bank trust departments, and I would guess they would have been fairly common. It is an old and traditional trust service, and at least as long as I have been aware of trust departments and their activities they have had this type of service; and I'm just trying to recall records from the institution with which I was involved-I remember there were a number of accounts of a custodial nature that had been there for many, many years. That's certainly not good evidence, but it's my impression. Senator WILLIAMS. Something has been added to custodial services now. The suggestion here by the bank that we were talking about in its solicitation is to make that custodial account an active investment account. Isn't that what was Mr. BUCHER. Many custodial accounts traditionally have been active investment accounts. How do you define "active?" What do you mean? It depends on whether the directions are from the principal on the account or his investment adviser. Some custodial accounts may be set up as very active trading accounts and that's been proper and traditional. There are other custodial accounts that may contain very conservatively managed investment portfolios with for instance bonds which are very rarely traded. I don't think there's really any difference other than the benefits through the savings in commission that would accrue to the principals who have created these accounts. Senator WILLIAMS. What area of the bank are these custodial accounts managed in? These are not within the trust department? Mr. BUCHER. Yes, traditionally, they are within the trust department. They certainly don't have to be by law or any other reason, but they are traditionally part of the trust activity. They are created under a contract and it's just an agreement between the person depositing the securities and the institution. The institution will hold the securities, collect the dividends, make payments, have safekeeping arrangements for the securities and will buy and sell securities on the order of the principal, the person who's deposited them with the bank, or his investment adviser. This is, to the best of my knowledge, a very old and traditional activity for bank trusts. Senator WILLIAMS. And his investment adviser can also be bank personnel, can they not? Mr. BUCHER. They could be, and that's what they call a discretionary custodial account. Yes, that's right. Senator WILLIAMS. What regulatory law is imposed upon that investment adviser within the bank's custodial or trust department? Mr. BUCHER. Well, probably the investment adviser would also be a part of that trust department. Those trust departments would have investment divisions, personnel within the trust department who would give investment advice to custodial accounts, to living trusts, to testamentary trust accounts, all the accounts where investment decisions must be made. As far as the law is concerned, I know of no specific legislation but performance would be reviewed in light of common law standards applicable to fiduciaries, such as the prudent man rule. Again, these are traditional functions that have been performed by trust departments. Glass-Steagall said that you could buy and sell securities for the account of a customer without recourse where there's not in effect a participation of the bank for its own account. And so these have continued on as long-time services. Senator WILLIAMS. Now the problem as I see it-and we have had a long journey of inquiry here-but from my questions and your answers, it appears there certainly is law and regulation covering the securities industry in all of the areas that we have been talking about. You're saying that on the bank side these are time-honored practices but they are not under the securities laws? Mr. BUCHER. They are certainly under supervision. Those investment advisers are not registered under the Investment Advisers Act. They don't have to take the NASD test or any of these other things. But those accounts, as I stated in the testimony, are examined on an annual basis by trust examiners who specialize in reviewing these types of accounts, looking for problems involving conflicts of interest, problems involving self-dealing, problems involving failure to comply with fiduciary standards as far as investment practices are concerned, and I think if you look at performance over the years as far as the type of prudence that has been engaged in in the management of these accounts, for the most part I think you will find the banks have done a very credible job. Senator WILLIAMS. But these regulatory overseers are bank, not securities regulators. Mr. BUCHER. That's right. They are representatives from the staffs of the Comptroller of the Currency, Federal Reserve, and FDIC, and they are also State bank supervisors who provide trust examination. Senator WILLIAMS. Now you said this is healthy competition and it is certainly competition. What is superficially disconcerting at this point is the different rules that competitors are working under. You see? Mr. BUCHER. Yes, there are different rules. Now I think before I would urge a change, however, I would want to know that the present procedures are leading to some detriment as far as investors or the public is concerned. I'm not convinced in my own mind, very frankly, that there is any detriment as far as public policy considerations. Senator WILLIAMS. Well, that's what we are here to find out. I wonder if we could, if there are other questions that are appropriate— we really haven't got the time this morning-if we could submit these in writing? Mr. BUCHER. Yes. I'd