class-action case were we able

to protect the consumers and our clients, though we didn’t protect

all of them, unfortunately.

Mr. WHITFIELD. And how many known victims were there of

this?

Mr. ALPERT. I have seen over a thousand letters. And I have examined Mr. McCall under oath about those, and I can’t discuss

that examination, because that’s confidential. But I’ve seen personally over a thousand. I’ve heard horror stories of—in the thousands

from Bank America, First Union, AMSouth, Barnett Bank customers, as well as banks we haven’t sued—we haven’t sued everybody—as well as banks in States as far away as Hawaii, Michigan,

and New York. And unfortunately, we can’t sue them all.

Mr. WHITFIELD. During this entire episode, did you have any contact with or work with the Office of Comptroller of the Currency?

Mr. ALPERT. Yes, sir.

Mr. WHITFIELD. What, were you simply notifying them of what

you thought was going on or what?

Mr. ALPERT. We had a meeting with bank securities regulators

in August 1994. They came to Tampa, and there was a meeting in

our office with some folks from the OCC and the SEC both. Many

of our clients before we got involved had written to the OCC. In

1995, the OCC told Leilani DeMint, one of our clients, a retired toll

taker who thought she was buying Sears EE bonds, that she was

not—that the OCC was closing its file on her case, because they

thought—because there was a lawsuit pending. I never heard of

that. I haven’t seen that in their regulations. And then in 1998, we

requested assistance from the OCC in terms of disclosure of some

examination reports of a bank that no longer existed, Barnett

Bank.

And the OCC, just refused to offer any assistance whatsoever at

all. And I’m puzzled—in terms of disclosing documents for private

litigation. And I’m puzzled by that attitude toward the constituents. And I think sometimes perhaps they don’t—they may have

thought we would just go away.

Mr. WHITFIELD. Okay.

Mr. UPTON. Thank you. I would note to our witnesses that there

are a number of activities going on this morning, and I’m going to

ask unanimous consent that all members of the subcommittee may,

particularly those that are not here, that they may follow up with

some questions in writing, and if you would respond to those—that

we can make part of the record, that would be terrific.

Mr. BURR. Mr. Chairman, could I also ask unanimous consent

that Ms. Crawford be allowed once the House has completed their

work on H.R. 10 to share in whatever form she feels appropriate

any suggestions that she has relative to the final drafting and

where concerns still might exist that might have gone undetected

in the passage of that bill.

Mr. UPTON. Without objection, I think that would be a terrific

idea.

Ms. CRAWFORD. Thank you.

Mr. UPTON. If we have no further questions, you are excused.

Thank you for your time this morning.
76

Our next panel includes Julie Williams, who is the Chief Counsel, Office of the Comptroller of the Currency, OCC.

Hello, Ms. Williams. We have a longstanding tradition and rule

in this subcommittee that we take testimony under oath. Do you

have any objection to that?

Ms. WILLIAMS. No, not at all.

Mr. UPTON. The rules of the House provide that you are allowed

counsel if you so desire. Do you need to have counsel?

Ms. WILLIAMS. No.

[Witness sworn.]

Mr. UPTON. Thank you. Thank you very much. Traditionally your

statement is made part of the record, and we would like to keep

you to 5 minutes if we can in terms of your summary that would

be great. This little bell will keep us in time.

Ms. WILLIAMS. I’m familiar with those.

Mr. UPTON. Yeah, me too.

TESTIMONY OF JULIE L. WILLIAMS, CHIEF COUNSEL, OFFICE

OF THE COMPTROLLER OF THE CURRENCY

Ms. WILLIAMS. Mr. Chairman and members of the subcommittee,

I appreciate this opportunity to discuss the OCC’s role and supervisory approach with respect to subsidiaries of national banks that

are registered broker- dealers and to review the NationsSecurities

matter. As I begin, however, I want to express my sympathy for

the victims in the NationsSecurities matter. The sales abuses that

occurred would be intolerable under any circumstances and it is deplorable that they occurred in connection with an entity affiliated

with a national bank.

Let me now briefly discuss each regulator’s role in the supervisory process. When a broker is a subsidiary of a national bank,

as you know, the SEC and the NASDR are the primary supervisors

of registered broker-dealers, including those who are subsidiaries

or affiliates of national banks. The OCC recognizes these securities

regulators have primary responsibility for overseeing the compliance by brokerage subsidiaries with banks with comprehensive securities law requirements.

However, because we are responsible for supervising the affiliated bank, the OCC also has an interest in responsibilities that

pertain to the activities of bank subsidiaries. Our approach begins

with identifying risks these activities pose and determining if those

risks are being managed appropriately. We emphasize the risk

identification and risk management systems applicable to the subsidiary’s operations. Risk may be present, for example, if the bank

and the subsidiary do not have in place procedures to assure the

bank customers receive full and accurate disclosures about the uninsured status and risks of investment products they buy through

the bank subsidiary. Failure to do so may injure the bank’s customers, damage their relationship with the bank, lower the bank’s

reputation and expose the bank to liability. Thus, we fully share

the goals of the SEC and the NASDR to assure fair treatment of

customers.

In the case of a brokerage affiliate or subsidiary that operates on

bank premises or effects sales through banks, a review of a bank’s
77

management and control systems for that activity will inevitably

touch on aspects of the operations of the broker as well.

However, we do not seek to duplicate or intrude into the responsibilities or activities of securities regulators. If as a result of our

oversight of a bank’s compliance and risk management systems the

OCC becomes aware of conduct or activities that raise concerns

about securities law compliance, by a brokerage affiliate or subsidiary of a national bank, we would consult with the primary regulator to determine appropriate examination efforts and supervisory responses by each regulator to the situation. My written statement describes a recent situation involving this

type of coordination and summarizes the various areas where we

coordinate productively with the SEC and the NASDR. OCC policies on functional oversight of broker-dealers that are affiliated

with national banks are reflected in revisions to the OCC’s bank

examination handbook that have been underway for some time and

will be published shortly in a new examination handbook.

My written statement also describes in some detail the sequence

of events that occurred in the NationsSecurities matter.

I will add just this: Those lapses were deplorable. They were corrected by the bank and NationsSecurities, however in 1995, in response to OCC exams that contained significant criticisms of the

customer safeguards applied in connection with investment product

sales by NationsSecurities through the bank. The OCC, SEC and

NASDR coordinated effectively and ultimately brought coordinated

enforcement actions imposing various sanctions in 1998.

I would be pleased to respond to any questions you have.

[The prepared statement of Julie L. Williams follows:]

PREPARED STATEMENT OF JULIE L. WILLIAMS, CHIEF COUNSEL, OFFICE OF THE

COMPTROLLER OF THE CURRENCY

Mr. Chairman and members of the subcommittee, I appreciate this opportunity

to discuss the Office of the Comptroller of the Currency’s (‘‘OCC’’) role and supervisory approach with respect to subsidiaries of national banks that are registered

broker-dealers, and to review the NationsSecurities matter. The OCC is the primary

supervisor for national banks. The National Association of Securities Dealers Regulations, Inc., (‘‘NASDR’’) and the Securities and Exchange Commission (‘‘SEC’’) are

the primary supervisors for registered broker-dealers, including those that are subsidiaries of national banks. The OCC recognizes that these securities regulators

have primary responsibility for overseeing the operations of brokerage subsidiaries

of national banks and their compliance with comprehensive securities law requirements.

However, because we are responsible for supervising the parent bank, the OCC

also has an interest in—and responsibilities that pertain to—the activities of bank

subsidiaries. Our approach begins with identifying risks these activities pose and

determining if those risks are being managed appropriately. Risk may be present,

for example, if the bank and its subsidiary do not have in place procedures to assure

that bank customers receive full and accurate disclosures about the uninsured status and risks of investment products they buy through the bank’s subsidiary. Failure to do so may injure the bank’s customers, damage their relationship with the

bank, mar the bank’s reputation, and expose the bank to liability. We thus fully

share the goals of the SEC and the NASDR to assure fair treatment of customers.

We do not, however, seek to duplicate or intrude into the responsibilities or activities of the securities regulatory bodies with respect to registered broker-dealers.

In that regard, we have learned a great deal about effective regulatory coordination in this area since our efforts in 1993 and 1994 to establish disclosure and operational guidance for sales of investment products on bank premises. We have

learned, for example, that no regulator’s supervisory interests need be compromised

simply because different regulators have different direct and indirect interests with

respect to the same entities. We have worked hard to coordinate on individual cases
78

as well as larger policy and regulatory issues with the SEC and the NASDR. And

we have learned that recognition of each agency’s respective responsibilities, and effective inter-agency coordination, maximizes both safety and soundness of national

banks and investor protection, and helps securities and bank regulators achieve

their goals.

OCC’s Supervisory Approach

It is in that spirit that I will explain in more detail the OCC’s current supervisory

approach to broker-dealer subsidiaries of national banks, and our particular experiences in the NationsSecurities matter. As noted at the outset, in determining our

role with respect to broker-dealers that are subsidiaries of national banks, the OCC

has been mindful of the vital primary supervisory role of the SEC and the NASDR.

One recent industry survey suggests that 96 percent of the sales force involved with

bank-related investment sales are registered with the NASDR and are subject fully

to regulation as brokers.

Brokerage subsidiaries of national banks must register with the securities regulators and comply with a comprehensive securities law regulatory scheme that offers

significant customer protection, to the same extent as brokers that are not affiliated

with banks. The NASDR and SEC have primary responsibility for inspecting these

subsidiaries, interpreting and applying securities law and regulatory standards, and

addressing any compliance concerns. We fully understand the SEC’s interest in

maintaining its primacy in this area, as the SEC has clearly communicated, and

fully support its supervisory efforts to assure adequate protections for investors. Accordingly, the OCC defers to the SEC and the NASDR to conduct inspections, address securities law compliance concerns and generally supervise brokers that are

subsidiaries of banks.

At the same time, due to our responsibilities for the safety and soundness of national banks, the OCC also has an interest in the operations of bank subsidiaries.

We seek to assure that the parent bank effectively monitors and controls risks presented by the subsidiary’s operations. We focus on the adequacy of policies, procedures and risk management systems, and we test and verify to determine whether

those systems work. With respect to brokerage subsidiaries of banks, we emphasize

risk identification and risk management systems applicable to a subsidiary’s operations, rather than attempting to duplicate the work of the SEC or the NASDR by

examining the subsidiary’s daily operations. In the case of a brokerage subsidiary

that operates on bank premises or effects sales through banks, however, a review

of the bank’s management and control systems for that activity will inevitably touch

on aspects of the operations of the brokerage subsidiary as well.

If, as a result of our oversight of a bank’s compliance and risk management systems, the OCC becomes aware of conduct or activities that raise concerns about securities law compliance by a brokerage subsidiary or affiliate, we would promptly

consult with the primary regulator to determine appropriate examination efforts

and supervisory responses by each regulator to the situation. A recent example of

how this functional approach works involved a national bank brokerage subsidiary

with plans to significantly expand its securities sales program through the parent

bank. OCC examination staff had concerns with the sales program based on our

knowledge of compliance function issues at the bank itself, and prior SEC inspections. Accordingly, prior to the expansion of the bank’s sales program, the OCC invited the SEC to participate in an examination that reviewed these sales activities.

Collaborative efforts between examiners on-site and the local SEC office contributed to the success of the examination. An SEC examiner participated directly in

the examination and OCC staff met with representatives of the local SEC office before, during and at the conclusion of the examination. Since that review, OCC and

SEC examiners have continued to share information and maintain communication.

Another joint examination is planned within the next twelve months. Staff from

both agencies found this approach efficient and effective.

The OCC coordinates in other respects with the primary regulators for brokerage

subsidiaries of national banks because of our related areas of responsibility. In January of l995, the OCC and the other federal financial institution regulators signed

an agreement with the NASDR relating to sharing information and coordinating efforts. Shortly thereafter, the OCC exchanged lists of local contacts with the NASDR

to facilitate exchanges of information and coordination at the local level, where coordination concerning individual institutions is most effective. The OCC also coordinates and shares information with the SEC. As noted above, we have contacted the

SEC when it appears that a substantive issue, subject to SEC’s jurisdiction, exists

with respect to a broker subsidiary of a bank. We also make examination reports

available to the SEC relating to investigations and provide access to examiner work
79

papers, internal documents and examination staff. The OCC also has provided examination staff as witnesses in SEC enforcement actions.

