Finally, another area of the securities business that banks have not entered is the retail brokerage business. While banks arrange for the purchase or sale of securities by their customers through a broker-dealer firm, they have not become direct participants in the broker-dealer community. Since it is not clear that the Glass-Steagall Act prohibits entry into the retail brokerage business, the failure of banks to enter the business may be the result of economic or business considerations, as well as legal considerations. V. Analysis of the Advantages and Disadvantages of Bank In assessing the desirability of bank participation in the above-described 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. The impact of bank participation in the various securities activities on the capital markets may be analyzed in terms of the impact on the primary capital markets or the "new issues" markets, and on the secondary capital markets. For example, bank underwriting or corporate securities would bear more directly on the functioning of the primary markets while dealing i.e., market making -- would involve the secondary markets. As assessment of the desirability of such bank activity would require a consideration of the probable effect on the competitive posture of the investment banking industry and its ability to service the capital needs of corporations, especially smaller companies. Some argue that the lifting of the restriction on bank underwriting would result in a more competitive investment banking industry. Other contend that, because of the competitive advantages possessed by banks, bank entry into the investment banking business would eventually result in a single integrated industry and a greater concentration of economic power within the financial community. Thus, it is argued, lifting of the GlassSteagall restrictions could result in less competition within the investment banking business through the consolidation of closely related financial activities in a single group of institutions. The desirability of other bank securities activities must be assessed in terms of their immediate effect on the secondary markets. Some argue that bank participation in brokerage-oriented and investment activities could reinforce the trend toward centralization of investment decisions in a small number of large institutions. Centralization of investment decisions, it is feared, could distort the valuation function of the market and, therefore, the allocation of capital to American enterprise. For example, it is alleged that institutional investors have in the past favored a few favorite stocks to the detriment of less favored companies, generally smaller or emerging companies. It further argued that the domination of secondary trading by large institutions may also decrease market liquidity and increase price volatility. On the other hand, proponents of such bank activities contend that they would increase investor participation in the secondary markets by providing investors with convenient and less costly access to those markets. Some claim that bank sponsorship of the various investment services could also indirectly affect the primary markets. For example, bank automatic investment plans and the other investment services, it is argued, may cause a net reduction in commission revenues paid to brokerage firms in a competitive rate environment. A reduction in commission revenues could result in a shrinkage in the number of retail brokerage firms that could affect the viability of the distribution system for new issues. The second important public policy consideration in assessing the desirability of bank entrance into the securities field is the effect that such an expansion of bank operations would have on the stability and integrity of the commercial bank system. The securities business, especially underwriting and dealing in securities, is inherently risky and subject to wide fluctuation in earnings. Concern has been expressed that bank participation in this business could seriously threaten the adequacy of bank capital, and could weaken public confidence in commercial banks since there is a risk that the fortunes and good will of the bank and its securities affiliates will rise and fall together. Moreover some people fear that the combination of investment banking and commercial banking would give rise to potential conflicts in that banks would be encouraged to make undesirable loans and investments to support their investment banking operations. This latter consideration is less cogent in some areas of the securities business than in others. Thus, for example, the provision by banks of investment services to customers would not appear to threaten the capitalization of banks since such business generally requires very little capital investment. Similarly, it can be argued that the provision of financial advice to corporate clients or the arrangement of private placements on an agency basis for corporate clients would not appear to pose any direct risk to bank capital or to threaten public confidence in commercial banks, although potential conflicts between their financial advisory and commercial lending business do exist. Investment Services In analyzing the advantages and disadvantages of bank participation in brokerage-oriented and money management activities, the focus must be on the economic and financial impact of concentration of such services in a few financial institutions. Other While automat. vestment plans also have a pe for not been 11 21.1 dotential s tate. Banks sponsor ng automatio Jesnes 1211 report that approximately 40 to 60 percent of Jars.c.33123 in the plans are first-time stock market invest Tester jarticipation in these plans has fallen frana111** 35 market s by the industry itself and, ralume of investment through these plans Voluntary investment plans have app in attracting bank customers to par marketi1. It can be argued that declining stock the nature of the investment sex the primary reason for low investor part 1137 prices, rather *hese plans. had ipate in ice itself, H It is argued that bank sponsorship of investment plans creates opportunities for abuse. One alleged abuse arises from interest-free use of customers funds during the acquisition interval of the investment plans. Banks offering automatic investment services are permitted to invest customers' funds pending the banks' execution of securities transactions for the investment plans. The banks' use of customers' funds during the acquisition interval of investment plass, it is argued, conflicts with the interest of customers in receiving prompt or best execution for their securities transactions. The 13 The American Bankers Association, in its response to the SEC's inquiry concerning bank-sponsored investment services (Securities Act Release No. 5491 of April 30, 1974), reported that approximately 40 percent to 60 percent of automatic investment plan participants were first-time stock investors. 