The laws that separate mutual funds, securities, insurance and banking are no longer appropriate in light of the modern financial services marketplace. In order to correct this problem, Congress should:
The Federal Reserve Board's role as umbrella regulator of the new financial holding companies
should be shaped by the fact that it will no longer simply be the umbrella regulator of banks and
affiliates that engage in activities closely related to banking. Instead, the Board will monitor
organizations that will engage in a broad array of mutual fund, securities, and insurance activities
in addition to banking.
Because other federal and state regulators with functional expertise in these areas have
successfully overseen these activities for decades, there is no need for the Board to govern the
day-to-day nonbanking activities of financial holding companies. Instead, the Board's regulatory
authority should be centered on banks and should not be used to impose bank-like regulation on
mutual funds and other functionally regulated entities. H.R. 10 should be amended to make this
H.R. 10 also should be amended to ensure that federal banking agencies other than the Federal
Reserve Board do not attempt to impose bank-like regulation on affiliates of banks.
Mutual fund companies and other securities and insurance firms should not be placed at a
competitive disadvantage relative to banks simply because they currently engage to some extent
in nonfinancial activities. Nonbank entities such as mutual funds have never been subject to
activities restrictions like those contained in H.R. 10, and should not be penalized if they now
become subject to its provisions. Accordingly, H.R. 10 should be amended to allow financial
holding companies to engage in a limited amount of nonfinancial activities.
My name is Matthew P. Fink. I am President of the Investment Company Institute, the national
association of the American investment company industry. The Institute's membership includes
nearly 7,000 open-end investment companies ("mutual funds"), 437 closed-end investment
companies and 9 sponsors of unit investment trusts. The Institute's mutual fund members have
assets of about $5 trillion, accounting for approximately 95 percent of total industry assets, and have over 62 million individual shareholders. The Institute's members include mutual funds
advised by investment counseling firms, commercial banks, broker-dealers, insurance companies
and affiliates of commercial firms.
The Institute has been an active participant in the debate on financial services reform and has
testified before Congress on subjects directly relating to financial services reform more than
twenty times over the last twenty-three years. I am pleased to be here today on behalf of the
Institute to testify with respect to H.R. 10, the "Financial Services Act of 1998."
A. Growth and Regulation of the Mutual Fund Industry
Since 1940, when Congress enacted the Investment Company Act, the mutual fund industry has
grown steadily from 68 funds to over 7,000 funds today, and from assets of $448 million in 1940
to about $5 trillion today. These include nearly 3,300 equity funds with over $2.8 trillion in
assets, much of which is invested in start-up companies and other growing enterprises in cities
and towns in every corner of the nation.
Many factors have contributed to the growth of the mutual fund industry over the years. They
include the capital appreciation of portfolio securities, additional purchases by existing fund
shareholders, new products and services designed to meet changing investor needs, the growth of
the retirement plan market, increased investment by institutional investors, new distribution
channels, and a shift by individuals from direct investment in securities to investment through
In our view, however, the most important factor contributing to the industry's growth and
success is that mutual funds are subject to stringent regulation by the United States Securities and
Exchange Commission under the Investment Company Act. The core objectives of the Act are
to: (1) ensure that investors receive adequate, accurate information about mutual funds in which
they invest; (2) protect the integrity of the fund's assets; (3) prohibit abusive forms of self-dealing; (4) restrict unfair and unsound capital structures; and (5) ensure the fair valuation of
investor purchases and redemptions. These requirements--and the industry's commitment to
complying with their letter and spirit--have produced widespread public confidence in the
mutual fund industry. In our judgment, investor confidence has been and continues to be the
foundation for the success that the industry now enjoys.
The mutual fund industry has always spoken out against legislation that would impair this
effective and time-tested regulatory system. For example, we continue to strongly oppose the
imposition of bank-type regulation on mutual funds.