The OCC’s policies on functional oversight of brokerage subsidiaries are reflected

in revisions to the OCC’s bank examination handbook that have been underway for

some time and will be published shortly in a new examination handbook. Under

these policies, examiners defer to the primary role of the securities regulators, while

reviewing risks to the bank from the subsidiaries’ operations in evaluating the composite risk profile of the parent bank. Examiners are instructed that if they have

concerns with the securities activities of a subsidiary, they should contact the primary regulator and work with the regulator to obtain necessary information and determine appropriate action. Examiners also are advised to maintain communications

with the local contacts for the primary regulators on an ongoing basis to keep

abreast of any developments that could affect the bank. The handbook also reminds

examiners of the OCC’s policy to refer evidence of potential violations of law that

fall within the jurisdiction of another primary regulator. All of these steps will enhance information sharing and coordination between our examination staff and securities regulators.

In addition to the guidance contained in revisions to the OCC’s bank examination

handbook, OCC bank supervision staff have held meetings with representatives of

the SEC in Washington, D.C., to identify areas where it is productive to exchange

supervisory information. We intend to continue this dialogue. The intent of these

meetings is to establish avenues of communication similar to those that have traditionally existed with other federal and state bank supervisory agencies.

Development of Consumer Protection Standards For Securities Sales

As noted at the outset, the OCC and the securities regulators share a common

concern that bank customers understand the risks involved in securities investments and not mistakenly believe these products are FDIC-insured or guaranteed

by the bank. In July of 1993, the OCC issued Banking Circular 274, which established standards for national banks offering mutual funds, annuities and other nondeposit investment products. The Circular stressed that ‘‘[b]anks should view customers’ interests as critical to all aspects of their sales programs.’’ It directed banks

to disclose that securities products are not FDIC-insured, not backed by the bank

and involve investment risks, including possible loss of principal. In addition, the

Circular further directed that banks obtain signed statements from customers acknowledging receipt and understanding of these disclosures. The Circular also addressed program management, physical separation of securities and depository activities, advertising, suitability, qualifications and training, and other consumer protection issues.

Shortly after the issuance of Banking Circular 274, the OCC worked with the

other federal banking regulators to establish uniform interagency guidance for securities sales through banks. In February of 1994, the agencies issued the Interagency

Statement on Retail Sales of Nondeposit Investment Products, which embraced the

standards from Banking Circular 274 and provided more detailed guidance on sales

programs. The OCC also issued detailed examination procedures for examiners on

evaluating compliance with the Interagency Statement. The banking agencies developed these standards due to the absence—at the time—of securities regulatory requirements directed at the special concerns that arise from sales by registered

broker-dealers through banks.

In 1998, the NASDR adopted its final rule applicable to broker-dealers governing

their securities sales through banks. The new NASDR standards incorporate many

of the standards in the Interagency Statement. We appreciate the efforts of the

NASDR to coordinate and establish consistent standards with the banking agencies,

and since then, the OCC and the other federal banking agencies have undertaken

a project to codify the Interagency Statement standards, in a manner consistent

with the NASDR rules. We anticipate our proposal will focus on activities and obligations that apply directly to banks, and should therefore mesh with the NASDR

rules, which focus on the activities of the broker-dealer.

OCC Supervisory Efforts Relating to NationsSecurities

I would now like to turn to the matter of securities sales abuses involving

NationsSecurities in late l993 and early 1994.

On April 9, l993, the OCC approved a partnership between a NationsBank subsidiary and Dean Witter named ‘‘NationsSecurities.’’ It was contemplated that the

partnership would operate from some NationsBank offices and would offer securities

to bank customers. Before approving the proposal, the OCC required representations

and imposed enforceable conditions of approval designed to establish proper man80

1The 2003 and 2004 Term Trusts were two closed-end investment companies that were sold

by NationsSecurities and other broker-dealers. 2 In November of l994, NationsBank bought out Dean Witter’s interest in NationsSecurities.

We were informed by the bank that it made these structural changes to assure greater control

over securities sales through the bank and compliance with regulatory standards, and to facilitate correction of the kinds of problems experienced with the sales of the Term Trusts.

agement oversight of and basic customer protection standards for securities sales effected by the partnership on the premises of, or otherwise through, NationsBank.

For example, one condition required that the partnership disclose that the products were not FDIC-insured, were not backed by the bank and involved investment

risks, including loss of principal. The condition also required that a signed statement be obtained from customers acknowledging receipt and understanding of these

disclosures. Another condition required that the partnership’s products not be marketed in a manner that would mislead or deceive consumers as to the products’ uninsured nature and lack of any guarantee by the bank or the partnership. Various

other disclosure and operational requirements designed to protect bank customers

were established in the 12 conditions imposed on this approval. The OCC approval

noted that the partnership would be registered as a broker-dealer and subject to the

requirements of the federal securities laws and Rules of Fair Practice of the

NASDR. Shortly after the partnership commenced operations on June 7, l993, the

OCC adopted Banking Circular 274, which imposed additional consumer protection

standards for banks offering securities on bank premises designed to avoid customer

confusion.

On November 1, l993, the OCC commenced an examination of NationsBank to

evaluate the bank’s progress towards compliance with the conditions in the OCC’s

approval and Banking Circular 274. At that time there was great interest in the

adequacy of disclosures of the uninsured nature of investment products sold on bank

premises, and the SEC had just issued its ‘‘Chubb Letter’’ addressing the propriety

of payment of referral fees to unregistered employees of financial institutions. Thus,

the examination concentrated on the disclosures being provided to customers and

reviewed the operational policies and procedures of the bank, particularly with respect to whether the incentives made available to bank employees for referring business to the partnership were appropriate. Our examiners issued an examination report that was critical of compliance efforts in general, stemming from a lack of coordinated effort by bank management to achieve compliance. The report found specific noncompliance with Banking Circular 274 provisions relating to advertising,

compliance management, disclosures and employee compensation.

On reviewing our examination findings, the bank took corrective actions to address areas criticized by the OCC and to ensure future compliance with the Interagency Statement. Bank management’s response commenced during the examination with the formation of a compliance committee in January of 1994 to establish

a corrective action response plan. The plan was drafted by February of 1994 and

the response was in place by April of 1994.

In late spring and summer of l994, the OCC received customer and broker complaints about sales abuses relating to sales of Term Trusts 1 that had occurred between August and September of 1993 and January and February of l994. After

learning of these complaints, OCC examination staff immediately began a review,

including interviewing employees of the bank and NationsSecurities and doing onsite reviews in the bank’s Tampa locations. The OCC also met with the SEC and

other regulators and began sharing information regarding their work and their findings. At roughly the same time, our on-site examination staff conducted additional

inquiries regarding the sales practices at issue and planned and organized an intensive examination of the bank’s nondeposit investment products sales practices.2 This

exam formally began in January of 1995, using resident examiners and a cadre of

expert examiners brought in from other parts of the country. During that examination, OCC examination staff advised the bank of major deficiencies in the customer

suitability and product selection process. Between May and September of 1995, at

the direction of the OCC, the bank and NationsSecurities responded to OCC concerns and took actions to correct the customer suitability and product selection deficiencies.

On July 24, l996, the OCC commenced another examination of NationsBank’s retail sales program. Following that exam, our examiners confirmed that corrective action had been taken to resolve concerns identified in the l995 examination and noted

no instances of noncompliance with the Interagency Statement.
81

The OCC, SEC and NASDR Coordinated their Efforts Along Functional Lines of

Regulation

The OCC and securities regulators pursued our examination and investigation reviews and enforcement actions consistent with our functional lines of regulation.

The SEC primarily investigated potential violations of securities laws by

NationsSecurities and the bank, while the OCC focused on the bank’s compliance

with banking laws and standards applicable to the bank that were relevant to customer protection.

On learning of the sales practice abuses, the OCC and SEC staff consulted with

one another and exchanged formal requests for access to each other’s documents.

The OCC provided the SEC access to our examination information and set up meetings between OCC examination staff and SEC investigators, which occurred in August of l994.

In September of l994, the SEC opened a formal Order of Investigation. Subsequently, the SEC would be conducting an in-depth investigation, including depositions of customers, and would share information from the investigation with the

OCC. The SEC shared with the OCC information gathered from its investigation.

The OCC also shared with the SEC our examination reports, work papers and other

internal information relating to the securities sales programs.

During the negotiation of settlement actions, the OCC, the SEC and the NASDR

effectively coordinated our respective enforcement efforts and announced the settlements together on the same date. At a joint press conference, the agencies expressed

appreciation for each other’s coordination and cooperation in these enforcement endeavors. The agencies’ final enforcement actions reflect a functional regulation approach. The OCC brought an action against the bank based on the bank’s failure

to comply with the OCC’s condition requiring that the bank assure that securities

products not be marketed in a manner that would mislead or deceive bank consumers as to the products’ uninsured nature and lack of any guaranty by the bank.

Through the bank’s noncompliance with this condition, the bank failed to adhere to

the OCC’s standards on retail nondeposit investment sales contained in Banking

Circular 274. The OCC assessed a civil money penalty of $750,000 against the bank

for this violation. The OCC also suspended from engaging in bank securities activities and assessed a penalty against a bank employee who had been involved in the

sales practice abuses and entered into agreements with two other individuals to prevent them from engaging in securities activities within banks during the period they

had been suspended by the NASDR. In addition, the SEC assessed a $4 million penalty and the NASDR assessed a $2 million penalty against NationsSecurities for securities law violations. The SEC also entered into a consent order with the bank

in which it agreed to cease and desist from causing or engaging in violations of certain securities law provisions. The NASDR also fined and suspended three individuals based on violations of the federal securities laws falling within their jurisdiction. The agencies relied upon information developed by each other in completing

their respective enforcement actions.

Legislative Proposals Affecting the Bank Regulators’ Role

In closing, I would like to briefly note a development that could impair much of

the progress that has been made in recent years in coordination between bank regulators and securities regulators who are working toward that common goal of fair

treatment of customers. The current system of functional regulation involves different regulators on the lookout—from their different perspectives—for customer

concerns arising from securities sales through banks. We are concerned that H.R.

10 could diminish these safeguards. Under Section 117, the ability of a bank or

thrift regulator to seek information from, or examine a functionally regulated bank

affiliate or subsidiary, would be severely limited. As a practical matter, this could

preclude a bank regulator from promptly taking reasonable steps to verify the existence of information relevant to a potential problem that would warrant a contact

with the appropriate functional regulator.

We would respectfully suggest that setting a framework for cooperation and coordination between, rather than segregation of, regulators would be preferable and

would enhance both investor protection and the safety and soundness of all types

of financial institutions that have functionally regulated affiliates and subsidiaries.

Conclusion

We appreciate this opportunity to explain to the Subcommittee the OCC’s role

with respect to brokerage subsidiaries of banks and our coordination with their primary regulators, and hope you will find this information useful in your oversight

activities. I would be pleased to answer any questions you have.
82

Mr. UPTON. Thank you again for appearing before this panel this

morning. I don’t know whether you have seen this national bank

securities service audit. It actually dates back from April 1996. It

says a profit market research consulting second annual national

bank securities service audit, which benchmarks services provided

by bank based retail securities brokers. And it asks a number of

questions, in this particular case comparing results with August

1994 and April 1996: Did not complete a customer profile before

the pitch was made—actually, sadly, it went up from 12 percent to

27 percent in that year and a half period of time—did not find out

prospect’s income level—again went up from 44 to 51 percent. Tax

bracket, et cetera.

I don’t know whether a report has been done since this was out.

Are you aware of any follow up? The reason why this is timely is

that in 1994 I think was when the regulations were just coming out

in terms of what operating subsidiaries were going to have to do.

Yet despite more regulations that were coming out, yet in fact, the

trend lines got worse. And I’m just wondering has there been any

follow up to this, have those numbers, percentages come back down

in terms of compliance? Are you aware of anything?

Ms. WILLIAMS. I’m not personally familiar with that report that

you have. The most, by far the bulk of the sales activities that

occur on bank premises or through banks are being conducted by

third party broker-dealers, either related third parties, affiliates of

the bank or subsidiaries of the bank. So they are fully subject to

all of the broker-dealer standards and requirements.

In addition, as I’m sure you know, the NASDR adopted, finalized

recently, specific regulations imposing special safeguards where

registered broker-dealers are selling on bank premises. The interagency statement that the banking regulators adopted was finalized in 1994. And that has comparable standards applicable to the

bank to ensure appropriate disclosures and appropriate safeguards

are in place.

So I would expect that as a result of all of those activities, that

the type of information that you have, if you looked at information

that is more current, it would reflect significant improvement. But

I’m not aware of any comparable survey for a more recent time.

Mr. UPTON. Okay. I don’t know if you heard Ms. Crawford’s testimony to the first panel. She’s a securities commissioner for the

State of Texas, Texas State Securities Board, and she spoke earlier

this morning. And she indicated that the OCC really had a record

of not being responsive—I’m paraphrasing here—not being responsive to the needs of the State of Texas and thought that as she had

heard from her peers in other States that in fact that was also

prevalent.