25/ The New York Clearing House Association, responding to the SEC's inquiry concerning bank-sponsored investment services, reported that, while there are approximately 18,000 automatic investor service accounts administered by banks, investor participation has fallen short of market projections. Similarly, the Security Pacific Naitonal Bank responded that after 1 year of operation, its service had only approximately 1,500 participants, or less than 2 percent of the projected market. Horizontal concentration of investment services in a few multiservice banks, however, may produce several adverse effects on the capital markets. Many observers argue that increased concentration of investment services in banks could lead to an overconcentration in investment in a few favored stocks, usually well established issues, and in an allocation of investment funds away from smaller emerging companies to larger established ones. Thus, bank investment services, it is argued, reinforce tendencies toward a tiered market. Stated another way, the argument is that such concentration harms market efficiency by reducing the diversity of investment opinions and the number of independent investment decision makers in the market place. Financial market efficiency, as opposed to efficiency in executing and clearing transactions, may well depend upon the maintenance of a broad range of diverse viewpoints and decision makers in the market place. Moreover, the concentrations of investment advice in a small number of large institutions could adversely affect the liquidity and stability of the securities markets. Agency and Brokerage-oriented Services As noted above, commercial banks presently offer several agency services which provide customers with access to securities markets. These include voluntary investment plans, automatic investment plans, dividend reinvestment plans and custodial accounts. It is argued that these services benefit investors and our capital markets by providing bank customers with a convenient, low cost and more competitive means of purchasing securities. While it is clear that these plans do provide customers with a convenient means of access to securities markets, the extent to which such services provide cost savings to investors is uncertain. On the one hand, banks, through their strong competitive position and by virtue of the economies associated with large orders, may be able to negotiate lower brokerage fees for their customers than the latter would be able to obtain by themselves. On the other hand, it is argued that the banks' own service charges may, in many cases, offset to a great extent any commission savings. To date, these investment services have had limited success in attracting new investors to the securities markets. However, they may have had some success in attracting new capital to the securities markets. Dividend reinvestment plans have experienced substantial growth in recent years and are now offered by almost 500 issuers.18/ Individuals participating in such plans often 187 See William E. Chatlos, "Growth of Automatic Dividend Investment Plans" Financial Executive at 38. (Oct. 1974). augment the amounts made available through dividends for investment. Therfore, it appears that these plans have had a positive effect in attracting additional capital to securities markets on the part of small investors. Because of the automatic nature of such plans and the allocation of fractional shares, they not only facilitate, but in many cases make possible, the reinvestment of typically small amounts of cash dividends. In so doing, they may reduce the tendency of shareholders to allocate dividend payments to consumption rather than savings. While automatic investment plans also have a potential for attracting new investors to the markets, they have generally not realized this potential to date. Banks sponsoring automatic investment plans report that approximately 40 to 60 percent of participants in the plans are first-time stock market investors. 19/ However, investor participation in these plans has fallen dramatically short of market projections by the industry itself and, thus, the volume of investment through these plans has not been significant.20/ Voluntary investment plans have apparently had even less success in attracting bank customers to participate in the securities markets. It can be argued that declining stock prices, rather than the nature of the investment service itself, has been the primary reason for low investor participation in these plans. It is argued that bank sponsorship of investment plans creates opportunities for abuse. One alleged abuse arises from the banks' interest-free use of customers funds during the acquisition interval of the investment plans. Banks offering automatic investment services are permitted to invest customers' funds pending the banks' execution of securities transactions for the investment plans. The banks' use of customers' funds during the acquisition interval of investment plans, it is argued, conflicts with the interest of customers in receiving prompt or best execution for their securities transactions. The 197 20/ The American Bankers Association, in its response to the SEC's The New York Clearing House Association, responding to the |