Opinion ID: 411108
Heading Depth: 1
Heading Rank: 3

Heading: application of the glass-steagall act

Text: 15 Taking account of appropriate deference to the Board's expertise and administrative responsibility, we find that its ruling and the reasoning which supports it are essentially correct. An inquiry into the language and legislative history of the statute, and the policies underlying it, supports the Board's conclusion that the commercial paper marketed by Bankers Trust is not a security within the Glass-Steagall Act.
16 Congress passed the Glass-Steagall Act in 1933, in response to what it perceived to be the abuses which resulted from the involvement of commercial banks in securities underwriting. Congress considered that commercial banks, by underwriting stocks, had fueled the rampant speculation that preceded the Great Depression. Congress' principal concern in amending the banking laws, however, was to protect the solvency and integrity of the banks themselves. 30 17 Stock underwriting by commercial banks undermined bank solvency in a number of ways. Most directly, commercial banks that engaged in underwriting tied up depositors' funds in the purchase of unsound or speculative securities. These investments placed commercial deposits at risk. 31 The promotional pressures exerted by underwriting activities also threatened bank solvency. To augment their commissions from securities sales, commercial banks used their credit facilities to lend to purchasers of securities. 32 Banks were also tempted to make unsound loans to client-issuers, because these loans might improve the balance sheet of these enterprises and thereby make their securities more marketable. When speculative ventures failed, these loans to purchasers and issuers were often not repaid, undermining bank solvency and depositor confidence in the banks. 33 18 In addition to inducing commercial banks to purchase unsound securities and to make unsound loans, banks' participation in the securities market had more indirect effects on bank solvency. Banks' association with speculative securities ventures undermine the confidence of bank depositors in the stability of the banks. 34 Moreover, banks which underwrote stock issues could not be relied upon to give prudent and disinterested investment advice to their depositors, for they naturally had an incentive to urge depositors to purchase shares of the issues the bank was underwriting. 35 Finally, these banks would also dump excess issues of unmarketable securities on their own trust departments. 36 19 Congress passed the Glass-Steagall Act to correct these abuses. The Act is a prophylactic measure designed to prevent commercial banks from being exposed to the dangers which inevitably followed upon their participation in investment banking. Congress acted to keep commercial banks out of the investment banking business largely because it believed that the promotional incentives of investment banking and the investment banker's pecuniary stake in the success of particular investment opportunities was destructive of prudent and disinterested commercial banking and of public confidence in the commercial banking system. 37
20 Congress accomplished the separation of commercial and investment banking in sections 16 and 21 of the Glass-Steagall Act. We first ask whether the language of these sections clearly evinces a congressional determination to prohibit the activities in which Bankers Trust has engaged; if so, our inquiry necessarily comes to an end. 38 21 Section 16 provides that a bank shall not underwrite any issue of securities or stock and shall not purchase ... for its own account ... any shares of stock of any corporation. 39 We can find nothing in the language of this section that explicitly articulates a congressional intent to bar commercial banks from trading in commercial paper. The terms securities and stock are not defined by the Act; section 16 in no way refers explicitly to notes, the generic financial term which Congress might have used to encompass commercial paper. 40 Indeed, banks are authorized to discount and negotiate promissory notes, drafts, bills of exchange, and other evidences of debt .... 41 It is clear, then, that section 16 does not prohibit banks from selling or underwriting all notes, but only securities or stock; and the section does not indicate whether the commercial paper at issue in this case is included within that statutory prohibition. 22 We turn then to section 21 of the Act, which forbids banks from underwriting stocks, bonds, debentures, notes, or other securities .... 42 Although this statutory provision explicitly refers to notes, that term is susceptible of at least two interpretations. First, it may refer to a specific type of long-term debt security, one that closely resembles a bond or debenture but is of shorter maturity. 43 A note in this sense, like a bond or a debenture, is issued under an indenture agreement to raise money available for an extended period of time as part of the corporation's capital structure. An investment note differs from these other instruments in that it matures more quickly--in a few, rather than twenty or more, years. 23 Second, the term notes is sometimes used generically to refer to any promissory instrument regardless of maturity or negotiability. 44 In this sense, commercial paper may also be referred to as a promissory note. Such a note differs sharply from an investment note: commercial paper is used to obtain short-term credit for current transactions, rather than capital funds for long-term projects. Its maturity generally ranges from one to two months, and rarely exceeds nine months. 45 24 The language of section 21 suggests that Congress intended only to prohibit the marketing of investment notes--i.e., that it intended to use notes in its more specific meaning. Each of the terms listed by Congress--stocks, bonds, debentures and notes--refers to a specific type of longterm investment security. 46 In contrast, notes in the more general sense would also include financial instruments, such as commercial paper, which have little in common with these long-term investment securities. 47 Moreover, notes used in its more general sense would include debt instruments such as bonds and debentures; the explicit statutory reference to the latter would then be redundant. 48 For these reasons, specific inclusion of the terms stocks, bonds, and debentures suggests that the narrower meaning of the term notes was intended. We conclude that the context in which the term notes is used strongly implies Congress' intent not to include commercial paper within the sweep of the Act's prohibition. 25 Both section 16 and section 21 thus demarcate a fundamental division between notes which represent commercial banking transactions--transactions which are, of course, permitted under the Act--and securities, such as investment notes, which commercial banks are prohibited from underwriting. Section 16 indicates this distinction by authorizing commercial banks to negotiate promissory notes, while forbidding banks to negotiate securities or stocks. Section 21 makes the distinction by barring banks from trading in specified instruments for raising capital as part of the permanent financial structure of a corporation--stocks, bonds, debentures and notes--while implicitly permitting transactions in other types of debt instruments. And the language of these sections, while not conclusive, strongly suggests that sale of commercial paper should be treated as a loan rather than a sale of securities for the purposes of the Act.