Ms. WILLIAMS. I——

Mr. UPTON. How would you react to that?

Ms. WILLIAMS. I don’t know what her experience was dealing

with us, but in the particular NationsSecurities matter we did coordinate with several State securities regulators to share information and documents. So I’m not sure what gave rise to her concern.

It certainly is our intention and desire to cooperate with both the

Federal and the State securities regulators.
83

Mr. UPTON. Mr. Dingell, a member of this committee and subcommittee as well, I don’t know if you saw the statement that he

gave almost a year ago, 1998, he says the office—‘‘NationsBank

and subsidiary NationsSecurities’’—let me just finish this if I

may—‘‘conspired to defraud elderly and retired citizens who held

maturing certificates of deposit worth hundreds of millions of dollars by selling them toxic derivatives disguised as safe government

backed term trusts. The OCC during Eugene Ludwig’s tenure identified these fraudulent sales practices while conducting routine

exams in 1994 1995, yet did nothing to stop them. Only after the

SEC presented the OCC with its findings and conclusions did the

OCC act. This begs the question of whether the OCC was negligent, corrupt or an active participant in wrongdoing by

NationsBank.

‘‘That question deserves a thorough investigation and an answer.

Unfortunately I predicted such shenanigans when I conducted O&I

hearings into these issues back in 1994. This sorry episode provides

definitive albeit regrettable proof why true separation and functional regulation must be in any financial modernization legislation.’’.

What do you think about—where are you since he made this

statement a year ago?

Ms. WILLIAMS. I think that there are——

Mr. UPTON. His office is just down the hall, by the way.

Ms. WILLIAMS. There are two points that that statement raises.

First of all, we did identify the problems and obtained immediate

corrective action from the bank and with respect to the procedures

employed by the subsidiary. That occurred in 1995.

The question about functional regulation and the larger issues of

how bank securities activities should be regulated, is I think a separate issue. And we’re very well aware that that’s comprehensively

addressed or would be comprehensively addressed in the financial

modernization bills that are pending. We’ve had issues with some

provisions of the modernization bills, but we are not taking issue

with the functional regulations titles in the financial modernization

bills.

Mr. UPTON. Okay. If I just might ask one question then I’ll pass

to my colleague, Mr. Burr. Have you compared the Banking versus

the Commerce Committee versions with regard to your role? In

terms of working with the op subs?

Ms. WILLIAMS. Specifically with respect to the activities on the

op subs?

Mr. UPTON. It’s my understanding that the Banking Committee’s

version is much broader in terms of its allowances by the OCC

whereas the Commerce version, as most would probably indicate,

tightens the loopholes and calls for stronger fire walls allowing for

a better enforcement.

Ms. WILLIAMS. I would have to go back and look more closely.

Because I thought that there were differences but I’m not familiar

right now with all of the details of the activities that would be exempt under the Commerce version versus the Banking Committee

version; but they’re not substantial issues. Both bills fundamentally repeal the broker-dealer exemptions from the Federal securities laws that the banks currently enjoy.
84

Mr. UPTON. Okay. Mr. Burr.

Mr. BURR. Thank you, Mr. Chairman. And my understanding,

there’s quite a few more changes as it relates to the Office of the

Comptroller of the Currency. So I do suggest that you look at that

closely.

Let me ask you, banks that have operating subsidiaries selling

securities, can one conclude today that they have twice the regulation of banks that don’t?

Ms. WILLIAMS. Well, I think if you talk to bankers that’s probably what they would say.

Mr. BURR. I’m asking you though.

Ms. WILLIAMS. I think they get oversight directly from the SEC

or the NASDR and then they get systemic oversight from the bank

regulator who’s looking at policies and procedures and systems,

whether risk control systems work, and is testing whether those

systems work.

Mr. BURR. Well, when you look at the situation with the

NationsBank case, let me ask you specifically, did the procedures

that you have set up in the other regulatory agencies, did it work?

Ms. WILLIAMS. Ultimately it did.

Mr. BURR. So there may have been a lag in identification of a

problem, but the procedures that were set up worked.

Ms. WILLIAMS. That’s correct.

Mr. BURR. Are there any procedural changes that you’ve made as

the result of that case?

Ms. WILLIAMS. I think we have done a variety of things in terms

of our own internal policies of interacting with functional regulators and I refer to that in both my written statement and alluded

to it in my oral. To make quite clear the recognition of the respective agency’s responsibilities and our practice of where we have information contacting——

Mr. BURR. There’s no confusion by agencies as to their role and

responsibilities in those procedures, is there?

Ms. WILLIAMS. I don’t think there should be. No, sir.

Mr. BURR. Let me ask you about one of Mr. Alpert’s statements

and I just want your view on it. Mr. Alpert said in his testimony

First Union/NationsBank also engaged in what amounted to be

money laundering, a practice more characteristic to racketeering

than banking. When you look back as legal counsel of the OCC,

what do you think about that statement?

Ms. WILLIAMS. Well, I don’t think this is money laundering or

racketeering. It was a failure to have in place good systems and

controls and customer safeguards.

Mr. BURR. If it were you would refer it somewhere, wouldn’t you?

Ms. WILLIAMS. Yes, we would be filing all sorts of criminal referrals and taking other action that we take when we have evidence

of money laundering.

Mr. BURR. But you never did.

Ms. WILLIAMS. No, I would not characterize these activities that

way.

Mr. BURR. Ms. Williams, I thank you for your testimony. I want

to allow the rest of my colleagues to try to get questions in prior

to us breaking for a vote. So I thank you and I would yield back,

Mr. Chairman.
85

Mr. UPTON. Mr. Whitfield.

Mr. WHITFIELD. I would also like to ask you to respond to the

statement that Mr. Alpert made in his testimony. You had mentioned in your testimony that various sanctions had been issued to

the volleying banks. Mr. Alpert said unfortunately the OCC has

never taken any action against Barnett Bank, has never taken any

action against First Union Bank, has taken only reluctant and

minimal action against NationsBank, has never taken any action

against Amsouth, even though State and Federal security regulators, including the NASD, have taken action against the brokerage subsidiaries of those banks. And it is our understanding that

the OCC has actively blocked or resisted the action of security regulators who have tried to protect the American people. How would

you respond to that?

Ms. WILLIAMS. Well, first of all, as to that last statement that’s

absolutely untrue. We cooperate and place great importance on

having good cooperative relationships with fellow regulators, including the SEC, the NASD and the State securities regulators.

With respect to the institutions other than NationsSecurities, I just

don’t have information about those particular institutions. I had

understood the focus of today’s hearing was on our general approach to supervision and the NationsSecurities matters. So I

would be happy to respond if there are any additional questions.

I would add we don’t regulate Amsouth. That’s a State bank.

Mr. WHITFIELD. But do you feel comfortable in the changes that

you have brought about as a result of what happened in

NationsBank?

Ms. WILLIAMS. I think you always look back and think what

could you have done differently and how can you learn from experiences. And I think that we have made a great deal of progress in

our cooperative and coordinating relationships with securities regulators in the last several years.

Mr. WHITFIELD. I yield back the balance of my time.

Mr. UPTON. Mr. Bilbray.

Mr. BILBRAY. I have no questions, Mr. Chairman.

Mr. UPTON. I have—we are in a vote. And I have two questions

and I’m sort of at that point done with my questions at the moment. I just historically when we saw something like NationsBank

come up—and I don’t know how involved you may have been in

that process—did you—in that particular case did the OCC actually

talk with any of the customers? Did they interview any customers

that claimed to have been defrauded?

Ms. WILLIAMS. Mr. Chairman, I don’t believe we did. Our exam

focus was on the bank, on the bank’s systems controls and safeguards. And I think that we ultimately were looking at records

which enabled us to compare certain transactions which flagged for

us the need to express criticism to the bank of their procedures and

their suitability processes.

Mr. UPTON. When you did flag that criticism and investigation

clearly was beginning to undergo, to proceed, why was it that it

was virtually the same year that all of that started happening that

in fact it’s my understanding that you all gave the satisfactory rating, a 2 rating, 1 being the best, 2 next, 5 being the worst, 2 rating

to their activities? I mean how does that comport?
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1 As of December 1998, mutual fund assets totaled $5.5 trillion. Investment Company Institute, Trends in Mutual Fund Investing: December 1998 (Jan. 28, 1999). 2 In 1998, businesses raised a record $1.8 trillion from investors, $1.31 trillion in 1997, and

$967 billion in 1996. (These figures include firm commitment public offerings and private placements but do not include best efforts underwritings.) Securities Data Corporation.

Ms. WILLIAMS. The 2 rating or any rating that we give a bank

is a composite rating. And it reflects everything that they do. Unlike, for example, the Community Reinvestment Act, we don’t give

a rating that is specific to how the bank is involved in selling retail

uninsured investment products.

Mr. UPTON. Because my staff shows that these financial institutions are in substantial compliance with laws and regulations,

overall risk management practices are satisfactory relative to the

institution’s size and complexity, and there are no material supervisory concerns as part of what’s part of 2. No material supervisory

concerns. And as a result supervisory response is informal and limited.

Ms. WILLIAMS. And in this case when we brought the particular

criticisms and concerns to the attention of the bank management

as a result of our exam, they immediately took corrective action.

Corrective actions were in place before we had an exit meeting in

the conclusion of the exam.

Mr. UPTON. Okay. Any more questions?

Mr. WHITFIELD. No.

Mr. BILBRAY. No.

Mr. UPTON. We have a vote. Again, we may follow up with additional questions. But this hearing is adjourned. Thank you.

[Whereupon, at 11:28 a.m., the subcommittee was adjourned.]

[Additional material submitted for the record follows:]

PREPARED STATEMENT OF THE U.S. SECURITIES AND EXCHANGE COMMISSION

Thank you for giving the Securities and Exchange Commission (‘‘SEC’’ or ‘‘Commission’’) the opportunity to present this statement concerning bank securities

issues. You have asked us to address the following issues: (i) the securities regulatory scheme as it compares with the bank regulatory scheme, including recent

SEC enforcement cases involving bank securities activities; (ii) the Commission’s examination program, including the SEC’s coordination with federal bank regulators;

and (iii) bank securities regulation under Section 12(i) of the Securities Exchange

Act of 1934 (‘‘Exchange Act’’). This statement addresses each of these issues in turn.

I. OVERVIEW OF THE U.S. SECURITIES REGULATORY SCHEME

Our securities markets today are strong, vibrant, and healthy. They are relied on

both by individual investors who are increasingly putting their savings in stocks,

bonds, and mutual funds,1 and by American businesses that need to raise capital.2

The success of our securities markets is based on the high level of public confidence

inspired by a strong system of investor protection, and on the entrepreneurial and

innovative efforts of securities firms.

The Commission has been the nation’s primary securities regulator for 65 years.

The Commission’s statutory mandate focuses on investor protection, the maintenance of fair and orderly markets, and full disclosure. Moreover, securities regulation encourages innovation on the part of brokerage firms, subject to securities capital requirements that are tailored to support any risk-taking activities. Significantly, securities regulation—unlike banking regulation—does not protect brokerdealers from failure. Securities firms are expected to have strong risk-management

controls and procedures. Ultimately, however, securities regulation relies on market

discipline, rather than a federal safety net. An additional capital cushion and customer segregation requirements insulate customers and the markets from the losses
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3SIPC is a non-profit membership corporation created by the Securities Investor Protection

Act of 1970. SIPC membership is required of nearly all registered broker-dealers, and SIPC is

funded by annual assessments on its members. If a broker-dealer were to fail and have insufficient assets to satisfy the claims of its customers, SIPC funds would be used to pay the brokerdealer’s customers (up to $100,000 in cash, and $500,000 in total claims, per customer). 4 United States v. O’Hagan, 521 U.S. 642, 117 S.Ct. 2199, 2210 (1997). 5See Testimony of Richard C. Breeden, President, Richard C. Breeden & Co., Before the

Subcomm. on Finance and Hazardous Materials, House Comm. on Commerce (May 14, 1997).

of broker-dealer firms. Moreover, protection of customer funds has been further assured by the Securities Investor Protection Corporation (‘‘SIPC’’).3

This Subcommittee is well aware of the many securities activities in which the

banking industry now engages. While these market developments have provided

banks with greater flexibility and new areas for innovation, they have also left U.S.

markets and investors potentially at risk. Because banks have, to date, retained

their blanket exemptions from most federal securities laws, their securities activities

have been governed by banking statutes and regulations that have not necessarily

kept pace with market practices or needs for investor protection. As you know,

banking regulation properly focuses on preserving the safety and soundness of banking institutions and their deposits, and preventing bank failures. But, because market integrity and investor protection are not the primary focus of banking regulation, banking regulation is not an adequate substitute for securities regulation. In

order for banks to be fully liberated from the outdated Glass-Steagall Act restrictions on their ability to conduct securities activities, banks must be willing to take

on the responsibility for full compliance with U.S. securities laws, with which all

other securities market participants must comply.

