<DOC>
[106th Congress House Hearings]
[From the U.S. Government Printing Office via GPO Access]
[DOCID: f:58493.wais]
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
U.S. GOVERNMENT PRINTING OFFICE
58-493 CC WASHINGTON : 1999
COMMITTEE ON COMMERCE
TOM BLILEY, Virginia, Chairman
W.J. ``BILLY'' TAUZIN, Louisiana JOHN D. DINGELL, Michigan
MICHAEL G. OXLEY, Ohio HENRY A. WAXMAN, California
MICHAEL BILIRAKIS, Florida EDWARD J. MARKEY, Massachusetts
JOE BARTON, Texas RALPH M. HALL, Texas
FRED UPTON, Michigan RICK BOUCHER, Virginia
CLIFF STEARNS, Florida EDOLPHUS TOWNS, New York
PAUL E. GILLMOR, Ohio FRANK PALLONE, Jr., New Jersey
Vice Chairman SHERROD BROWN, Ohio
JAMES C. GREENWOOD, Pennsylvania BART GORDON, Tennessee
CHRISTOPHER COX, California PETER DEUTSCH, Florida
NATHAN DEAL, Georgia BOBBY L. RUSH, Illinois
STEVE LARGENT, Oklahoma ANNA G. ESHOO, California
RICHARD BURR, North Carolina RON KLINK, Pennsylvania
BRIAN P. BILBRAY, California BART STUPAK, Michigan
ED WHITFIELD, Kentucky ELIOT L. ENGEL, New York
GREG GANSKE, Iowa THOMAS C. SAWYER, Ohio
CHARLIE NORWOOD, Georgia ALBERT R. WYNN, Maryland
TOM A. COBURN, Oklahoma GENE GREEN, Texas
RICK LAZIO, New York KAREN McCARTHY, Missouri
BARBARA CUBIN, Wyoming TED STRICKLAND, Ohio
JAMES E. ROGAN, California DIANA DeGETTE, Colorado
JOHN SHIMKUS, Illinois THOMAS M. BARRETT, Wisconsin
HEATHER WILSON, New Mexico BILL LUTHER, Minnesota
JOHN B. SHADEGG, Arizona LOIS CAPPS, California
CHARLES W. ``CHIP'' PICKERING,
Mississippi
VITO FOSSELLA, New York
ROY BLUNT, Missouri
ED BRYANT, Tennessee
ROBERT L. EHRLICH, Jr., Maryland
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 RON KLINK, Pennsylvania
CHRISTOPHER COX, California HENRY A. WAXMAN, California
RICHARD BURR, North Carolina BART STUPAK, Michigan
Vice Chairman GENE GREEN, Texas
BRIAN P. BILBRAY, California KAREN McCARTHY, Missouri
ED WHITFIELD, Kentucky TED STRICKLAND, Ohio
GREG GANSKE, Iowa DIANA DeGETTE, Colorado
ROY BLUNT, Missouri JOHN D. DINGELL, Michigan,
ED BRYANT, Tennessee (Ex Officio)
TOM BLILEY, Virginia,
(Ex Officio)
(ii)
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)
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 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 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.
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.
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 assuring 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
answer 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'').<SUP>1</SUP> 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.
---------------------------------------------------------------------------
\1\ The 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.
---------------------------------------------------------------------------
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.
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 securities 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. Morgan & Co.,
that's a recipe for regulatory undersight. It leaves regulators
unable to stop sleazy selling practices by stockbrokers dressed
in bankers' pinstripes.<SUP>2</SUP>
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\2\ 2David Greising, ``Commentary,'' Business Week, May 18, 1998,
p. 154
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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 limitations, 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, testing 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 overaggressive 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.''
One of those preemption actions by the OCC involved New
Jersey'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
misinformation 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
protections 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
assurances 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 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.
<bullet> 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.
<bullet> 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.
<bullet> 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.
<bullet> 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 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.
<bullet> 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.
<bullet> 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.