B. Differences Between Bank Regulation and Mutual Fund Regulation
If financial services reform is to succeed in producing more vibrant and competitive financial
services companies, it must provide a regulatory structure that respects and is carefully tailored to
the divergent requirements of each of the business sectors that comprise the financial services
marketplace. The securities, mutual fund, banking and insurance industries all historically have
been and presently are subject to extensive governmental oversight. But for reasons that
continue to make good sense even in this era of consolidation and conglomeration, the
regulations governing each of these businesses rest on different premises, have different public
policy objectives and respond to distinct governmental and societal concerns.
Our mutual fund and securities markets are based on transparency, strict market discipline,
creativity and risk-taking. The federal securities laws, including the Investment Company Act,
reflect the nature of this marketplace and, accordingly, do not seek to limit risk-taking nor do
they extend any government guarantee. Rather, the securities laws require full and fair
disclosure of all material information, focus on investor protection and the maintenance of fair
and orderly markets, and prohibit fraudulent and deceptive practices. Securities regulators
strictly enforce the securities laws by bringing enforcement actions, and imposing substantial
penalties--in a process that by design is fully disclosed to the markets and the American public.
Banks, by contrast, are supported by federal deposit insurance, access to the discount window and the overall federal safety net. Therefore, regulation imposes significant restraints and requirements on the operation of banks.
It may well be that this regulatory approach is prudent and appropriate when it comes to the
government's interest in overseeing banks. But it would be fundamentally inconsistent with the
very nature of the mutual fund and securities markets to impose bank-like regulation on mutual
fund companies and other securities firms affiliated with banks. To do so could profoundly
impair the ability of mutual funds and securities firms to serve their customers and compete
effectively. More worrisome, it could compromise the continued successful operation of the
existing securities regulatory system.
Finally--and perhaps most importantly--imposing bank-like regulation on an industry for which
it was not designed could even jeopardize the functioning of our broad capital markets. This
would risk the loss of a priceless and valuable national asset. As SEC Chairman Arthur Levitt
has stated, "[o]ur capital markets must remain among our nation's most spectacular
achievements . . . . Those markets, and investors' confidence in them, are a rich legacy we have inherited, but do not own. They are a national asset we hold in trust for our children, and for
generations of Americans to come."(1)
III. Principles of Successful Financial Services Reform
To most observers, it is now abundantly clear that the laws that separate mutual funds, securities, insurance and banking are no longer appropriate in light of our modern and fiercely competitive financial services marketplace. In order to correct the mismatch between these rigid and atrophied laws and the reality of today's dynamic financial services marketplace, the Institute believes that financial services reform legislation should include four key elements. Simply put, Congress should:
S. 298, the "Depository Institutions Affiliation Act," as introduced by Chairman D'Amato,
reflects many of these key elements for successful financial services reform. In particular, S. 298
embraces the concept of true functional regulation without a single umbrella regulator and allows
unrestricted mixing of banking and commerce. H.R. 10, the "Financial Services Act of 1998," in
many respects also reflects elements of successful financial services reform. More changes,
however, are needed.
In particular, H.R. 10 should clarify and tighten the proposed role of the Federal Reserve Board
as umbrella regulator of the new diversified financial holding companies. H.R. 10 also needs to
be revised to provide for true functional regulation that recognizes the differences between bank
regulation and mutual fund regulation. And H.R. 10 should better recognize the reality of the
evolving financial services marketplace and permit mutual fund companies and other securities
firms to continue to engage, to some extent, in nonfinancial activities.
IV. Rationalizing the Role of the Federal Reserve Board
A. Clarifying its Role as Umbrella Regulator
The Federal Reserve Board currently serves as the umbrella regulator of bank holding companies
under the Bank Holding Company Act. Under current law, in general, bank holding companies
and their nonbank subsidiaries may only engage in activities that the Board has determined to be
closely related to banking. Additionally, the banks owned by a bank holding company are only
required to be adequately capitalized. Thus, the Board's principal role as a bank regulator is
centered on protecting taxpayers and the banking system by restricting banks and ensuring that
bank holding companies only engage in activities under bank-like regulation.