The following is a more detailed discussion of several key elements of the securities regulatory scheme, highlighting some of the fundamental differences between

the Commission’s program and that of the federal bank regulatory scheme. The key

elements of the securities regulatory scheme include:

• Aggressive SEC policing and oversight of securities activities;

• Safeguarding customers and markets through market-sensitive SEC net capital

rules; and

• Protecting investors by applying SEC sales practice rules to securities activities.

A. Aggressive SEC Policing and Oversight of All Securities Activities

Public confidence in our securities markets hinges on their integrity. As the Supreme Court recently stated: ‘‘an animating purpose of the Exchange Act. . .[is] to

insure honest securities markets and thereby promote investor confidence.’’ 4 The

Commission has an active enforcement division, whose first priority is to investigate

and prosecute securities fraud. The banking regulators, on the other hand, are required to focus their efforts on protecting the safety and soundness of banks. As a

former Commission Chairman said in recent Congressional testimony, detecting securities fraud is a full-time job, and it is a far cry from formulating monetary policy.5

Examinations. To effectively police and oversee the markets, the Commission

must be able to monitor the securities activities of market participants through regular examinations and inspections, which includes access to all books and records

involving securities activities. This is currently not the case with respect to banks.

The following is an important example of this problem.

Banks increasingly advise SEC-registered mutual funds. In fact, we understand

that the trend in banking has been to convert bank trust funds into mutual funds.

Mutual funds allow their shareholders to monitor the value of their investments on

a daily basis because mutual funds are required to price their shares at their current market value on a daily basis, and those prices are widely published in newspapers. In contrast, bank trust accounts are not marked-to-market daily, and there

is no transparency—that is, wide dissemination—of their daily market value. Although banks are increasingly active as investment advisers to mutual funds, banks

are exempt, under outmoded bank exemptions from the securities laws, from regulation under the Investment Advisers Act.

As a practical matter, this means that SEC examiners only have access to part

of the information necessary to assess the integrity of mutual funds. Key documents

concerning bank advisory activities that could impact the integrity of bank-advised

mutual funds are not readily available to SEC examiners. Without access to bank

advisory records, for example, SEC examiners cannot examine bank advisers to detect front-running, abusive trading by portfolio managers, and conflicts of interest

(involving, for example, soft-dollar arrangements, allocation of orders, and personal

securities transactions by fund managers). As part of its review for conflicts of inter88

6 12 U.S.C. § 1818(u).

est with respect to the activities of a bank mutual fund adviser, Commission examiners must be able to compare trading activity in the funds’ portfolios to that in the

bank’s trust accounts. Because the Commission has had difficulty obtaining full access to all relevant information involving the securities activities of banks that advise mutual funds, shareholders of bank-advised mutual funds may be at risk.

As requested by the Subcommittee, a more detailed discussion of the Commission’s examination program and coordination with bank regulators is contained in

Section II.

Enforcement. There is a significant difference between the enforcement programs

of the SEC and the banking regulators. The Commission’s enforcement program

fully informs the investing public of enforcement actions brought under the federal

securities laws. Commission and self-regulatory organization (‘‘SRO’’) disciplinary

proceedings are matters of public record. Commission press releases fully describe

the nature of the proceedings and the identity of the parties disciplined. In addition,

as mandated by the Exchange Act, the National Association of Securities Dealers

(‘‘NASD’’) operates an ‘‘800’’ number hotline that allows investors to obtain information about the disciplinary records of broker-dealers’ registered representatives. In

contrast, while the banking agencies are required to ‘‘publish and make available

to the public’’ final orders issued in connection with enforcement proceedings,6 the

banking agencies’ releases typically do not describe the nature of the violation and

the enforcement action taken. It is thus difficult for an investor to determine which

proceedings are of interest in order to request copies of documents relating to specific final actions from the banking agencies.

B. SEC Capital and Financial Responsibility Rules

Securities positions can be highly volatile. The Commission’s capital requirements

recognize this fact and are, with respect to protection from market risk, more rigorous than those imposed by bank regulators. Market exposures and volatility are

risks that the net capital rule was designed to address, unlike bank capital requirements, which focus more on credit exposure. Thus, the Commission’s net capital rule

is designed to protect the liquidity of any entity engaging in often volatile securities

transactions.

In addition to promoting firm liquidity, the Commission’s net capital rule is a critical tool to protect investors and securities markets because the Commission also

uses the net capital rule to address abusive or problematic practices in the market.

For example, the Commission can expand on the margin rules with respect to particularly risky stocks by increasing capital charges. In addition, the net capital

rule’s 100-percent capital charge for illiquid securities serves to constrain the market for securities that have no liquidity or transparency. Without the ability to uniformly apply its net capital rule to securities businesses, the Commission’s ability

to oversee and influence U.S. securities markets is severely inhibited.

In addition to detailed net capital requirements that require broker-dealers to set

aside additional capital for their securities positions, the Commission’s customer

segregation rule prohibits the commingling of customer assets with firm assets.

Thus, customer funds and securities are segregated from firm assets and are wellinsulated from any potential losses that may occur due to a broker-dealer’s proprietary activities. Furthermore, federal securities law, unlike banking law, requires

intermediaries to maintain a detailed stock record that tracks the location and status of any securities held on behalf of customers. For example, the broker-dealers

must ‘‘close for inventory’’ every quarter and count and verify the location of all securities positions. Because banks are not subject to such explicit requirements, the

interests of customers in their securities positions may not be fully protected.

Because the Commission’s financial responsibility requirements are so effective at

insulating customers from the risk-taking activities of broker-dealers, the back-up

protection provided by SIPC is seldomly used. Although there have been brokerdealer failures, there have been no significant draws on SIPC, and there have been

no draws on public funds. In fact, because there have been few draws on SIPC

funds, SIPC has been able to satisfy the claims of broker-dealer customers solely

from its interest earnings and has never had to use its member firm assessments

to protect customers. This is in sharp contrast to the many, often extensive, draws

on the bank insurance funds to protect depositors in failed banks.

C. SEC Sales Practice Rules Applied to All Securities Activities

All investors deserve the same protections regardless of where they choose to purchase their securities. Unfortunately, gaps in the current bifurcated regulatory
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7The federal bank regulatory agencies have issued guidelines that address some bank sales

practice issues. See Board of Governors of the Federal Reserve System, Federal Deposit Insurance Corporation, Office of the Comptroller of the Currency, and Office of Thrift Supervision,

‘‘Interagency Statement on Retail Sales of Nondeposit Investment Products’’ (Feb. 15, 1994).

These guidelines are advisory and therefore not legally binding, and they may not be legally

enforceable by bank regulators. 8See In the Matter of Michael P. Traba, File No. 3-9788, Release No. 33-7617 (Dec. 10, 1998). 9 In the Matter of NationsSecurities and NationsBank, N.A., Release No. 33-7532 (May 4,

1998).

scheme leave investors at risk. For example, broker-dealers are subject to a number

of key enforceable requirements to which banks are not, including requirements to:

• recommend only suitable investments;

• arbitrate disputes with customers;

• ensure that only fully licensed and qualified personnel sell securities to customers;

• disclose to investors, through the NASD, the disciplinary history of employees;

and

• adequately supervise all employees.

Investors are generally not aware of these gaps in regulation and the risks that

such gaps create.

In addition, federal banking statutes do not provide customers with a private

right of action for meritorious claims. Although some customer protections have

been suggested by the bank regulators, they are less comprehensive than the federal

securities laws and serve to perpetuate the disparities between the bank and securities regulatory schemes.7

Two recent Commission enforcement actions highlight the need for more universal

application of strict sales practices rules to all entities engaged in securities activities.

In the Matter of Michael P. Traba 8: In this case, the Commission is alleging that

the portfolio manager of two money market mutual funds sponsored by a bank committed a number of illegal acts. First, the portfolio manager purchased a number

of volatile derivative instruments for the funds, and then caused the funds to improperly price the securities. This caused the funds to ‘‘break the buck.’’ Then, in

an attempt to conceal the funds’ losses, the portfolio manager fraudulently transferred the securities among the funds, a number of bank trust funds, and other

bank accounts over which he had control. The Commission investigated and has initiated an enforcement action against the mutual funds’ portfolio manager for violating the antifraud provisions of the Securities Act of 1933 and the Exchange Act,

as well as for causing the funds’ violations of the Investment Company Act. However, because of the current bank exemptions from federal securities laws, the Commission was unable to bring charges against the bank or its personnel for failing

to adequately supervise the fund manager. Under these facts, the Commission ordinarily would have brought charges against any of its regulated entities for similar

misconduct, and the Commission considers its ability to bring ‘‘failure to supervise’’

claims to be critical to investor protection. Securities fraud of this type—where

transactions occur both in mutual funds and in bank trust accounts—illustrates the

need for securities regulators to have access to books and records involving all securities activities conducted by banks.

In the Matter of NationsSecurities and NationsBank, N.A.9: In this case, employees of a bank and its affiliated broker-dealer blurred the distinction between the two

entities and their respective products during sales presentations to customers and

in marketing materials. For example:

• The bank provided the affiliated broker-dealer with maturing CD lists and lists

of likely prospective investors. The broker-dealer’s employees also received other

bank customer information such as financial statements and account balances.

• Some broker-dealer representatives sat at desks in the bank that were not physically demarked from the bank’s retail banking business, used bank stationery

for correspondence, and suggested that the products being sold were ‘‘accounts

at the bank’’ rather than mutual funds or securities.

• The broker-dealer’s employees mischaracterized certain products as conservative

‘‘safe’’ investments when, in fact, they were highly leveraged funds that invested

in interest-rate-sensitive derivatives.

The combination of improper sales practices and practices that blurred the distinction between the bank and the affiliated broker-dealer resulted in unsuitable

purchases by investors. Many of these customers were elderly and thought they

were purchasing investments in stable government bond funds, rather than making

unsuitable purchases of high-risk funds. This case is also evidence of how partial
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10The SROs, including the New York Stock Exchange and the NASD, conduct regular examinations of their members pursuant to examination cycles that are tailored to each member firm.

securities regulation split between banks and their securities affiliates is inadequate

to fully protect investors.

II. THE SEC’S EXAMINATION PROGRAM

A. Introduction

In response to your request for detailed information regarding the Commission’s

examination process, this section describes in more detail the Commission’s examination process and coordination with bank regulators.

The Commission’s primary mission is to protect investors and maintain fair and

orderly markets. As part of the Commission’s broad mission, the examination program’s mandate is to protect investors through fostering compliance with the securities laws, detecting violative conduct, ensuring that violations are remedied, overseeing self-regulation in the securities industry, and informing the Commission of

developments in the regulated community. To carry out its mission, the Commission’s examination staff selects registrants for examination, conducts on-site reviews

of their operations, and then takes steps to remedy the problems it finds. Examinations do not interfere with the competitive discipline of the marketplace. To use

Adam Smith’s words, the Commission’s mission is to ‘‘hold the ring’’ in which securities firms compete. So long as they play by the rules, securities firms are free to

innovate, to enjoy the profits of creativity, and also to fail.

In essence, the work of the Commission’s examination program is a practical application of functional regulation. The program examines the functions of the securities industry. Because the Commission’s authority is generally coextensive with the

securities markets, the Commission’s examiners can follow the evidence wherever

it leads. In other words, because the examination staff has the authority to examine

the underwriter who brought the securities to market, the traders who maintained

the secondary market, the investment adviser who recommended the product as a

good buy, the registered representative who made the sale, and the SRO that allowed the registered representative to enter the business, the staff can follow the

evidence until the staff tracks down the source of a compliance problem. A notable

exception to the Commission’s authority arises with respect to banks performing securities functions. The Commission is handicapped if an exempt bank is a major

market participant.

B. The Examination Process

The securities laws establish a comprehensive examination system for the securities industry. The Commission examines broker-dealers, investment advisers, investment companies, and transfer agents. The SROs for broker-dealers examine

their members.10 In turn, the SEC provides quality control and programmatic oversight of the SROs’ work. This system provides a great deal of flexibility in the

broker-dealer program. SROs conduct the bulk of front-line routine examinations,

allowing the SEC to focus on more serious or systemic issues. In areas other than

broker-dealers, the Commission provides both front-line and more systemic oversight.

The Office of Compliance Inspections and Examinations (‘‘OCIE’’) administers the

Commission’s examination program. OCIE ensures consistency among examinations,

flexibility in directing resources where they are needed most, and, perhaps most importantly, an improved capacity for taking a coordinated approach to industry-wide

developments. OCIE has embarked on a number of recent initiatives to enhance its

oversight of industry-wide developments. But most importantly, whether an issue

involves the entire market, or only one firm, the Commission’s examiners are

trained specialists in this type of oversight.

