SECURITIES EXCHANGE ACT AMENDMENTS OF 1973 WEDNESDAY, SEPTEMBER 12, 1973 HOUSE OF REPRESENTATIVES, SUBCOMMITTEE ON COMMERCE AND FINANCE, COMMITTEE ON INTERSTATE AND FOREIGN COMMERCE, Washington, D.C. The subcommittee met, pursuant to notice, at 10 a.m., Wednesday, September 12, 1973, in room 2322, Rayburn House Office Building, Hon. John E. Moss, chairman, presiding. Mr. Moss. The subcommittee will be in order. As our first witness this morning, we have Mr. Frederic Solomon, Director of the Division of Supervision and Regulation of the Board of Governors of the Federal Reserve System. Mr. Solomon. STATEMENT OF FREDERIC SOLOMON, DIRECTOR, DIVISION OF SUPERVISION AND REGULATION, BOARD OF GOVERNORS, FEDERAL RESERVE SYSTEM Mr. SOLOMON. Thank you, Mr. Chairman. Mr. Chairman and members of the subcommittee, my name is Frederic Solomon. I am Director of the Division of Supervision and Regulation of the Board of Governors of the Federal Reserve System. The Board appreciates the opportunity you have extended to us to comment on H.R. 5050. Our comments on that bill will be concerned with the provisions of title IV. At the same time, we will comment briefly on S. 2058, a bill passed by the Senate on August 1 and also pending before your committee. At the outset, let me reiterate comments I made last year before your subcommittee on the significance of this undertaking. The paperwork problems encountered by the securities industry several years ago, and the subsequent consideration of these problems by your subcommittee, the Securities and Exchange Commission, and others, made it clear that there is a need to confront the problems of handling transactions in the securities business in a comprehensive and consistent way. The Board agrees with the Congress that this is an area for Federal regulation. Thus we welcome your subcommittee's efforts to arrive at a satisfactory regulatory framework for the development of an efficient national system for the prompt and accurate processing and settlement of securities transactions. Because of the complexities of the securities business, and the varying types of institutions which are deeply involved these can be roughly divided between banks and nonbanks-the formulation of the optimal regulatory framework is no easy task. We believe it would be an oversimplification, and ultimately a self-defeating action, if the need for comprehensiveness and consistency were translated into a rigid regulatory scheme assigned to a single agency. Thus the Board has opposed the idea that a single agency be given. both regulatory and enforcement powers over the diverse kinds of institutions included in the definitions of clearing agency, securities. depository, and transfer agent. In our view, because there is such diversity in the securities business, and particularly because many of the important functions are carried on at banks, it is desirable that the bank regulatory agencies be assigned a commensurate role in the regulatory framework. We at the Board are convinced that a multipleagency regulatory arrangement can be both comprehensive and consistent and, in the light of operating realities, most effective. The regulatory precedent that comes most readily to mind— although not completely comparable-is what Congress provided in the Truth-in-Lending Act. As you know, the Federal Reserve Board has rule-writing responsibilities for this law, while responsibility for enforcement is divided among a number of agencies, including the three Federal bank supervisory agencies as to banks coming within their respective jurisdictions. Speaking for the Board-and I am confident my colleagues in the office of the Comptroller of the Currency and in the Federal Deposit Insurance Corporation feel the same—I can assure the subcommittee that the enforcement responsibility is one we all take very seriously. A great deal of work has gone into the Board's supervision program, and we are consistently trying to improve it. The result, we believe, is that the interests of consumers who deal at banks under this disclosure law have been well protected. At the same time, because enforcement is carried out by an agency which maintains close, systematic, and regular scrutiny over the banks, the disruptions in the functions of the institutions have been held to a minimum. The result is that the aim of Congress has been met with optimal efficiency. In view of the fact that securities depositories are now being organized as banks, there is a need for bank supervisory agencies to play an important role not only in enforcement but in regulating securities processing operations as well. We intend to take nothing away from the SEC when we say that the Board believes that the writing of the rules governing depositories should be a joint effort by the SEC and the bank regulatory agencies. These agencies possess expert knowledge and have information about banks which can make a significant contribution to the rulewriting process. In addition, under section 7 of the Securities Exchange Act of 1934 the Board presently has some responsibility in this field. The problem to be solved by any proposed legislation