However, under H.R. 10, financial holding companies and their subsidiaries would be allowed to
engage in a much broader array of financial activities, including mutual fund, securities and
insurance activities. Because federal and state regulators other than the Board--with functional
expertise in these areas--have successfully overseen these financial activities for decades, there
is no need for the Board to govern the day-to-day nonbanking activities of a financial holding
company. Moreover, Board oversight of nonbank affiliates is unnecessary given that banks
owned by a financial holding company must be well capitalized and well managed.
Additionally, as discussed above, imposing bank-like regulation on mutual funds and securities
firms would likely harm innovation, damage our capital markets, and hurt our growing
population of investors.
Effective oversight for diversified financial services organizations operating in a highly
competitive global economy should be shaped by three basic concepts: functional regulation,
bank-centered supervision and enforcement, and effective regulatory coordination. Functional
regulation envisions that each subsidiary of the financial holding company will be separately
regulated by function with, for example, the Securities and Exchange Commission acting as the
primary regulator of mutual funds and securities firms, the states acting as the primary regulator
of insurance companies, and the appropriate federal banking agency acting as the primary
regulator of banks. Bank-centered supervision and enforcement refers to a system in which
regulatory actions considered necessary to protect the safety and soundness of individual banks
and the payment system are imposed directly on banks, rather than spread to other functionally
regulated entities affiliated with banks. Effective regulatory coordination means providing
mechanisms for communication and cooperation among the functional regulators to avoid
duplicative and unnecessary oversight in carrying our their regulatory responsibilities.
H.R. 10 is based on the premise that the Federal Reserve Board should serve as an umbrella
regulator for new financial holding companies that own both banks and nonbanks, to monitor and
protect against risks to individual banks and the payments system. While we believe that other
equally effective regulatory structures could be implemented, we understand Congress's concern
that a single regulator be responsible for monitoring the entire financial services organization.
We believe, however, that it is equally important that this regulatory authority be clearly defined
to center on banks. It must be made explicit that this authority does not extend to regulating the
day-to-day activities of other functionally regulated nonbank entities within the holding
company, such as securities firms and mutual funds that are regulated by the SEC, simply
because those entities are within a financial holding company structure.
B. Provisions of H.R. 10 Concerning Federal Reserve Board Authority
H.R. 10 attempts to balance these concerns by including certain provisions that delineate the
Federal Reserve Board's authority to regulate and examine financial holding companies and their
functionally regulated subsidiaries. In particular, H.R. 10: (i) clarifies the Board's authority to
require reports from, examine, and impose capital requirements on functionally regulated
subsidiaries of financial holding companies;(2) (ii) makes the SEC the exclusive federal agency
authorized to examine any mutual fund that is not a bank holding company;(3) and (iii) clarifies
the Board's rulemaking, supervisory and enforcement authority with respect to the business of
functionally regulated subsidiaries of financial holding companies.(4) While these clarifications
of the Board's authority are very important in addressing the concerns cited above, certain
additional changes to H.R. 10 are necessary to ensure that bank-like regulation is not imposed on
functionally regulated subsidiaries of financial holding companies.
Actions Against Functionally Regulated Affiliates
Section 116 of H.R. 10 limits the Board's authority to impose restraints or requirements on
functionally regulated affiliates of banks, such as investment advisers to mutual funds, broker-dealers or insurance companies. In general, the Board may not take actions against functionally
regulated affiliates unless there is an unsafe or unsound practice that poses a material risk to the
financial safety and stability of an affiliated depository institution or the payments system.
Although this provision allows some protection to functionally regulated affiliates from day-to-day regulation of their activities by the Board, greater clarification is needed.