To deal with the tremendous growth and innovation in the securities markets,

OCIE increasingly targets firms through a risk-based and systematic methodology.

Registrants are targeted for examination based on factors suggesting that the firm

poses a heightened compliance risk to investors. These factors can include: the nature and size of the registrant’s business; the number of public customers it serves;

whether it holds customer funds and securities; the length of time it has been registered; its examination history; the products it offers; its disciplinary history; customer complaints; regulatory problems of employees; its advertising and performance claims; and information obtained from other regulators. Financial and operational soundness may be a factor, but it is only one of many types of compliance

risk that are considered.
91

It is important to note that risk factors help us prioritize firms for examination.

They do not necessarily indicate that violations are in progress. Instead, they indicate a possibility of heightened risk or weaknesses that may lead to deficiencies or

violations.

To properly implement this approach, examiners are trained to have an overall view of the regulated community. For example, examiners participate in many different examinations, so they can see how a variety of firms operate. Examiners are

sent to different parts of the country in teams from different offices and specializations, and receive extensive classroom and field training. Commission staff are

trained to recognize when a firm is deviating from an industry norm. This approach

also allows the Commission to obtain a broad overview of compliance practices in

the industry. In addition, SEC examiners conduct numerous stand-alone systematic reviews— special purpose examinations often called ‘‘sweeps.’’ Recent sweeps have reviewed

day trading, on-line brokerage, compliance systems creating informational barriers

within firms (previously known as ‘‘Chinese Walls’’), consistently high performing

money managers, internal controls at trading firms, the use of soft dollars, salesmen

with career profiles of disciplinary and compliance problems (what some call ‘‘rogue’’

brokers), sales practices for variable annuity products, supervisory systems for firms

registered as both brokers and investment advisers, compliance practices by financial planners, and operations by certain types of transfer agencies. Once a registrant has been selected for review, examiners visit its offices, inter- view management, review documents and analyze its operations. Examiners often

ask for downloads of data relating to trading, portfolio activity, and other matters,

for analysis back at the Commission. The examiners use the information to check

for irregularities—often called ‘‘red flags’’—that signal that the firm may be violating the securities laws and related rules, or engaging in practices that heighten

the likelihood of such violations.

During examinations, the staff digs deeply into the areas selected for review. For example, to examine for sales practice violations, or other abusive mistreatment of

customers, SEC examiners review the details of specific transactions and accounts.

As many broker-dealers know, it is not uncommon for examiners to ask them why

they thought a particular security was suitable for a particular customer, or why

the portfolio in a particular account turned over as often as it did, or why a particular customer made multiple purchases of mutual fund shares, when a single

purchase would have entitled them to a discount on the sales charge. Broker-dealers

are also asked to produce the books and records of the firm documenting what they

tell the examiners. The SEC’s examiners are trained to follow the evidence, wherever it may lead. Deficiencies identified during examinations range from record-keeping problems and sloppy compliance practices, to serious violations such as hidden insolvencies

threatening customers and the market, misrepresentations, conflicts of interest,

market manipulation and sales practice abuses.

Many examinations conclude with the issuance of a deficiency letter to the registrant. A deficiency letter describes the problems the staff found and requires the

registrant to correct them. This provides highly focused specific deterrence. SEC examiners have developed a new computer-based tracking system to better monitor

deficiencies and firms’ follow-up. When a deficiency letter notes more serious supervisory impact, examiners often send the deficiency letter to the firm’s board of directors, hold a conference call or a face-to face meeting with the firm to emphasize examiners’ concerns, and take other, similar actions.

Examinations also frequently conclude with a recommendation for additional examination work at other firms. For example, if, during an examination of an investment adviser, the staff discovers that the adviser is engaging in questionable soft

dollar transactions with a particular broker-dealer, then an examination of the

broker-dealer may be warranted. Similarly, if, during an inspection of a variable

product sponsor, the staff discovers evidence of sales practice abuses by the product’s distributors, then examinations of those salesmen or their broker-dealer employers may be warranted.

When examiners discover serious violations, such as fraud or sales practice

abuses, they refer the matter to the SEC’s Division of Enforcement (or to an SRO

enforcement department for broker-dealers) for possible further investigation and

enforcement action. Every year, somewhere on the order of 20 to 30 percent of

broker-dealer examinations, 4 to 6 percent of investment adviser and investment

company examinations, and 6 to 8 percent of transfer agent examinations result in

enforcement referrals. Cases brought against regulated entities make up a significant portion of the enforcement cases that the Commission brings each year. Many

of those cases originated with referrals from the examination program.
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11The NASD also examines broker-dealers operating on bank premises for compliance with,

among other rules, NASD Rule 2350, which governs the sale of securities on the premises of

a bank. 12While banks are excepted from the Investment Advisers Act, § 202(a)(11), 15 U.S.C. § 80b2(a)(11), many own or are affiliated with registered advisers. 13 Arthur Levitt, The SEC and the States, Toward a More Perfect Union, Remarks to the North

American Securities Administrators Association Conference (October 23, 1995). 14For example, among other things, the Commission has entered into a Memorandum Of Understanding with SRO and state broker-dealer regulators to enhance coordination of broker-dealer examinations. In the international arena, OCIE has worked with foreign securities regulators

to conduct coordinated global inspections of multinational money managers. 15The procedure is set forth in Exchange Act § 17(b), 15 U.S.C. § 78q(b). 16The Commission also consults with bank regulators prior to conducting examinations of

clearing agencies and municipal securities dealers. See id.

The Subcommittee’s primary interest is in how the examination program relates

to bank affiliates, including SEC-registered broker-dealers and bank-advised mutual

funds. With respect to broker-dealers, the Commission’s examination program applies equally to all broker-dealers. Affiliations play a role in the Commission’s oversight, such as, for example, when the staff reviews broker-dealers’ quarterly risk assessment reports. But fundamentally, the examinations of broker-dealers operating

on the premises of banks are the same as for other broker-dealers— SEC and SRO

examiners review firms for compliance with net capital, customer protection, and

sales practice rules.11

Like its program for broker-dealers, OCIE is generally interested in the same

issues when the staff examines a bank-advised mutual fund as when the staff examines any other fund.12 Of course, the adviser’s status and affiliations play a role in

our oversight, such as, for example, when the staff examines for conflicts of interest.

The one way in which SEC (and SRO) examinations of firms affiliated with a

bank differ from examinations of other types of firms is with respect to examiners’

review of disclosure. When investors purchase an investment in a bank, they may

be confused about whether their investment is federally insured. To address this

concern, whenever the staff examines a bank-advised fund or a broker-dealer operating on the premises of a bank, the staff (or the SRO) carefully reviews how the

fund markets itself, and what types of disclosures are made to potential investors,

to make sure they understand that a mutual fund or the securities sold are not protected by deposit insurance.

C. Coordination with Bank Regulators

As noted above, there is a fundamental difference between the Commission’s program and that of the bank regulators. Bank regulators are concerned about the safety and soundness of banking institutions and the prevention of bank failures. The

Commission, on the other hand, focuses on disclosure, investor protection, and the

maintenance of fair and orderly markets. The Commission is very interested in risks

posed to securities firms by their significant affiliated companies. However, the

Commission’s fundamental mission is the same whether the securities firm is affiliated with a bank, an insurance company, or has no affiliations at all.

The Commission defers to bank examiners on issues related to bank functions. At

the same time, because of the Commission’s expertise in the securities markets, the

Commission should receive deference with respect to the functions that the Commission oversees.

Improving the Commission’s coordination with other regulators is a high priority.13 To further this goal, the examination program has embarked on a number

of initiatives.14 Over the past several years, the Commission has increased its coordination with the bank regulators. In particular, with the bank regulators, we

have worked to heighten our mutual understanding and appreciation for each other’s mission. To this end, the staff has held discussions with the Federal Reserve

Board and the Office of the Comptroller of the Currency (‘‘OCC’’). In addition, beginning in 1995, the Commission and the OCC conducted a pilot program of joint examinations of mutual funds advised by national banks and national banks that provide investment services to banks. We believe these regulator-to-regulator links can

play an important role in enhancing our overall coordination.

The Commission’s examination programs and the bank regulators have also been

cooperating for many years with respect to transfer agents. Prior to examining any

bank transfer agent, the staff notifies its bank regulator and consults on the feasibility and desirability of coordinating examinations.15 In many instances, the bank

regulator will participate in the staff’s examination. Every year, the Commission

also refers the results of several transfer agent examinations to the appropriate federal bank regulator for further action.16
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17 15 U.S.C. § 78l(i). 18 Bank holding companies and savings and loan holding companies are not covered by Section

12(i). Rather, these companies, like all other of the approximately 12,500 public companies, file

their annual and other periodic reports with the Commission and the Commission has full

power to enforce compliance with all provisions of the securities laws.

Finally, the Commission coordinates with bank regulators when the Commission finds that bank-affiliated registrants have committed serious securities laws violations. The Commission’s Division of Enforcement contacts the appropriate bank regulator when the staff is considering recommending that the Commission bring an

enforcement action against a bank-affiliated firm. Through these processes, the

Commission has established a long-term working relationship with all of the federal

bank regulators. The Commission is hopeful this coordination will continue, and

that a relationship will develop in which each regulator’s functions are coordinated

in the public interest.

D. Conclusion

Through careful risk-based selection, systematic oversight, and solid examination work and follow-up, the Commission’s examination program protects investors and

maintains fair and orderly markets. The Commission, through its examination program, also oversees complex market phenomena, such as transactions or abuses involving multiple firms and multiple parties. Artificial barriers within the securities

industry that shield certain players from the SEC’s ability to follow the evidence undercut the SEC’s compliance mission, and, ultimately, the integrity of our markets.

III. SECTION 12(I) OF THE SECURITIES EXCHANGE ACT OF 1934

Some have suggested that bank securities regulation could be achieved by a sys- tem of parallel securities regulation by the banking regulators. Such a system would

be similar to the system currently in place under Section 12(i) of the Exchange Act,

which governs securities reporting by bank issuers. Briefly, under Section 12(i) of

the Exchange Act,17 banking regulators are required to adopt rules ‘‘substantially similar’’ to the Commission’s rules within 60 days after the Commission’s publication of its final rules.

The current Section 12(i) model confers on four separate federal banking regu- lators—not the Commission—the authority to administer and enforce the most important disclosure and reporting provisions of the Exchange Act with respect to publicly held banks and thrifts: Sections 12, 13, 14, and 16. The OCC is assigned responsibility for national banks; the Federal Deposit Insurance Corporation (‘‘FDIC’’),

for state banks that are not members of the Federal Reserve System; the Federal

Reserve, for state member banks; and the Office of Thrift Supervision, for savings

and loan associations.18

The anomaly in this arrangement is that while approximately 12,500 public com- panies, including 915 publicly owned bank holding companies and savings and loan

holding companies, are subject to the Commission’s jurisdiction, approximately 280

publicly held banks and thrifts are exempted from the Commission’s jurisdiction

under this provision. Section 12(i) thus carves out an exception to the jurisdiction

of the Commission, the agency primarily responsible for administering and enforcing

the integrated disclosure system, the Williams Act (which addresses beneficial ownership disclosure, tender offers, and changes in control), the proxy rules, and the

short-swing trading provisions of the Exchange Act. This treatment dates back to the 1964 amendments to the Exchange Act. When the Exchange Act’s coverage was expanded to require periodic reporting by all publicly held companies with securities traded in the over-the-counter markets, Congress subjected banks to the new requirements but conferred jurisdiction over the

reporting obligations of banks and thrifts on their respective regulators.

Section 12(i) contains an assumption that banks and thrifts should be treated differently from other public companies. If that assumption ever justified the separate

treatment of banks and thrifts found in Section 12(i), it no longer does. The resulting fragmented reporting structure creates a barrier to the flow of meaningful, comparable information about publicly held companies. Section 12(i) perpetuates, for a

small number of Exchange Act registrants, an arrangement that permits differences

in the interpretation, administration, and pattern of enforcement of the securities

disclosure laws. This arrangement unnecessarily limits the flow of full, comparable,

and accurate information to our financial markets.