26 The distinction between commercial loans and securities emerges as well from an analysis of the legislative history. Throughout its debates on the causes of the imperiled state of the banking industry, Congress nowhere considered the banks' activity in the commercial paper market as contributing to their difficulties. 49 The commercial paper market was simply not part of the problem to which the Glass-Steagall Act was addressed. 50 Rather, Congress focused its attention on the commercial banks' participation in speculative securities markets: their extensive underwriting of long-term holdings of high risk stocks and bonds. 27 For example, the Senate Report on the Act notes that [t]he outstanding development in the commercial banking system during the prepanic period was the appearance of excessive security loans, and of over-investment in securities .... [A] very fruitful cause of bank failures ... has been the fact that the funds of various institutions have been so extensively 'tied up' in long-term investments. 51 Congress condemned the excessive use of bank credit in making loans for the purpose of stock speculation .... 52 In short, the purpose of the Act was to reverse a loose banking policy which had turned from the making of loans on commercial paper to the making of loans on security. 53 28 The distinction between bank participation in the securities and in the commercial paper markets is also illustrated in Congress' treatment of section 2(b) of the McFadden Act. 54 Section 2(b) limited the amounts of investment securities national banks could hold. 55 It is clear, however, that commercial paper was not considered an investment security under the McFadden Act: banks were left free to trade in commercial paper without restriction. 56 It is significant, therefore, that Congress preserved the provisions of the McFadden Act when it passed the Glass-Steagall Act six years later. 57 The legislative history of the Glass-Steagall Act provides no indication that Congress intended to change the McFadden Act's definition of investment security. 58 Moreover, it is unlikely that Congress would consider commercial paper to be a security but not an investment security. 59 Thus, Congress' incorporation of the McFadden Act into the revised banking laws, like other aspects of the legislative history, indicates an intent to continue to leave banks free to deal in commercial paper.
29 Plaintiffs suggest that we may infer Congress' intent from its use of the term security in two contemporaneous statutes--the Securities Act of 1933 and the Securities Exchange Act of 1934. Both acts define security to include any note. 60 There is no reason, however, to assume that Congress intended that term to bear the same meaning in these different statutory contexts. Congress enacted the Glass-Steagall Act primarily to protect bank depositors. 61 By contrast, [t]he primary purpose of the [Securities] Acts of 1933 and 1934 was to eliminate serious abuses in a largely unregulated securities market. The focus of the Acts is on the capital market of the enterprise system: the sale of securities to raise capital for profit-making purposes, the exchanges on which securities are traded, and the need for regulation to prevent fraud and to protect the interest of investors. 62 30 Therefore, although Congress used the term securities in both the Glass-Steagall and the Securities Acts, different interpretations of securities may follow upon the differing regulatory purposes behind the Acts. 63 Because securities transactions are economic in character Congress intended the application of [the Securities Acts] to turn on the economic realities underlying a transaction .... 64 Similarly, the Court has defined the term securities in the Glass-Steagall Act by analyzing the economic policy behind the Act--to protect bank depositors from the hazards which ensue when commercial banks enter the investment banking business. 65 In short, the Glass-Steagall Act uses the term security to fence off investment banking activities from commercial banks; the securities laws use the term to define the capital markets whose economic functioning is to be regulated by the securities laws. Clearly, the scope of the term may differ in these differing contexts. We must assign the term security a different meaning in the Glass-Steagall and the Securities Acts if a different interpretation is called for by the respective policies of those Acts. 66 31 The Supreme Court recently reaffirmed this approach to the Securities Acts in Marine Bank v. Weaver. 67 The [Securities Exchange] Act was adopted to restore investors' confidence in the financial markets .... We have repeatedly held that the test [of whether an instrument is a security] 'is what character the instrument is given in commerce by the terms of the offer, the plan of distribution, and the economic inducements held out to the prospect.'  68 Therefore, [e]ach transaction must be analyzed and evaluated on the basis of the content of the instruments in question, the purposes intended to be served, and the factual setting as a whole. 69 32 In deciding that a certificate of deposit was not a security, Marine Bank noted two facets of the economics of these certificates: first, holders receive a fixed rate of interest rather than dividends based on profits; second, [i]t is unnecessary to subject issuers of bank certificates of deposit to liability under ... the federal securities laws since the holders of bank certificates of deposit are abundantly protected under federal banking laws. 70 In short, the Court focused on the potential economic gains and losses of the investors, who are the intended beneficiaries of federal securities regulation, in deciding whether the purposes of that regulation would be furthered by its application to the instrument in question. A different focus of analysis is called for under the Glass-Steagall Act, which aims at protecting the integrity of banks and the financial resources of depositors rather than investors. 33 We conclude that the meaning of the term securities under the securities laws is of little immediate relevance to the problem before us; rather, the example of these laws suggests the need for a careful economic analysis of the commercial paper market itself.