be very pleased to answer any questions in writing. Senator WILLIAMS. If the answers come from the Board of Governors, that's all right. I don't know what your plans are, Governor Bucher, but you're leaving here within a matter of days now. If you could work that out, if we do have any written questions Mr. BUCHER. I'll be very happy to. Senator WILLIAMS. Thank you very much. [The following letter was sent to the Federal Reserve Board:] U.S. SENATE, COMMITTEE ON BANKING, HOUSING AND URBAN AFFAIRS, Hon. ARTHUR F. BURNS, DEAR MR. CHAIRMAN: By agreement between Governor Bucher and the Subcommittee on Securities at his appearance on behalf of the Board of Governors of the Federal Reserve System on December 9, 1975, I am submitting for record the following list of questions. Because the hearing record will be held open pending receipt of the Board's response, I would appreciate your responding to this letter as promptly as possible. Examination of the Bank Commercial and Trust Departments 1. Describe the extent to which bank examiners, in connection with the Fed's examination of both trust and commercial operations of banks are required, or authorized as a matter of discretion, to examine: a. the management, operation and performance of Individual Retirement Accounts; b. the management, operation and performance of Keogh Plans; c. the operation of automatic investment services; d. the operation of dividend reinvestment plans; e. the execution of orders for the purchase or sale of securities on behalf of trust or custodial accounts; f. the execution of customer orders (other than for trust or custodial accounts) for the purchase or sale of securities; g. the management, operation and performance of investment companies and similar companies; h. the management, operation and performance of real estate investment trusts and similar companies; i. the management, operation and performance of investment advisory (agency) accounts; j. the underwriting of and principal transactions in general obligation bonds of state and local governments? 2. What standards are applicable to such reviews? Please attach copies of any pertinent regulation or procedure. 3. Which of the services listed in Question 1 may be offered only by a bank permitted to exercise trust powers? Conflict of Interest 4. Are your examiners required, or authorized as a matter of discretion, to analyze the relationships of a bank's commercial or trust departments with issuers whose securities are held by accounts supervised by the trust department? 5. Are your examiners required, or authorized as a matter of discretion, to review the timing of purchases and sales in connection with automatic investment services and dividend reinvestment plans in relationship to purhases and sales for trust or advisory accounts? 6. Are your examiners required, or authorized as a matter of discretion, to review the length of time money remains uninvested in accounts established in connection with the services listed in Question 1? 7. What standards are applicable to such reviews? Please attach copies of pertinent regulations or procedures. Inside Information 8. Are your examiners required, or authorized as a matter of discretion, to approve or review internal bank procedures relating to the flow of information which may be useful for investment purposes between the commercial and trust departments of a bank? 9. What standards are applicable to such reviews? Please attach copies of any pertinent regulation or procedure. 10. Are banks required to report or keep records of any violation of such regulations or procedures? Reports of Possible Impropriety 11. In the last five years, have any examinations revealed any cases of improper or unlawful conduct in the trust, brokerage or investment advisory activities of any bank? 12. If there have been such cass, please specify: (a) the number, (b) the factual situations involved (name of banks and issuers may be omitted), and (c) the corrective action taken in each case. 13. If an examination reveals a possible violation of the Federal securities laws (e.g., Rule 10b-5 under the Securities Exchange Act of 1934), is the Securities and Exchange Commission notified? Written Policies and Procedures 14. Are banks subject to your supervision required to maintain any written policies or procedures relating to any of the activities listed in Question 1? If so, please attach copies of any pertinent regulation or procedure. 15. Are your office's examiners required, or authorized as a matter of discreion, to request or require that banks adopt written policies or procedures relating to any of the activities listed in Question 1? If so, please attach copies of any pertinent regulation or procedure. Advertisements and Sales Literature 16. Are banks required to file with your office advertisements or sales literature relating to any of the activities listed in Question 1? If so, please attach copies of any pertinent regulation or procedure. 17. Does your office or its examiners review advertisements or sales literature relating to any of the activities listed in Question 1? If so, please attach copies of any regulation or procedure relating to such review. Real Estate Investment Trusts 18. With respect to the Board's amendments to Regulation Y in 1972 to authorize bank holding companies to act as advisors to registered investment companies and real estate investment trusts (REITs), what services are bank advisors permitted to provide? 