The legislative history of Section 12(i) reflects a tacit subordination of the interests of public investors, who depend for their protection upon readily accessible and

uniform periodic disclosure of financial and other material results, to the interests

of banks. The effect of the provision is to involve bank regulatory agencies in a dif94

19 Reports of publicly held banks and thrifts are not available to the public through EDGAR because they are not filed with the Commission. 20Figure includes proceedings involving banks, bank holding companies, thrifts, and state sav- ings banks. 21Michael P. Malloy, The 12(i)’ed Monster: Administration of the Securities Exchange Act of

1934 by the Federal Bank Regulatory Agencies, 19 Hofstra L. Rev. 269, 285 (1990). 22 Blueprint for Reform: The Report of the Task Group on Regulation of Financial Services,

July 1984, at 91. 23 Although the Treasury’s proposal was not introduced as a separate piece of legislation, a

hearing was held by the House Banking Committee on the Treasury’s proposal on June 3, 1997. 24See, e.g., Testimony of Arthur Levitt, Chairman, U.S. Securities and Exchange Commission,

Concerning H.R. 10 ‘‘The Financial Services Act of 1999,’’ Before the Subcomm. on Finance and

Hazardous Materials of the House Comm. on Commerce (May 5, 1999); Testimony of Arthur

Levitt, Chairman, U.S. Securities and Exchange Committee, Concerning Financial Modernizaficult and potentially dangerous conflict between their efforts to protect the banking

system and the deposit insurance fund, on the one hand, and the integrity of the

public securities market, on the other. This conflict becomes greatest at the very moment when a bank is in trouble and an investor’s need-to-know becomes most urgent. In such moments, the first casualty is apt to be market discipline, with its

corollary principle of prompt disclosure. Section 12(i) in operation has had some anomalous results. First, Section 12(i)

makes it difficult for many investors to know where to find the reports of a particular financial institution. Investors must first know the institution’s organizational structure and details of its business operations—for example, whether it is

owned by a holding company or not; whether it is a bank or a thrift; whether it

is a state bank or a national bank; whether it is a member bank or a non-member

bank.19

Second, even when investors can locate financial institution reports under the current system, they may be unable to make meaningful use of the information they

find. Whenever five agencies, rather than one, have responsibility for interpreting

and administering a single body of law, differences among interpretations are likely

to result.

Third, the current allocation of jurisdiction under Section 12(i) requires each of the four federal banking agencies to maintain a separate securities disclosure staff.

It is unnecessarily duplicative and inefficient to have ‘‘mini-SECs’’ at the four banking agencies. Fourth, enforcement is hampered. The fact that enforcement of the Exchange Act can only be, at best, a secondary focus for banking regulators is indicated by the

raw numbers of securities enforcement actions filed by the respective agencies over

the last few years. From fiscal year 1988 through fiscal year 1997, the Commission

commenced 36 injunctive and administrative proceedings involving depository institutions.20 The banking agencies, by contrast, have brought relatively few securities enforcement cases.

The Commission notes that the 12(i) model for regulation of bank issuer reporting has not achieved the objectives of the federal securities laws. Notably, one commentator has stated that ‘‘final action by the [banking] regulators in promulgating ‘substantially similar’ Exchange Act rules has been delayed in some cases over five

years after pertinent SEC amendments have been issued.’’ 21

As the Subcommittee may be aware, the Commission has long advocated repeal of Section 12(i) of the Exchange Act. The Commission’s position is part of a broad

consensus that Section 12(i) should be repealed. In 1984, the Bush Task Group on

Regulation of Financial Services proposed repeal of Section 12(i): The registration requirements of the Securities Act of 1933 should be made applicable to publicly offered securities of banks and thrifts (but not deposit instruments), and administration and enforcement of disclosure and other requirements of the Securities Exchange Act of 1934 for bank and thrift securities

should be transferred from the bank and thrift regulatory agencies to the SEC,

as is currently the case for securities of all other types of companies (including

bank and thrift holding companies).22

The report was signed by, among others, the Comptroller of the Currency, the

Chairman of the FDIC, and the Chairman of the Board of Governors of the Federal

Reserve System. In addition, more recently, in 1997, the Department of the Treasury’s proposal for Glass-Steagall reform also included a provision repealing Section

12(i).23

IV. CONCLUSION

The Commission has testified many times during the past decade in support of

financial modernization.24 Whatever version of financial modernization legislation is
95

tion Legislation Before the Senate Comm. on Banking, Housing, and Urban Affairs (Feb. 24,

1999); Testimony of Harvey J. Goldschmid, General Counsel, U.S. Securities and Exchange

Commission, Concerning H.R. 10, The ‘‘Financial Services Act of 1999,’’ Before the House Comm.

on Banking and Financial Services (Feb. 12, 1999); Testimony of Arthur Levitt, Chairman, U.S.

Securities and Exchange Commission, Concerning H.R. 10, The ‘‘Financial Services Act of 1998,’’

Before the Senate Comm. on Banking, Housing, and Urban Affairs (June 25, 1998). For additional Commission testimony prior to 1998, see note 16 of Testimony of Arthur Levitt, Chairman, U.S. Securities and Exchange Commission, Concerning H.R. 10 ‘‘The Financial Services

Act of 1999,’’ Before the Subcomm. on Finance and Hazardous Materials of the House Comm.

on Commerce (May 5, 1999).

finally enacted, as the nation’s primary securities regulator, it is critical that the

Commission be able to continue to fulfill its mandate of investor protection and to

safeguard the integrity, fairness, transparency, and liquidity of U.S. capital markets. The Commission cannot ensure the integrity of U.S. markets if it is only able

to supervise a portion of the participants in those markets. Neither can it ensure

fair and orderly markets if market participants operate by different rules and investors receive different levels of protection.

COMPTROLLER OF THE CURRENCY

July 8, 1999

The Honorable TOM BLILEY

Chairman

Committee on Commerce

U.S. House of Representatives

Washington, D.C. 20515-6115

DEAR CHAIRMAN BLILEY: This letter responds to the questions you raised in a let- ter dated June 25, 1999, following the Subcommittee on Oversight and Investigations’ hearing on operating subsidiaries. Each question is listed below followed by

our response.

Question 1: How much money did investors lose in the NationsBank operating subsidiary fraud? Answer: We do not know the exact amount of money investors lost as a result of their investments in the 2003 and 2004 Term Trusts. It is our understanding,

however, that NationsBank and NationsSecurities contributed approximately $60

million in reimbursement and compensation to investors in the 2003 and 2004 Term

Trusts.

Question 2: Did NationsBank own the operating subsidiary? Answer: NationsBank of North Carolina, N.A. (the ‘‘Bank’’), through its wholly owned operating subsidiary, NationsBanc Enterprise, Inc. (‘‘NBEI’’), owned a 50 percent interest in NationsSecurities. At all times relevant to the sales of the Term

Trusts, NationsSecurities was jointly owned by NBEI and Dean Witter. Question 3: Are the profits and losses of the operating subsidiary represented in the bank’s GAAP Accounting statements? Answer: Yes. Fifty percent of profits and losses arising from NBEI’s joint owner- ship interest in NationsSecurities would have been represented in the Bank’s accounting statements under the equity method of accounting. Under this method,

losses would generally be limited to the amount of the Bank’s investment in

NationsSecurities.

Questions 4-6: Do the officers of NationsBank have the authority to supervise the operating subsidiary? Do they have the duty to supervise the operating subsidiary?

Does the OCC require banks to supervise their operating subsidiaries? Answers: NationsBank has the authority to oversee the activities of the operating

subsidiary and in fact the OCC requires oversight by a national bank of its operating subsidiaries. The Comptroller’s Handbook—Large Bank Supervision (July

1998) provides that in order to properly identify, manage and monitor risks, ‘‘a bank

must recognize and understand existing risks or risks that may arise from new business initiatives, including risks that originate in nonbank subsidiaries and affiliates.’’ The Handbook also states that ‘‘[f]or large, complex companies, monitoring

[risk] is essential to ensure that management’s decisions are implemented for all geographies, products, and legal entities.’’ The attached 1993 approval letter for the

NationsBank-Dean Witter Joint Venture includes additional details regarding the

level of oversight of NationsSecurities by the Bank under this arrangement. Question 7: Did NationsBank receive customer complaints about activities in the

operating subsidiary? Answer: Yes.

Questions 8-9 Did the OCC interview any person who made complaints as part

of its investigation of the operating subsidiary fraud? How many?
96

Answers: As the primary regulator of the Bank, our review focused upon the role of the Bank in this matter and we did not interview the customers of the brokerdealer subsidiary. In conducting its review, the OCC considered customer complaints that were filed directly with the OCC as well as complaints that were submitted by customers to the Bank and information about particular investors obtained pursuant to customer suitability procedures. In addition, OCC staff reviewed

notes taken by SEC staff attorneys during their telephone interviews of Bank customers as well as transcripts of depositions taken by state, federal, and self-regulatory organizations of NationsSecurities employees who sold the Term Trusts to the

investing public.

Question 10: Why did you interview no victims. How can you do an investigation if you only interview the people supervising the fraud? Answer: Because the transactions at issue were effected by a broker-dealer affili- ated with the Bank and not the Bank itself, the primary regulators of the brokerdealer conducted the interviews with the affected customers of that firm. The OCC

relied upon information obtained through bank examinations, which reviewed bank

policies, procedures, internal bank records, and customer complaints. In addition,

the OCC reviewed information concerning individual investors and obtained access

to notes of telephone interviews conducted by the SEC and deposition transcripts

of NationsSecurities sales representatives taken by state, federal and self-regulatory

organizations. The OCC did not need to duplicate the efforts of the SEC and others

in this area.

The information and documentation collected by the OCC established that the Term Trusts were marketed in a manner that violated Condition 4 of the Approval

Letter. Condition 4 required that NationsSecurities not mislead or deceive customers as to the products’ uninsured nature and lack of guarantee by either the

Bank or NationsSecurities.

Question 11: What were the assets of NationsBank at the time of the operating subsidiary fraud? Answer: As of December 31, 1993, the Bank’s assets were approximately $25 bil- lion. (At that time, the assets of the holding company were approximately $160 billion.)

Question 12: What was the compensation of CEO Hugh McColl, including stock options, that year? Answer: According to the March 25, 1996, proxy materials filed by the holding company with the SEC, Mr. McColl, who was Chairman and CEO of the holding

company, received in 1993 a salary of $800,000, a bonus of $1,800,000, and other

compensation of $183,042. In 1994, Mr. McColl received a salary of $900,000, a

bonus of $2,100,000, restricted stock awards valued at $10,725,000, and other compensation of $203,298. The proxy materials provide additional explanation about the

specifics of Mr. McColl’s compensation.

Question 13: How much did defrauded investors recover in private lawsuits

against the NationsBank operating subsidiary?

Answer: Please see Answers 1 and 15.

Question 14: How much did the OCC fine NationsBank for failure to supervise

and control its operating subsidiary?

Answer: The OCC assessed a $750,000 civil money penalty against the Bank.

Question 15: How can a $750,000 fine have a deterrent effect on a $100 billion

entity?

Answer: The OCC’s fine was only one element of the penalties, sanctions and remedial actions resulting from the sales of the Term Trusts. Importantly, as a result

of OCC intervention as part of its supervision of the Bank, the Bank was directed

to take and did take significant corrective actions with respect to the activities of

NationsSecurities. These remedial actions, together with the actions brought against

NationsSecurities and the Bank by private litigants, state and federal securities regulators, and the OCC relating to the sales practice abuses, and the attendant adverse publicity, should together serve as a powerful deterrent against similar misconduct. We note that NationsSecurities and/or the Bank paid in excess of $59 million to settle private actions, $1.375 million to resolve actions brought by state securities regulators, $2 million to settle an action brought by the NASD, $4 million to

settle an action brought by the SEC, and $750,000 to settle an OCC action, or a

total of approximately $67 million relating to these sales practice abuses.

Questions 16-17: Why was NationsBank given a satisfactory rating the year of the

operating subsidiary fraud? How is defrauding elderly people out of over $100 million satisfactory?

Answer: As I said in response to a question at the hearing, the rating is a composite rating based on the ‘‘CAMEL’’ rating system used by all the bank regulators.

The components of the rating refer to a bank’s capital, assets, management, earn97

1 Customer lists of the Partnership also will be accorded confidential treatment by the Partners, including DW, and, except for customers who have a relationship with a Partner or its

affiliate outside of the Partnership, will not be provided by a Partner to any affiliate or other

third party other than in connection with services provided to the Partnership. 2We understand that this also will be true of any other employees of the Partnership previously employed by the Bank, DW or their affiliates.

ings, and liquidity, and are evaluated on a bankwide basis. A bank’s rating will also

be affected by whether any identified problems or weaknesses have been corrected

by a bank. As I also said at the hearing, the conduct at issue was deplorable, but

we do not give separate ratings to bank subsidiaries and affiliates.

I hope this information is helpful to you. Please contact me if you have any additional questions.