34 The language and the legislative history of the Glass-Steagall Act strongly suggest that commercial paper should be viewed as a loan rather than as a security for the purposes of the Act. However, as we have seen, neither the language nor direct evidence from the legislative history is decisive of the question before us. There is no foolproof formula by which we can decide whether the commercial paper marketed by Bankers Trust constitutes a security. Rather, as the Board observed, 35 a broad generic or literal reading of the term security would likely encompass a number of instruments that banks routinely deal with in the course of their business and would, consequently, be contrary to the basic purpose of the Act. On the other hand, a highly technical or formalistic approach might permit evasions of the mandate of Congress. 71 36 Because neither the literal language of the statute nor other expressions of congressional intent available to us directly indicate whether commercial paper is a security, it is necessary to conduct a functional analysis of Bankers Trust's commercial paper to resolve this question. The problem becomes whether classifying commercial paper as a security would further the policies of the Act. As the Board phrased this inquiry:[I]f a particular kind of financial instrument evidences a transaction that is more functionally similar to a traditional commercial banking operation than to an investment transaction, then fidelity to the purposes of the Act would dictate that the instrument should not be viewed as a security. 72 37 In adopting this functional analysis, the Board followed the Supreme Court's reasoning in its recent cases construing the Glass-Steagall Act. In Investment Company Institute v. Camp (ICI I) the Court noted that 38 Congress was concerned that commercial banks in general and member banks of the Federal Reserve System in particular had both aggravated and been damaged by stock market decline partly because of their direct and indirect involvement in the trading and ownership of speculative securities. The Glass-Steagall Act reflected a determination that policies ... which might otherwise support the entry of commercial banks into the investment banking business were outweighed by the hazards and financial dangers that arise when commercial banks engage in the activities proscribed by the Act. 73 39 Thus, if confronted with a banking practice which involves the sale of securities and for that reason threatens the hazards at which the Act is aimed, neither the Federal Reserve Board nor this court is free to balance these hazards against the perceived benefits of the proposed practice. If the practice does not threaten to cause these hazards, however, we need undertake no such balancing. Rather, we effectuate the will of Congress by concluding that the proposed banking practice is not within the scope of the statutory proscription. 40 For example, in ICI I the Court found that the bank's sale of participations in a bank-sponsored mutual fund posed the dangers that the Glass-Steagall Act was designed to prevent; the Court concluded that these participations were securities within the meaning of the Act. 74 Once these participations were found under this functional analysis to be securities, the literal language of the Act prohibited sale by the bank. 75 41 The Federal Reserve Board, in resolving the present case, therefore correctly focused on whether the commercial paper marketed by Bankers Trust functioned economically as a loan or as a security. Only if commercial paper displayed the economic characteristics of a security would the marketing of commercial paper by Bankers Trust cause the hazards the Act was designed to prevent. The Board concluded that, in all relevant respects, the commercial paper had the economic characteristics of a loan. 76 We agree. 42 It is useful to review the traditional lending functions of commercial banks. The commercial lender extends short-term credit to businesses to finance immediate needs for working capital. 77 To assure itself of timely repayment, the commercial bank carefully evaluates the credit-worthiness of the borrower and the borrower's representations as to the use of funds. In recent years, the lender has characteristically been either a bank or a syndicate of lenders, which may include banks and lending institutions such as credit or mortgage companies. 78 43 We find that the commercial paper at issue here has the economic characteristics of a traditional loan. Purchase of commercial paper, like lending by a commercial bank, represents a very reliable means by which the lender may earn a return on excess cash over a short period of time. Several features of the commercial paper market are salient in this respect. 44 First, the default rate on commercial paper is extremely low: only highly solvent corporations, with the best possible bond ratings, are able to market commercial paper. Indeed, the default rate on commercial paper is much lower than that on ordinary commercial loans made to high-grade commercial customers. 