19. Has the Board established any regulations relating to conflicts of interest between a bank and an investment company or REIT sponsored or managed by the bank or an affiliate of the bank? 20. Are investment companies or REIT's which are sponsored or managed by a bank or an affiliate of a bank an "affiliate" for purposes of 12 U.S.C. § 338, § 371c and other provisions of Title 12? 21. What regulatory jurisdiction does your office have over transactions which involve the exchange of assets of REIT's for assets of a creditor bank (sometimes referred to "loan swaps")? 22. Has your agency made any investigations of these types of transactions? If not, are any planned? 23. Please list all banks, or affiliates of banks, under your jurisdiction which manage or advise registered investment companies or REIT's and the name of the banks and their affiliates, and the investment companies and REIT's. Thank you for your cooperation. Sincerely, HARRISON A. WILLIAMS, Jr. Senator WILLIAMS. Our next witnesses are Hon. Edwin H. Yeo III, Under Secretary of the Treasury for Monetary Affairs, and Mr. Robert Gerard, Deputy Secretary of the Department of Treasury. We appreciate your contribution to this initial hearing. STATEMENT OF EDWIN H. YEO III, UNDER SECRETARY OF THE TREASURY FOR MONETARY AFFAIRS; ACCOMPANIED BY ROBERT A. GERARD, DEPUTY ASSISTANT SECRETARY, DEPARTMENT OF THE TREASURY Mr. YEO. Thank you, Mr. Chairman. I am pleased to testify before you today on behalf of the Treasury Department in connection with your study of securities activities of commercial banks. The role of commercial banks in the securities markets has attracted increasing attention in recent years. Spurred by changing economic conditions and market forces, commercial banks have gradually expanded their financial services in the securities field. This expansion, of course, has been circumscribed by the boundaries of the Banking Act of 1933, more popularly known as the GlassSteagall Act, and has been inhibited in some cases by uncertainty and confusion concerning the extent to which the act limits bank securities activities. This is particularly true with respect to those activities which commercial banks did not perform in 1933 and which Congress consequently did not contemplate when enacting the Glass-Steagall Act restrictions. It seems clear that a thorough review of the GlassSteagall Act restrictions is desirable at this time. We should determine to what extent the act's restrictions on bank entry into the securities business remain valid in light of changes that have occurred in the economy, the banking industry, and Government regulation of banking and securities transactions since 1933. As you are aware, the Capital Markets Working Group is in the process of conducting a review of these matters. That review does not emphasize the legal aspects of current bank security activitites. Although these questions are important, in our view, the first priority should be to examine each bank security activity to determine whether as a matter of public policy each is desirable and should be permitted by law. Only after the determination is made that a bank security activity be permitted, need the question of regulation be considered. Our initial issues paper, titled "Public Policy Aspects of Bank Securities Activities" which I will submit for the record (see p. 22), Mr. Chairman, attempts to identfy the various public policy considerations that should be weighed in determining the proper scope of commercial bank participation in the securities business. As our issues paper indicates, we have avoided definite judgments on these questions because we believe that they would be premature. Instead, the paper presents the potential advantages and disadvantages of each activity for the purpose of eliciting comment and factual data that will enable us to reach conclusions. I would like to summarize for this committee the major areas covered by the study. In assessing the desirability of bank participation in particular securities activities, the foremost consideration should be the effect of such bank activities upon the long-term health of the securities markets and their ability to meet the capital needs of American enterprise. A second and perhaps equally important consideration is the effect that such bank activities would have on the stability and integrity of the commercial banking system. This will require an examination of the probable impact of these activities upon competition between various segments of the financial community and an assessment of the likely benefits in terms of increased efficiencies and lower costs in obtaining financial services. The broad ramifications of increased economic concentration within the financial community must also be explored. With respect to bank brokerage-oriented and money management activities, the effect on the liquidity and efficiency of secondary markets is an important public policy consideration. Finally, bank security activities must be analyzed in terms of their compatibility with sound banking practices and their potential for creating conflicts of interests and other difficulties within the commercial banking system. AGENCY AND BROKERAGE-ORIENTED SERVICES Commercial banks presently offer several agency and brokerageoriented services which provide customers with access to securities markets. These services include the dividend reinvestment plans, automatic investment services, and voluntary investment plans. In each of these services, the bank acts as a conduit between its customers and the broker-dealer community by channeling the bank's customers' orders to purchase or sell securities to a broker or dealer. |