In particular, the types of "material risk" that can trigger Board action are not clear under the
legislation. We are also concerned that the Board could bypass this test to allow it to prevent or
impede mutual funds from engaging in activities that are completely permissible under the
securities laws. For example, we do not believe that the Board should be allowed to prohibit the
creation of a mutual fund that invests in high yield bonds simply because those investments may
entail certain risks to investors. The Board should not regulate the business operations or day-to-day activities of a functionally regulated affiliate unless it engages in an activity that poses a
serious risk to its affiliated bank or the payments system. Accordingly, we believe that H.R. 10
should be amended to add a statutory provision that sets forth Congress's intent of what would
constitute a "material risk" for these purposes.
Deference to Other Functional Regulators
Section 111 of H.R. 10 grants the Board authority to conduct certain examinations and require
certain reports from functionally regulated affiliates of banks, such as investment advisers to
mutual funds, broker-dealers or insurance companies. However, the Board is required to defer to
the SEC with regard to the interpretation and enforcement of all federal securities laws governing
SEC-regulated entities, and to the states with regard to all state insurance laws governing
insurance companies and agents. The Board also is required to defer to other functional
regulators' examinations and reports, such as the SEC's examinations of, or reports on, mutual
funds. The Institute strongly supports the concept of Board deference to examinations, reports
and securities law interpretations by the SEC. Without such deference, the Board could apply
the securities laws in a manner that is inconsistent with the prior interpretations of the SEC.(5)
Holding Company Capital Requirements
The Institute also believes that H.R. 10 should prohibit the imposition of capital requirements on
financial holding companies. Because banks, broker-dealers and insurance companies are
already subject to capital standards, it is unnecessary and redundant, as well as inconsistent with
the notion of functional regulation, for H.R. 10 to require financial holding companies to
maintain an additional layer of capital. Moreover, in order to engage in a broad array of financial
activities, all of the bank subsidiaries of a financial holding company must be well capitalized
and well managed, eliminating the need for bank-like holding company capital requirements.
If the Board has authority to impose capital requirements, it could restrict innovative product
development by functionally regulated affiliates. For example, the Board could require higher
capital as the price for offering a wider array of mutual funds. The holding company capital
requirement should not be used to deter nonbanking product development.
V. Rationalizing the Role of the Other Federal Banking Agencies
The provisions discussed above only address the regulatory authority of the Federal Reserve
Board with regard to functionally regulated affiliates of banks. Regrettably, there are no parallel
provisions in H.R. 10 that limit the authority under current banking laws of other federal banking
agencies to regulate functionally regulated affiliates of banks, including mutual fund companies.
We believe that provisions similar to those that clarify the Board's authority with respect to
functionally regulated subsidiaries of financial holding companies should also apply to the other
federal banking agencies. Otherwise, these agencies may claim to have broader authority
relating to functionally regulated entities than the Board. Given that the Board is intended to be
the umbrella attempting to engage in the day-to-day regulation of functionally regulated nonbank
affiliates, the legislation should make clear that the banking agencies' authority is not broader
than the Board's authority.
Indeed, history demonstrates that bank regulators have asserted authority over securities affiliates of banks and have imposed requirements that are inconsistent with fundamental tenets of securities regulation. For example, the FDIC adopted a rule in 1984 that limited certain state
nonmember bank securities affiliates to underwriting investment quality securities.(6) The release accompanying the rule stated that the FDIC's purpose in adopting the rule was to address the risk associated with bank subsidiaries underwriting securities. The release also stated the FDIC's view that it had the authority to address, on a case-by-case basis, practices, acts or conduct of the securities affiliate that it found to constitute unsafe or unsound practices not specifically addressed by the rule.
As discussed above, applying bank-like regulations to mutual funds and the securities markets
generally could profoundly impair the continued successful operation of the existing securities
regulatory system and damage our capital markets. If the banking agencies have authority to
impose restrictions on the activities of securities affiliates of banks based on whether such
activities meet bank safety and soundness standards, such a result could occur. Accordingly, it is
critical that H.R. 10 be amended to rationalize the role of the banking agencies with regard to
mutual funds and securities firms in order to protect the existing securities regulatory system and
the capital markets.