79 45 Second, Bankers Trust commercial paper, like most commercial loans, is of very short maturity: it is generally redeemable at face value within 30 to 90 days. 80 Short maturity not only makes commercial paper a very liquid investment; it also reduces risk, because the financially strong corporations which can issue commercial paper are unlikely to deteriorate over the short period during which purchasers must hold the paper. 46 Third, because commercial paper is sold by Bankers Trust in denominations averaging one million dollars or more, 81 this paper is placed only with sophisticated purchasers--large institutions such as pension funds, money market mutual funds, insurance companies and nonfinancial corporations with large amounts of idle cash. 82 These purchasers, like commercial banks, are well able to evaluate the riskiness of the investments by verifying representations about the issuers. Three independent rating services also conduct thorough periodic investigations of issuers' financial condition. 83 47 For all these reasons, investment in commercial paper, far from resembling securities speculation, is less risky even than banks' ordinary commercial lending. 84 The key difference between the commercial paper sold by Bankers Trust and the traditional lending of commercial banks is that capital is lent by other investors rather than by the bank. 85 In the traditional loan transaction, the commercial bank purchases commercial paper; in the present case, the bank acts as agent in the sale of commercial paper. The bank is simply on the other side of the transaction. The question which faced the Board is whether commercial paper should be considered a security merely because the bank acts as the seller rather than the purchaser of the commercial paper--i.e., whether the role of the bank in and of itself makes the transaction one prohibited by the Glass-Steagall Act. 86 48 We agree with the Board that Bankers Trust may sell as well as purchase commercial paper. The bank's role as seller does not threaten the bank with those dangers which the Glass-Steagall Act was designed to prevent. Because commercial paper is like a loan rather than a security, marketing of commercial paper by the bank does not have the same economic impact on the bank as would marketing of securities. 49 This is confirmed by an analysis of the dangers which the Glass-Steagall Act was designed to prevent. 87 One such danger was that bank underwriting of securities may tie up depositors' funds in speculative securities. Bankers Trust's sale of commercial paper does not create this danger because of the features of commercial paper already noted. First, the bank acts simply as an agent in the sale of commercial paper; it does not agree to purchase the paper on its own account--i.e., with the funds of depositors. 88 Second, commercial paper is of prime quality, sold only by corporations with well-established credit ratings: commercial paper is not a speculative holding. 89 Third, commercial paper is held by the lender only for 30 to 90 days: 90 the lender may readily convert his holdings to cash and does not bear the risk of long-term fluctuations in the value of the enterprise. 50 The other set of dangers addressed by the Glass-Steagall Act comprises the conflicts of interest that arise when a commercial bank underwrites securities. 91 Again, Bankers Trust does not face these conflicts. 51 First, the bank cannot use its credit facilities in order to facilitate sale of its commercial paper. Because the interest on a commercial loan is higher than that paid out on commercial paper, a purchaser of commercial paper would not use a commercial loan to finance its purchases. 92 Conversely, the bank is under no incentive to advance unsound loans to shore up its issuers of commercial paper, because these issuers must be, by the nature of the commercial paper market, financially sound. 93 52 Second, Bankers Trust is not in a position to abuse its reputation for prudence, or give unreliable financial advice to its depositors, in order to promote the sale of commercial paper. Commercial paper is purchased only by large sophisticated buyers who are capable themselves of evaluating the wisdom of their investment. 94 Moreover, commercial paper is very low-risk, and is issued only by very solvent corporations about whose financial prospects information is widely available. 95 It is inconceivable that a commercial bank such as Bankers Trust could, under these conditions, seek improperly to influence potential purchasers of commercial paper. 96 53 Finally, the bank's reputation for prudence will not suffer by its association with the issue of commercial paper. Commercial paper is a highly sound short-term investment. And even if a commercial paper issuer were to default, the sophisticated purchasers of commercial paper will understand that this paper is not backed by the guarantees on commercial bank deposits. 54 The Board's functional analysis leads inexorably to the conclusion that Bankers Trust's commercial paper is not a security within the meaning of the Glass-Steagall Act. Transactions in commercial paper display the key economic characteristics of a commercial bank loan; and, because of these characteristics, Bankers Trust's dealings in commercial paper pose none of the hazards the Glass-Steagall Act was designed to prevent.