<bullet> 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 comply 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:
<bullet> Enact Strong and Effective Retail Sales Protections: These
include:
<bullet> Disclosure that products they sell are not FDIC-insured or
guaranteed and subject to risk of loss;
<bullet> Anti-coercion rules that prohibit a financial institution
from peddling to loan applicants uninsured products until
after the loan has been made:
<bullet> Suitability requirements to make sure sales are based on
consumers' financial needs, not solely the commissions and
fees paid to the seller;
<bullet> 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;
<bullet> 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.
<bullet> 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.
<bullet> 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.
<bullet> 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.
<bullet> 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.
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 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, Glass-Steagall 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 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]
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 requested. 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.
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 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 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.
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.
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 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 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 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 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.
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 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 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 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
management 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
<SUP>1</SUP> 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 on-site 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.<SUP>2</SUP> 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.
---------------------------------------------------------------------------
\1\ The 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.
---------------------------------------------------------------------------
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.
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.
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.
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.
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.
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?
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,<SUP>1</SUP> and by
American businesses that need to raise capital.<SUP>2</SUP> 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.
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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.
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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
broker-dealers 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 of broker-dealer firms. Moreover, protection of customer funds
has been further assured by the Securities Investor Protection
Corporation (``SIPC'').<SUP>3</SUP>
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\3\ SIPC 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 broker-dealer's customers (up to $100,000 in
cash, and $500,000 in total claims, per customer).
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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:
<bullet> Aggressive SEC policing and oversight of securities
activities;
<bullet> Safeguarding customers and markets through market-sensitive
SEC net capital rules; and
<bullet> 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.'' <SUP>4</SUP> 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.<SUP>5</SUP>
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\4\ United States v. O'Hagan, 521 U.S. 642, 117 S.Ct. 2199, 2210
(1997).
\5\ See 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).
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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 interest 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,<SUP>6</SUP> 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.
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\6\ 12 U.S.C. Sec. 1818(u).
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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 well-insulated
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 broker-dealer 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 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:
<bullet> recommend only suitable investments;
<bullet> arbitrate disputes with customers;
<bullet> ensure that only fully licensed and qualified personnel sell
securities to customers;
<bullet> disclose to investors, through the NASD, the disciplinary
history of employees; and
<bullet> 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.<SUP>7</SUP>
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\7\ The 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.
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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 <SUP>8</SUP>: 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.
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\8\ See In the Matter of Michael P. Traba, File No. 3-9788, Release
No. 33-7617 (Dec. 10, 1998).
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In the Matter of NationsSecurities and NationsBank,
N.A.<SUP>9</SUP>: 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:
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\9\ In the Matter of NationsSecurities and NationsBank, N.A.,
Release No. 33-7532 (May 4, 1998).
<bullet> 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.
<bullet> 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.
<bullet> 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
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.<SUP>10</SUP> 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.
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\10\ The 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.
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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.
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, interview 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.
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.<SUP>11</SUP>
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\11\ The 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.
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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.<SUP>12</SUP> 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.
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\12\ While banks are excepted from the Investment Advisers Act,
Sec. 202(a)(11), 15 U.S.C. Sec. 80b-2(a)(11), many own or are
affiliated with registered advisers.
---------------------------------------------------------------------------
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.<SUP>13</SUP> To further this goal, the examination
program has embarked on a number of initiatives.<SUP>14</SUP> 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.
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\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).
\14\ For 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.
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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.<SUP>15</SUP> 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.<SUP>16</SUP>
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\15\ The procedure is set forth in Exchange Act Sec. 17(b), 15
U.S.C. Sec. 78q(b).
\16\ The Commission also consults with bank regulators prior to
conducting examinations of clearing agencies and municipal securities
dealers. See id.
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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 system 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,<SUP>17</SUP> 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.
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\17\ 15 U.S.C. Sec. 78l(i).
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The current Section 12(i) model confers on four separate federal
banking regulators--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.<SUP>18</SUP>
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\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.
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The anomaly in this arrangement is that while approximately 12,500
public companies, 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 difficult 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.<SUP>19</SUP>
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\19\ Reports of publicly held banks and thrifts are not available
to the public through EDGAR because they are not filed with the
Commission.
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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.<SUP>20</SUP> The banking agencies, by contrast, have
brought relatively few securities enforcement cases.