is the elimination of cumbersome, inefficient, and slow clearing and transfer procedures. Insofar as these conditions inevitably lead to the possibility of direct and indirect extensions of credit, the Board has been involved for some time in monitoring the role of banks in this area. The SEC, however, has experience in the securities industry that is not possessed by the bank regulatory agencies. Thus some sharingof rule writing and a division of enforcement responsibilities appears to be called for. As you know, Depository Trust Co., formerly the Central Certificate Service and a subsidiary of the New York Stock Exchange has now been reorganized as a State member bank, and as such is a member of the Federal Reserve System. Moreover, it is our understanding that other such trust companies are being formed and are contemplating applying for membership in the Federal Reserve System. This trend suggests that the regulatory framework surrounding such institutions ought to consist primarily of rules either fashioned or approved by a bank supervisory agency. But perhaps more sig nificant, it is important for the success of this type of depository that banks which now function as depositories in their own right will voluntarily deposit their securities holdings in the new institutions. The officers of banks holding securities have understandable misgivings about placing those securities in a securities depository unless it is supervised by an agency with a deep knowledge of fiduciary responsibilities and banking standards in general. These officials recognize that the custody and handling of securities is first and foremost a fiduciary function-an operation that banks have long engaged in as a regular part of their business. A joint rule-writing effort between SEC and the bank regulatory agencies for securities depositories would provide the needed assurance to bank managements that the new depositories will be properly regulated, supervised, and examined by a bank regulatory agency. Accordingly, the Board on July 13 sent a letter to Senator Harrison Williams' Securities Subcommittee in which we said: the public acceptability of bank clearing agencies (depositories) *** will be enhanced by providing for the concurrence of the appropriate bank supervisory agency prior to the adoption of any rule by the SEC applying to any clearing agency (depository) which is a bank. In reporting S. 2058 on July 30, the full Senate Committee on Banking, Housing and Urban Affairs adopted a somewhat different approach than the Board's recommendation, but the reported bill and the accompanying report gave important recognition to the role that bank regulatory authorities should play in regulating securities processing operations. In addition to placing upon the bank supervisors enforcement and inspection responsibilities for institutions under their jurisdiction, the Senate's bill provides authority for the supervisors to have primary responsibility for the promulgation of regulations concerning the safeguarding of funds and securities held by banks as clearing agencies (depositories) and as transfer agents. The bill thus recognizes the expertise of the bank supervisory agencies in areas with which they have been traditionally concerned, while giving SEC overall policy responsibility for the development and coordination of all facets of the securities processing system. With regard to both clearing agencies and transfer agents, S. 2058 establishes coordinating mechanisms to assure to the maximum extent possible, that the various functions set out under the bill will be handled as effectively as possible. For example, the agencies charged with regulation of the various firms are required to consult with and request the views of each other prior to issuing a proposed rule for public comment, or prior to adopting a rule. This is a desirable-even necessary-adjunct to the regulatory-enforcement arrangement in the bill, and is something that we heartily applaud. Title IV of H.R. 5050, as you know, gives SEC both regulatory and enforcement authority over clearing agencies, depositories, and transfer agents. Thus SEC would have broad authority over banks which function in these areas, while the role of the bank supervisory agencies would be limited largely to cooperating with SEC "toward the end that their mutual regulatory needs and responsibilities be fulfilled to the maximum extent practicable." One of the troubling aspects of title IV is the extent to which SEC is given enforcement powers over banks. The SEC is given power to censure, bar, suspend, place limitations on, or revoke the registration of transfer agents. With respect to clearing agencies and depositories, it may suspend or revoke their registrations, or impose limits on their operations. By contrast, the Senate bill provides similar powers to the appropriate regulatory authorities, which, in the case of banks, would be the Federal bank supervisory agencies. The Board believes that authority for such fundamental regulatory actions should be imposed solely upon the appropriate bank supervisor in the case of banks as provided in the Senate