Sincerely,

JULIE L. WILLIAMS

Chief Counsel

April 9, 1993

Interpretive Letter No. 622

Mr. PAUL J. POLKING

NationsBank Corporation

Legal Department

NationsBank Corporate Center

Charlotte, North Carolina 28255-0065

Re: NationsBank of North Carolina, N.A., Operating Subsidiary Notice; Control

Number 92 ML08010

DEAR MR. POLKING: This letter responds to the notification filed on October 26,

1992, on behalf of NationsBank of North Carolina, N.A. (‘‘Bank’’) pursuant to 12

C.F.R. § 5.34, of the Bank’s intent to establish a wholly-owned operating subsidiary

(‘‘Subsidiary’’) to participate, as a general partner, in a proposed general partnership

(‘‘Partnership’’) with a subsidiary of Dean Witter Financial Services Group (‘‘DW’’).

The Partnership will be created pursuant to a joint venture agreement (‘‘Joint Venture’’) between the Bank and DW relating to the sale, on a retail basis through the

partnership of various types of investment products, including securities and annuities.

Based on the information and representations in the Bank’s notification letter, accompanying legal memorandum, supplemental documentation, and other materials,

we conclude that the proposed activities are permissible for national banks and

their operating subsidiaries and are consistent with prior opinions of the Office of

the Comptroller of the Currency (‘‘OCC’’). Accordingly, the Bank may implement its

proposal pursuant to 12 C.F.R. § 5.34, based on the facts as described and in accordance with all the representations made in the submitted materials. This determination also subjects the Bank, the Subsidiary, and the Partnership to all the conditions set forth in this letter.

THE BANK’S PROPOSAL

Under the proposal, the Bank’s Subsidiary and a newly established subsidiary of

DW will enter into a general partnership, each with a fifty (50%) percent interest.

The Partnership will be a separate and distinct entity from the Bank, DW, and their

affiliates. The Partnership will not provide or permit access to a partner of confidential and proprietary information received from the other partner or any of its affiliates.1 As such, DW will not have direct access to Partnership customers.

The day-to-day business of the Partnership will be managed by a chief operating

officer who will have the authority to make decisions within operating guidelines

set forth in the Partnership agreement. The initial chief operating officer will be a

former senior officer of DW or an affiliate thereof, and the next ranking officer will

be a former senior officer of NationsBank Corporation (‘‘NBC’’) or a subsidiary thereof. The chief operating officer and next ranking officer will completely sever their

previous employment relationships with DW or its affiliates, and the Bank or its

affiliates, respectively. These individuals will be employed exclusively by the Partnership.2 The Partnership agreement will specify that all major decisions of the

Partnership and any changes in the operating guidelines must be approved by both

Partners. Each partner in effect has veto power over actions proposed by the other

partner. Accordingly, the Subsidiary could not be precluded by the other partner
98

3The Subsidiary’s principal office also will be located in Charlotte, North Carolina.

4The Bank states that the Partnership will not be registered as an investment advisor under the Investment Advisors Act of 1940, as the advice provided by the Partnership will be incidental to the conduct of its brokerage business and the Partnership will not receive special compensation for providing such advice. See 15 U.S.C. § 80b-2(a)(11). 5The Bank represents that the Partnership will not act as a ‘‘principal’’ in connection with

any investment products. However, as part of its brokerage activities, the Partnership may engage in so-called ‘‘riskless principal’’ transactions, whereby the Partnership on behalf of a customer may effect the purchase and sale of a security on a principal basis but only if it can conduct a concurrent offsetting sale and purchase of the same security with another party. In no

event will the Partnership maintain an account for the purchase and sale of securities on its

own behalf or initiate an order or hold the securities for its own account. 6The fixed and variable annuities sold may be issued/underwritten by an insurance company affiliated with DW, although unaffiliated with the Subsidiary or the Bank. 7The funds are sponsored and distributed by an independent party.

from having the Partnership’s operations and activities conform to the national

banking laws, including any condition imposed pursuant to 12 C.F.R. § 5.34.

The Partnership agreement will fully delineate the activities of the Partnership, which activities will be limited to those permissible for a national bank or its operating subsidiary. Further, the Partnership agreement will provide that the Partnership will be subject to full OCC regulation, supervision and examination, including

an undertaking by the Partnership to cease engaging in any activity which the OCC

formally determines not to be permissible. While the Partnership contemplates an

initial five year term, certain events, such as an adverse regulatory decision, could

trigger an earlier termination of the Partnership. Under the submitted proposal, the

Partnership will not own or control any subsidiaries. If the Partnership intends or

proposes such ownership or control of subsidiaries in the future then the OCC would

require the submission of a notice pursuant to 12 C.F.R. § 5.34.

The proposed name of the Partnership is ‘‘Nations Securities, a Dean Witter/

NationsBank Company.’’ The principal executive office of the Partnership will be located in Charlotte, North Carolina,3 however, the Partnership will establish offices

at other NBC locations, including branch offices of bank subsidiaries of NBC, and

other locations. The Bank has assured us that various efforts will be made by the

Partnership to promote separateness between the Bank’s operations and those of

the Partnership. In particular, the Bank has represented that the Partnership office

typically will be segregated by panels, planters, walls or similar physical elements.

Each Partnership office will be separately identified as an office of the Partnership

through appropriate signs, which will include the Partnership’s name and logo. The

Partnership’s logo will be distinct from the logo of the Bank. The Partnership also

will have different telephone numbers.

The Partnership will be registered as a broker/dealer under the Securities Ex- change Act of 1934 (‘‘Act’’) and under applicable state securities laws. The Partnership also will be a member of the National Association of Securities Dealers, Inc.

(‘‘NASD’’) and a licensed insurance agent to sell fixed and variable annuities in

states where so required.4 The Partnership will be subject to all applicable require- ments of the federal securities laws and the Rules of Fair Practice of the NASD.

PROPOSED ACTIVITIES OF THE PARTNERSHIP

The Bank Program

The business of the Joint Venture will consist initially of the Bank Program and subsequently of the Syndication Program. The Bank Program will consist of sales,

entirely on an agency basis, to existing customers and new customers of the Bank

and DW or their subsidiaries.5 The brokerage activities of the Partnership will in- volve primarily the sale of ‘‘packaged products,’’ such as mutual funds, fixed and

variable annuities,6 unit investment trusts, and equity and fixed income securities. The mutual funds sold will include funds advised by the Bank and its affiliate

banks,7 mutual funds sponsored, distributed and advised by DW and its affiliates, and mutual funds sponsored, distributed and advised by parties not affiliated with

either the Bank or DW. The compensation received by the Partnership for its brokerage activities will be consistent with that customarily received by an agent and

not that of a principal or dealer. Nor will Bank employees receive direct compensation for referring customers to the Partnership based upon completed sales. The Partnership also may provide investment advice to customers in connection with the purchase and sale of the investment products. The ultimate investment decision, however, will rest exclusively with the customer. The Partnership will not

have any accounts over which it has discretionary authority. The Partnership may,

in a manner consistent with all applicable rules governing broker/dealers in such

circumstances, recommend or suggest certain mutual funds. If it is the case with
99

8 In addition, the Bank has represented that internal policies and procedures concerning appropriate disclosures may be adopted with respect to particular products. 9 If the Partnership determines to recommend any DW or Bank product in which either has

a financial interest, the Bank has given assurances that the Partnership representative will be

mindful of suitability requirements and will confirm that the nature of the financial interest of

DW or the Bank in such products has been disclosed to the customer.

any such recommended mutual fund, customers will be advised that the Bank or

an affiliate is the advisor to the mutual fund.

In addition, the Bank has represented that the Partnership will not provide brokerage services to the Bank’s trust account customers or Bank customers with other

fiduciary relationships, except where explicitly authorized by the customer and in

accordance with all applicable laws, including the applicable provisions of 12 C.F.R.

Part 9 and interpretations thereunder. Further, if the Partnership provides any

services to Keogh accounts, self-directed individual retirement accounts, or other

similar accounts of the Bank, such activities will be consistent with prior OCC

precedents requiring specific customer authorization and full disclosure of the arrangements, including fees or commissions. See Trust Interpretive Letter No. 88

(March 24, 1987); Interpretive Letter No. 302 (February 21, 1984), reprinted in

[1985-87 Transfer Binder] Fed. Banking L. Rep. (CCH) ¶ 85,472. We also remind the

Bank of its fiduciary obligations under state law and pursuant to the OCC’s selfdealing regulation, 12 C.F.R. § 9.12, which reflects a trustee’s duty of loyalty, a basic

principle of trust law. As such, the Bank must carefully consider all applicable laws

with respect to the purchase in a fiduciary capacity of any products underwritten

by DW or other products in which DW has an interest.

The Partnership will provide full disclosure to insure that customers who purchase on bank premises are not confusing the investment products with insured deposits. The information provided by the Partnership will advise customers that the

products are not endorsed or guaranteed by, and do not constitute obligations of,

the Partnership, the Subsidiary, the Bank, or their affiliates, and that the products

are not insured by the Federal Deposit Insurance Corporation (‘‘FDIC’’). The Partnership also will provide disclosure to customers explaining the relationship of the

Partnership and the products that it sells, to the Bank and its affiliates and to DW

and its affiliates. The Bank has represented that customers will receive these disclosures in several ways, including (1) disclosures built into the customer account

agreements or additional disclosure documents provided when the customer relationship is initiated; (2) in connection with a particular product, disclosures in the

prospectus, sales literature, or other materials;8 (3) verbal disclosures and explanations by the sales staff;9 and (4) confirmations to customers of the securities

transactions in accordance with securities laws.

In particular, with respect to mutual funds, customers will be fully informed if

the Bank or an affiliate is an advisor to a fund or if DW or an affiliate is a sponsor/

distributor or advisor to a fund. Similarly, regarding annuities, customers will be

fully informed if the products are issued or underwritten by a company affiliated

with DW or an affiliate. Similar to recent OCC precedents relating to annuities activities, as a condition of this approval, a signed statement will be obtained from

a customer prior to the purchase of any non-deposit investment product indicating

that the customer understands the nature of the investment product being purchased. See Interpretive Letter No. 499 (February 12, 1990), reprinted in [1989-90

Transfer Binder] Fed. Banking L. Rep. (CCH) ¶ 83,090.

The Bank has described various plans which may be put into effect to market the

Partnership’s services. These include making lobby materials on the Partnership

available to Bank customers; putting advertisements in newspapers; sending statement stuffers; and providing other descriptions of the variety of services that are

available. The Bank points out that these marketing tools are the same as those

currently in use by the Bank’s brokerage subsidiary, NationsBank Securities, Inc.

(‘‘NSI’’), and will be in conjunction with all the disclosures and representations previously discussed. All such marketing activities by the Partnership and any by the

Bank would seek to minimize the possibility of customer confusion with respect to

the products being offered and the relationship between the entities. For example,

all sales materials will clearly describe the relationship between the Partnership,

the Bank, and DW and its affiliates. Further, the confidentiality requirements between the involved entities and the restrictions of the sharing of customer lists will

apply. The Bank has indicated that it does not plan on specific references to DW

products in the materials describing the Partnership and, instead, emphasizes that

its marketing will focus on the Partnership rather than DW.
100

10This includes being deemed a ‘‘principal underwriter’’ under the Investment Company Act

of 1940 of any mutual fund it sells because the Bank represents that the Partnership will not

be in privity of contract with any mutual fund. See 15 U.S.C. § 80a-2(a)(29). 11 Bank counsel has represented that DW currently engages predominantly in retail brokerage

and only conducts limited underwriting activities. 12 As you know, however, insurance industry trade groups have filed suit in federal court challenging the OCC’s approval of the sale of fixed rate annuities by national bank operating subsidiaries. See Variable Annuity Life Insurance Co. [VALIC] v. Clarke, 786 F. Supp. 639 (S.D.

Tex. 1991); National Association of Life Underwriters v. Clarke, 761 F. Supp. 1285 (W.D. Tex.

1991). While the lower court decision in VALIC upheld the OCC’s approval, this case presently

is on appeal. The final resolution of this litigation could result in a different outcome and possibly affect the Partnership’s ability to engage is such activities.

The Bank has represented that the Partnership will not be deemed an underwriter or dealer within the meaning of any provision of the federal securities laws.10

The Partnership is prohibited from acting as a sponsor or distributor of any of the

mutual funds it sells as agent. Moreover, the Partnership will have no obligation

to sell any securities which DW or any of its affiliates underwrite or participate in

underwriting in any way, serve as a market maker in, or hold in any principal position.11 With respect to securities underwritten by DW or its affiliates, the Partner- ship will not participate in any underwriting activities, or act as a selling group

member, and will only act in the same capacity as any other broker/dealer not engaged in the underwriting. While it is contemplated that DW or an affiliate will provide the Partnership certain clearing services, these services will be of a type customarily provided by a clearing broker and consistent with general brokerage industry practices. The Partnership and the DW affiliate acting as clearing broker, as

registered broker/dealers, will be subject to the requirements of the federal securities laws, as well as the Rules of Fair Practice of the NASD, regarding their respective activities.