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\20\ Figure includes proceedings involving banks, bank holding
companies, thrifts, and state savings banks.
---------------------------------------------------------------------------
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.'' <SUP>21</SUP>
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\21\ Michael 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).
---------------------------------------------------------------------------
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).<SUP>22</SUP>
---------------------------------------------------------------------------
\22\ Blueprint for Reform: The Report of the Task Group on
Regulation of Financial Services, July 1984, at 91.
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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).<SUP>23</SUP>
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\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.
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iv. conclusion
The Commission has testified many times during the past decade in
support of financial modernization.<SUP>24</SUP> Whatever version of
financial modernization legislation is 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.
---------------------------------------------------------------------------
\24\ See, 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 Modernization 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).
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______
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 letter 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 ownership 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?
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 broker-dealer 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 affiliated with the Bank and not the Bank itself, the
primary regulators of the broker-dealer 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 billion. (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, earnings, 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. Sec. 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. Sec. 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.
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\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.
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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 from having the
Partnership's operations and activities conform to the national banking
laws, including any condition imposed pursuant to 12 C.F.R. Sec. 5.34.
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\2\ We understand that this also will be true of any other
employees of the Partnership previously employed by the Bank, DW or
their affiliates.
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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. Sec. 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.
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\3\ The Subsidiary's principal office also will be located in
Charlotte, North Carolina.
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The Partnership will be registered as a broker/dealer under the
Securities Exchange 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
requirements of the federal securities laws and the Rules of Fair
Practice of the NASD.
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\4\ The 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. Sec. 80b-
2(a)(11).
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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
involve 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.
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\5\ The 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.
\6\ The fixed and variable annuities sold may be issued/
underwritten by an insurance company affiliated with DW, although
unaffiliated with the Subsidiary or the Bank.
\7\ The funds are sponsored and distributed by an independent
party.
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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 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) para. 85,472. We also
remind the Bank of its fiduciary obligations under state law and
pursuant to the OCC's self-dealing regulation, 12 C.F.R. Sec. 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.
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\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.
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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) para. 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.
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 Partnership 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.
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\10\ This 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. Sec. 80a-2(a)(29).
\11\ Bank counsel has represented that DW currently engages
predominantly in retail brokerage and only conducts limited
underwriting activities.
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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. Sec. 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. Sec. 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), reprinted in
[1989-90 Transfer Binder] Fed. Banking L. Rep. (CCH) para. 83,090;
Interpretive Letter No. 403 (December 9, 1987), reprinted in [1988-89
Transfer Binder] Fed. Banking L. Rep. (CCH) para. 85,627; Interpretive
Letter No. 386 (June 19, 1987), reprinted in [1988-89 Transfer Binder]
Fed. Banking L. Rep. (CCH) para. 85,610; Interpretive Letter No. 363
(May 23, 1986), reprinted in [1985-87 Transfer Binder], Fed. Banking L.
Rep. (CCH) para. 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) para. 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.
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\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.
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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) para. 83,220;
Interpretive Letter No. 411 (January 20, 1988), reprinted in [1988-89
Transfer Binder] Fed. Banking L. Rep. (CCH) para. 85,635; Interpretive
Letter No. 289 (May 15, 1984), [1983-84 Transfer Binder] Fed. Banking
L. Rep. (CCH) para. 85,453. Moreover, the OCC has not objected to
operating 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 operating subsidiaries and investment banks or
subsidiaries thereof, and analogous here, the proposed Partnership
would not be prohibited by section 20 of the Glass-Steagall Act, 12
U.S.C. Sec. 377, or section 32 of the Act, 12 U.S.C. Sec. 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. Sec. 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) para. 83,244; Interpretive Letter No. 406 (August
4, 1987), reprinted in [1988-89 Transfer Binder] Fed. Banking L. Rep.
(CCH) para. 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. Sec. 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 multiple 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).
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\13\ These 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.
Sec. 1818.
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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.
(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\
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\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.
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(12) The Bank must submit a notice to us pursuant to 12 C.F.R.
Sec. 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. Sec. 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