bill. The enforcement approach of title IV is cumbersome because it provides the SEC with duplicative authority to examine the securities depository, clearing agency, or transfer agent activities conducted by any bank. Should the SEC and a bank regulatory agency disagree concerning the evaluation of the activities, the remedial action to be taken, or whether remedial action should be taken, the bank concerned would find itself in an untenable position. Moreover, the remedial structure provided in title IV-censure, supervision, revocationmay in most situations be too drastic for effective utilization. The remedial structure embodied in title IV should be contrasted with the structure set forth in the Senate bill which allows the bank regulatory agencies to apply intermediary enforcement powers in the form of cease and desist orders-including the provision for temporary orders, where appropriate under section 8(b) of the Federal Deposit Insurance Act to insured banking institutions. The experience under Truth in Lending seems opposite here. While the Board writes the rules, and makes every attempt in doing so to coordinate its efforts with the agencies having enforcement authority under the act, the actual job of enforcement is left up to the various agencies enumerated in the act. The Board does not have-and would not seek-coextensive enforcement authority, for example, over nonbank lenders such as consumer finance companies or credit unions. The preferable regulatory structure, as I have outlined it above, should reflect the traditional skills of the bank supervisory agencies in both the rule-writing and enforcement functions. Such an arrangement would give recognition to the SEC's legitimate interest in providing for order in the securities business while fully utilizing the specialized knowledge of the bank regulatory authorities. One important result which we expect from this structure-besides administrative efficiency is the greater acceptance of the new securities depositories by other institutions, particularly banks, whose cooperation is vital to achieve the worthwhile goal of an integrated national securities processing system. Thank you, Mr. Chairman. Mr. Moss. Thank you, Mr. Solomon. Mr. WARE. Thank you, Mr. Chairman. Briefly, Mr. Solomon, we appreciate your being here. Do I understand from your testimony this morning that, while an approach to S. 2058 is slightly, somewhat different from your recommendations, you find this approach acceptable as compared to the present provisions of H.R. 5050? Mr. SOLOMON. Mr. Congressman, I am sure the Board would consider the provisions of S. 2058 considerably preferable to H.R. 5050. In frankness, I would have to say the Board would prefer the position it stated to Senator Williams, but I think it would probably find it workable to operate under S. 2058. Mr. WARE. Thank you. Mr. Moss. Mr. Breckinridge? Mr. BRECKINRIDGE. No questions, Mr. Chairman. Mr. Moss. Mr. Goldwater, who is sitting with the committee this morning, do you have any questions? Mr. GOLDWATER. Thank you, Mr. Chairman. In your statement, you say security depositories are now being organized as banks. Is this something being encouraged by your organization in particular or is this something that is occurring nationally? Mr. SOLOMON. Mr. Congressman, our organization has really had no part in encouraging or discouraging this. This has been arrived at by the industry itself and that seems to be what the industry considers a natural line of development. Mr. GOLDWATER. When you say "being organized as banks," can you describe this bank, as the interpretation of a bank to a layman may take completely different forms, but when a security depository is organized as a bank, does it fulfill all functions that a bank normally does? Mr. SOLOMON. Mr. Congressman, no, it would not fill all functions. I think the main reason why one might describe these as being organized as banks, is that they are organized under the banking laws of the State in which they operate and they receive a charter from the bank supervisor of that State, unlike most ordinary corporations which almost pro forma can receive a charter almost mechanically through the Secretary of the State or something like that. It is a very pro forma type of thing, whereas a bank receives its charter under the banking laws, which is a separate set of laws that govern banking institutions and, instead of receiving it in the pro forma way that ordinary business corporations receive their charter, it receives it from the superintendent of banks and is under the supervision of the superintendent of banks. Now these institutions do not receive deposits in the usual way that a bank does, but they do exercise nondeposit trust functions in the way that banks do and that, I think, is the way they operate. Mr. GOLDWATER. Well, now, when you say securities depository, is that also the same as a clearinghouse or a clearing agency? Mr. SOLOMON. It is my understanding that at present these do not plan to act as clearing agencies, they plan to operate only as depositories. Whether in the future they might act as clearing agencies, I do |