THE SYNDICATION PROGRAM

The Partnership also plans on entering into arrangements with other unaffiliated depository institutions in the future to operate essentially a third-party managed securities and annuities program at the branch locations of those depository institutions. The Syndication Program will involve generally the same brokerage and investment advice activities as described above in connection with the Bank Program.

All activities in connection with the Syndication Program will be permissible for national banks and their subsidiaries. Clear identification and disclosure will be made

to customers that the Partnership and the depository institution are separate businesses, that the employees of the Partnership are not employees of the depository

institution, that the products being offered are not obligations of the institution and

are not FDIC insured. In addition, the same disclosures with respect to the Bank

Program discussed above will be made to customers concerning the relationship of

the Partnership, the Bank, or DW, to the products themselves.

As in leasing arrangements previously approved by the OCC with unaffiliated tenants, the Partnership contemplates leasing space at branch locations of these depository institutions on a ‘‘gross receipts’’ basis. In the event the Partnership intends

to engage in any new activities with respect to the Syndication Program, the OCC

would require submission of a notice pursuant to 12 C.F.R. § 5.34.

We understand that the operations of the Bank, the Subsidiary, and the Partnership will be conducted in accordance with all applicable laws and regulations. The

Bank, the Subsidiary, and the Partnership also will be expected to conduct these

activities in a prudent manner, consistent with safe and sound banking practices.

DISCUSSION

National banks may choose to engage in activities which are part of or incidental

to banking by means of an operating subsidiary. See 12 C.F.R. § 5.34(c). The activities to be conducted by the Subsidiary through the Partnership are permissible

banking and securities activities and are consistent with previous opinions of the

OCC.

It is well-established that national banks and their subsidiaries may perform brokerage services for their customers. See e.g., Securities Industry Association v.

Comptroller of the Currency, 557 F. Supp. 252 (D.D.C. 1983), aff’d per curiam, 758

F.2d 739 (D.C. Cir. 1985), cert. denied, 474 U.S. 1054 (1986) (brokerage issue), rev’d,

479 U.S. 388 (1987) (branching issue) (‘‘Security Pacific’’). The Glass Steagall Act

(‘‘GSA’’) permits securities brokerage activities by national banks including the purchase and/or sale, as agent, of shares in mutual funds, units in unit investment

trusts, or annuities.12 See e.g. Interpretive Letter No. 499 (February 12, 1990), re101

printed in [1989-90 Transfer Binder] Fed. Banking L. Rep. (CCH) ¶ 83,090; Interpre- tive Letter No. 403 (December 9, 1987), reprinted in [1988-89 Transfer Binder] Fed.

Banking L. Rep. (CCH) ¶ 85,627; Interpretive Letter No. 386 (June 19, 1987), re- printed in [1988-89 Transfer Binder] Fed. Banking L. Rep. (CCH) ¶ 85,610; Interpre- tive Letter No. 363 (May 23, 1986), reprinted in [1985-87 Transfer Binder], Fed.

Banking L. Rep. (CCH) ¶ 85,533. Moreover, the OCC has permitted bank operating subsidiaries to engage in riskless principal brokerage. See Interpretive Letter No.

371 (June 13, 1986), reprinted in Fed. Banking L. Rep. (CCH) ¶ 85,541. The combination of investment advice and brokerage services in the same subsidiary also

has been previously approved by the OCC. See e.g., Interpretive Letter No. 403,

supra; Interpretive Letter No. 386, supra.

The conduct of these activities for national banks through a partnership structure also is permissible. In prior instances, the OCC has permitted the subsidiary of a

national bank to enter into a general partnership with another general partner, so

long as the partnership will engage only in activities that are permissible for a national bank. See e.g., Interpretive Letter No. 516 (July 12, 1990), reprinted in [1990-

91 Transfer Binder] Fed. Banking L. Rep. (CCH) ¶ 83,220; Interpretive Letter No. 411 (January 20, 1988), reprinted in [1988-89 Transfer Binder] Fed. Banking L. Rep. (CCH) ¶ 85,635; Interpretive Letter No. 289 (May 15, 1984), [1983-84 Transfer Bind- er] Fed. Banking L. Rep. (CCH) ¶ 85,453. Moreover, the OCC has not objected to op- erating subsidiary notices involving joint venture/partnership proposals between national bank subsidiaries and subsidiaries of investment banks. See Interpretive Letter No. 516, supra; OCC Letter from J. Michael Shepherd to Kenneth L. Bachman, Jr. (March 26, 1990); Interpretive Letter No. 411, supra. As in these earlier letters,

the partnership structure poses no problems provided certain conditions are met.

See id.

As discussed in detail in earlier letters involving partnerships between bank oper- ating subsidiaries and investment banks or subsidiaries thereof, and analogous

here, the proposed Partnership would not be prohibited by section 20 of the GlassSteagall Act, 12 U.S.C. § 377, or section 32 of the Act, 12 U.S.C. § 78. See Interpretive Letter No. 516, supra; Interpretive Letter No. 411, supra. Section 20 provides

that a member bank shall not be affiliated in any manner described in 12 U.S.C.

§ 221a with a business organization engaged principally in the issue, flotation, underwriting, public sale or distribution of securities. Assuming arguendo that DW is

so engaged, since no affiliation under section 221a will occur, the proposed Partnership would not cause the Bank to become affiliated with DW or its subsidiaries in

any manner prohibited by section 20. Section 32 provides that no officer, director,

or employee of any business organization primarily engaged in the issue, flotation,

underwriting, public sale or distribution of securities shall serve at the same time

as an officer, director or employee of a member bank. Under the proposed Partnership, no Bank officer, director or employee will serve as such in the parent investment bank and no investment bank officer, director or employee will serve as such

in the Bank; thus, there are no prohibited relationships. See id.

While certain Partnership employees previously may have been employees of the

Bank, DW, or their affiliates, the Bank has represented that no Partnership employees will concurrently be directors, officers, or employees of either the Bank, DW, or

their respective affiliates. The OCC has taken the position that a partnership’s management and staff are not ordinarily attributed to the parent firms of the business

entities involved. See id.

The Syndication Program feature of the Bank’s proposal also is permissible for national banks and their operating subsidiaries under the facts described. The OCC

has approved percentage leasing where an unaffiliated tenant makes its services or

products available, through its own employees, on bank premises. See e.g., Interpretive Letter No. 533 (October 5, 1990), reprinted in [1990-91 Transfer Binder] Fed.

Banking L. Rep. (CCH) ¶ 83,244; Interpretive Letter No. 406 (August 4, 1987), reprinted in [1988-89 Transfer Binder] Fed. Banking L. Rep. (CCH) ¶ 85,630. The

Partnership will conduct the Syndication Program’s activities in accordance with

previous precedents and will maintain the Partnership’s operations separate from

those of the other unaffiliated depository institutions.

Further, the Bank’s proposal is consistent with branching limitations on national

banks. See 12 U.S.C. § 36; Securities Industry Association v. Comptroller of the Currency, 577 F. Supp. 252 (D.D.C. 1983), aff’d per curiam, 758 F.2d 739 (D.C. Cir

1985), cert. denied, 474 U.S. 1054 (1986) (brokerage), rev’d, 479 U.S. 388 (1987)

(branching). While the Partnership need not limit its brokerage activities to its parent bank’s branch locations, to the extent the Partnership is required to perform any

activity at a bank branch location, it represents that it will do so.

While the OCC has carefully considered the potential for customer confusion or

misunderstanding inherent in the Bank’s proposal, the Bank has provided that mul102

13These conditions are deemed to be ‘‘conditions imposed in writing by the agency in connection with the granting of any application or other request’’ within the meaning of 12 U.S.C.

§ 1818.

tiple opportunities will exist for the appropriate disclosures to customers concerning

the nature of the products being sold and the relationship of the involved entities

to the products. Specifically, the Bank has represented that disclosures on mutual

funds and annuities will conform with those required in previous OCC opinions. The

conditions relating to disclosures to customers and compliance with state laws imposed in the recent letters are, likewise, imposed on the Partnership as well as the

Bank and its operating subsidiary.13 See e.g., Letter from J. Michael Shepherd, Senior Deputy Comptroller for Corporate and Economic Programs (March 20, 1990)

(fixed and variable annuities); Interpretive Letter No. 403, supra (mutual funds and

unit investment trusts); see also Letter from William P. Bowden, Jr., Chief Counsel

(October 14, 1992).

Given the nature of the joint venture proposed by the Bank, the OCC is particularly concerned that bank customers understand that products being offered or recommended by the Partnership are uninsured, not obligations of the Bank or the

Partnership, and not deposit substitutes and that in some instances the Bank or

DW or their affiliates may have a relationship to and a financial interest in the

products themselves. The OCC cautions the Partnership to use special care in ensuring that the interests of customers are protected and that customers are able to

evaluate any potential conflicts of interest that may exist when a DW product is

sold or recommended. As stated earlier, the Bank has represented that the Partnership will comply with all applicable disclosure requirements under the federal securities laws, the Rules of Fair Practice of the NASD, previous OCC precedents, and

any state securities laws requirements.

The Partnership’s activities are permitted subject to the conditions and representations as provided in this letter and based on the Bank’s assurances that full and

adequate information will be provided to the Partnership’s customers to ensure full

disclosure of the relationship with DW when the Partnership recommends a DW

product. Please be advised that if compliance difficulties arise related to this activity

(including any evidence that customers were unaware of or did not understand the

relationships involved), the OCC may impose additional limitations on the Partnership’s activities with respect to DW products.

SUPERVISORY CONDITIONS

The OCC’s approval of the Bank’s operating subsidiary notice is subject to the following conditions, in addition to the representations and conditions specified in your

notification letter and other materials:

(1) The Partnership shall disclose to customers at the time an account is established that the investment products offered by the Partnership (a) are not FDIC insured; (b) are not obligations of the Bank or the Partnership; (c) are not guaranteed

by the Bank or the Partnership; and (d) involve investment risks, including possible

loss of principal. These disclosures shall be provided using the above language or

substantially similar language. The Partnership shall also obtain at the time an account is established a signed statement acknowledging that the customer has received and understands the above disclosures.

(2) The disclosures described in condition (1) above also must be conspicuously

disclosed to customers in all written sales presentations, advertising and promotional materials, confirmation forms, and periodic statements.

(3) The Partnership shall provide full disclosure to customers at the time an account is established explaining the relationships between the Partnership, the Bank,

and DW, and the products sold by the Partnership, and also shall disclose that from

time to time the products offered by the Partnership may involve entities having

other relationships, including lending relationships with the Bank and DW.

(4) The Partnership may not offer uninsured investment products with a name

identical to the Bank. The Partnership’s products may not be marketed in a manner

that would mislead or deceive consumers as to the products’ uninsured nature and

lack of any guarantee by the Bank or the Partnership.

(5) The Partnership will maintain an operations manual and other written materials addressing the conduct of retail sales activities of the Partnership, which will

be made available for OCC review. Customer suitability judgment procedures and

compliance with 12 C.F.R. Part 9 conflict of interest prohibitions should be emphasized.

(6) The Subsidiary will be adequately capitalized.
103

14 Neither the Bank nor the Partnership will be obligated or committed to extend credit to

any customer of the Partnership for purposes of purchasing any product through the Partnership. All credit so extended will be on an arm’s length basis and consistent with safe and sound

banking.

(7) The Partnership will be managed to minimize the risk of piercing the corporate veil.

(8) The Partnership agreement will fully delineate the activities of the Partnership.

(9) The Bank, through the Subsidiary, will have veto power over the activities of

the Partnership and its major decisions.

(10) The Partnership will be subject to OCC regulation, supervision and examination.

(11) The Bank’s aggregate direct and indirect investments in and advances to the

Subsidiary and the Partnership shall not exceed an amount equal to the Bank’s

legal lending limit.14

(12) The Bank must submit a notice to us pursuant to 12 C.F.R. § 5.34 if the Partnership at some future time decides to engage in new activities, i.e., activities not

covered by your current notice and our response thereto. This submission must be

made even though the activities have been found to be permissible for national

banks.

Please be advised that the conditions of this approval are deemed to be ‘‘conditions imposed in writing by the agency in connection with the granting of any application or other request’’ within the meaning of 12 U.S.C. § 1818.

CONCLUSION

Subject to the representations and conditions specified in your notification letter

and other submitted materials, as well as those in this response, the Bank may proceed with its proposal. This response is based solely on the facts as represented and

any changes in the facts might require a different result. Our analysis also reflects

current legal and prudential standards, and may be subject to revision as future developments warrant.

Sincerely,

FRANK MAGUIRE Acting Senior Deputy Comptroller

Corporate Policy and Economic Analysis