The danger also exists that a banking agency might be tempted to stifle innovation and preclude
new product developments by a securities affiliate on the ground that they may compromise the
competitive standing of banks. For example, Professor John C. Coffee, Jr. observed that a single
financial services regulator might have barred or restricted the growth of money market mutual
funds in the 1970s because of the competition these funds posed to bank accounts. Such an
outcome not only would have been anticompetitive, but also a notable disservice to consumers
and the capital marketplace.
VI. Nonfinancial Activities
An important objective of any financial services reform legislation is to create competitive
equality among banks, mutual funds, securities firms and insurance companies. Unfortunately,
H.R. 10 falls short in this respect because it retains the strict separation between "banking" and
"commerce." Specifically, mutual fund firms, securities firms or insurance companies would
only be able to acquire banks by becoming financial holding companies and divesting their
nonfinancial activities within 15 years. This approach would introduce competitive inequities:
all banks could enter the securities and insurance businesses, but not all securities firms and
insurance companies could own commercial banks.
To provide a fair and balanced competitive environment, the Institute recommends that H.R. 10
be amended to allow financial holding companies to engage to some degree in nonfinancial
activities. This would create a financial services holding company that reflects the realities of
today's marketplace. For example, many mutual fund companies are affiliated with entities
involved in some degree in commercial activities. For these companies fully to participate in the
landmark regulatory realignment contemplated by this legislation, they must be permitted to have
some part of their business involved in nonfinancial activities. While the versions of H.R. 10
passed by the House Banking and Commerce Committees contained provisions for limited
commercial activities by financial holding companies, the version passed by the full House did
not.(7) Mutual fund companies and other securities firms have never been subject to activities restrictions like those contained in H.R. 10, and should not be penalized if they now become subject to its provisions. Accordingly, we would support adding back into H.R. 10 a provision
allowing financial holding companies to engage in a limited amount of nonfinancial activities.
The Institute continues to support efforts by Congress to modernize the nation's financial laws.
H.R. 10 represents a major step in this direction by permitting affiliations of banks, mutual fund
companies, securities firms and insurance companies in diversified financial holding companies.
However, any change in financial services law needs to recognize the reality of today's financial
services marketplace. Financial services companies are engaging in a broad array of mutual
fund, securities and insurance activities, as well as banking. Because federal and state regulators
have successfully overseen these activities for decades, there is no need to impose bank-like rules
and regulations on the mutual fund, securities and insurance industries. In fact, imposing a bank-like regime on the mutual fund industry could destroy the highly successful regulatory system
that is a major cause of the success that our industry enjoys today.
Accordingly, modifications are needed to H.R. 10 to ensure that regulatory principles that may
be appropriate for banks and bank holding companies are not inappropriately applied to mutual
funds to the detriment of the investing public and our capital markets. Additionally, H.R. 10
needs to recognize the reality of today's financial services marketplace and not create barriers to
entry for financial services companies engaged to some extent in nonfinancial activities. We
strongly encourage the Committee to carefully consider these issues as it moves forward with the
We thank you for the opportunity to present our views and look forward to working with the
Committee as H.R. 10 moves forward.
1 "A Declaration of (Accounting) Independence," Remarks by Arthur Levitt, Chairman, U.S. Securities and Exchange Commission, before The Conference Board, New York, New York (Oct. 8, 1997).
2 See Financial Services Act of 1998 § 111.
3 See id. § 115.
4 See id. § 116.
5 The Institute has drafted certain technical changes to Section 111 of H.R. 10 that we believe help clarify the scope of the Board's deference to SEC examinations, reports and securities law interpretations.
6 See 12 C.F.R. § 337.4.
7 H.R. 10 does, however, permit the "grandfathering" of certain limited nonfinancial activities of companies that become
financial holding companies after the bill's enactment for up to 15 years. See Financial Services Act of 1998 § 103(a).
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