different on those services. The bank regulatory culture is intended to protect the banks. The culture of securities regulation is intended to protect investors. Those two can work in a complimentary fashion, and there is no reason to substitute one for the other. If we look at this 5 years from now and Merrill Lynch owns a large bank, I see no reason to suggest at that point in time that the SEC supervise Merrill's banking activities. That is not our experience; that is not our culture. That would not be in the best interests of banks or their customers.

Mr. OXLEY. The gentleman's time has expired. The gentleman from Staten Island.

Mr. FOSSELLA. Thank you, Mr. Chairman. Chairman Levitt, let me concentrate briefly on securities regulation. I gather from your words you support SEC regulation of credit derivatives or swaps. Correct?

Mr. LEVITT. Yes, I do.

Mr. FOSSELLA. You state one of the principles at least for SEC support is that of sales practice regulation. Explain to me what the sales practice regulation is, please.

Mr. LEVITT. Well, the current provision allows banks to sell all derivatives to all investors without sales practice requirements. I think, to the extent that derivatives may be sold to nonsophisticated investors, to noninstitutional investors, there would clearly be the need to have certain disclosures.

Mr. FOSSELLA. With respect to the investor, I guess in some people's mind that would depend on the investor. I appreciate your advocacy clearly, in private and public, your support of protecting investors. But if you have a bank like a Citibank selling a derivative instrument to a sophisticated investor like a hedge fund, how does SEC sales practice regulation enter into that equation?

Mr. LEVITT. I think what the SEC has done with respect to the marketing of derivatives has been a very reasoned approach. We convened the largest derivatives dealers in the country, securities dealers representing nearly 90 percent of the securities activity in the derivatives market, and asked them to come up with a voluntary program of disclosure, of risk disclosure. That was called the Derivatives Policy Group. That has worked effectively without the need for regulatory oversight. I have said on a number of occasions that I'm not looking to develop a new series of regulations in the derivatives markets.

Mr. FOSSELLA. So where in there lies the sophisticated investor? They should self-regulate it?

Mr. LEVITT. I wouldn't use the word self-regulate. I think there is a need for greater disclosure, and we are getting that now with the Derivatives Policy Group, which up to now has worked reasonable effectively. The President's Working Group has made some suggestions, which Chairman Greenspan, Secretary Rubin, and I all support, for more disclosure. We simply cannot have enough disclosure in this regard, and I think I would use that expression rather than

Mr. FOSSELLA. In an unrelated topic while I have you, however, I would like to get your opinion on what is commonly referred to as section 31 fees which support the SEC.

Mr. LEVITT. That is an easy one.

Mr. FOSSELLA. I beg your pardon?

Mr. LEVITT. That is an easy one.

Mr. FOSSELLA. That is what I am here to do, throw some softballs your way. It has been, I guess, demonstrated that section 31 fees generated are now in the area of $1.7 billion. There is different approaches as to what to do with the fees, I guess, on capital investment or tax on capital investment, depending on how you look at it.

Do you have a belief as to what should happen with the section 31 fees? There are different approaches that are being discussed, the rate cap, cap on fees. I would be interested to hear your opinion.

Mr. LEVITT. The section 31 fees changed their complexion when we extended those fees to include over-the-counter transactions. That happened as part of a funding mechanism for the SEC that Chairman Bliley devised. I guess it was 3 or 4 years ago.

There were a half dozen committees involved in this in both the House and the Senate, and I understand the desirability of reducing those fees. Indeed, by eliminating the double-counting that took place in the over-the-counter market, we have been able to constructively reduce those fees, I guess, by $10 or $15 million a year. I think to further address that issue, the proposal to place a cap on the fees appears to be the most reasonable of the various proposals that I have seen. And the trick is to get the various committees that have an interest in these fees to come to the table and agree. But I think, of the various proposals that I have seen, that appears to be the one most likely to produce a consensus.

Mr. FOSSELLA. Thank you very much for your time, Mr. Chairman. I yield back.

Mr. OXLEY. The gentleman yields back time. The gentleman from New York, Mr. Engel.

Mr. ENGEL. Thank you, Mr. Chairman. Good afternoon, gentlemen. Chairman Levitt, this morning Secretary Rubin both in his written statement and his oral response to a question from Congresswoman DeGette indicated that the Banking Committee's security provisions in the bill provided inadequate consumer protections. I believe that he said that the exceptions swallowed the rules. And he indicated his willingness to work with you and with us to provide stronger investor protections.

I am wondering if you could help us understand what the sticking points are. I guess that is my question. He said there had been ongoing discussions with you and the bankers, but he felt there was still no solution.

Mr. LEVITT. That is true. We have had extensive discussions with Secretary Rubin and with Chairman Greenspan. And we have told them that we feel this bill does great, great harm to investor interest. With respect to the exemptions that have been created through the years, various changes that were made in the Senate version of this bill last year would, in effect, just substitute banking regulation for securities regulation over securities activities conducted within the walls of the banks.

Now, I don't have to tell you that any piece of complex legislation is a function of various interest groups that have an axe to grind. The insurance companies have an interest. You have heard about

them. The banks have an overwhelming interest, and heaven knows we have heard about that. We have an interest. But the most powerful interest of all, in terms of the implications for the economy, is investor interest.

It is a question of who is willing to stand up, who is willing to say to the banks, look, I know you are not going to give in, but if you are not, you are not going to get a bill if you are going to hurt investors.

I have outlined before the loopholes created with respect to future products, trust activities, the way that derivatives and swaps are handled and private placements-private placements alone could be a proxy for investment banking activity. It's just there. It is there to happen. I understand Secretary Rubin is sympathetic and Chairman Greenspan is sympathetic. But will they say this issue is as important to them as the various issues that concern them? Time will tell.

Mr. ENGEL. One of the things that he also mentioned is that it would be cheaper for a small minority-owned bank to get into insurance and securities through an operating subsidiary versus a separate affiliate. I was wondering if that was your view as well. Mr. LEVITT. I don't believe that. I think there are ways that an affiliate could be comparable. And certainly the Commission would be responsive to encouraging that in any way that we could.

Mr. ENGEL. What are the costs associated with setting up a broker-dealer as a separate affiliate?

Mr. LEVITT. I don't know precisely. I would have to do some work on that and get back to you, if I might.

Mr. ENGEL. The Secretary also said in his opinion the problem that our financial services face abroad is lack of access and not lack of competitiveness. I know it is a trade issue obviously in large part, but several large broker-dealers have told us that their access in some countries is hindered because they don't have a consolidated regulator or an umbrella supervisor.

Is there anything in H.R. 10 that would address this concern, and if not, should this concern be addressed? Do you have any suggestions for us on that?

Mr. LEVITT. I think to some extent the WFI might be one way to do this, and I think the problem that the Secretary mentions is a legitimate problem and something that I think we have to be mindful of.

Mr. ENGEL. Thank you very much. Thank you, Mr. Chairman.

Mr. LEVITT. By that I meant the broker-dealer holding company containing a WFI, which I think this committee considered seriously the last time out.

Mr. ENGEL. Thank you.

Mr. OXLEY. The gentleman's time has expired.
The gentleman from Florida, Mr. Deutsch.

Mr. DEUTSCH. Thank you, Mr. Chairman.

I thank the Commissioner as well.

Mr. Levitt, if you could, I have read through your testimony and I have heard some of the responses to questions in the last couple minutes as well, but just for a couple seconds, you have discussed the current bill's possible adverse effect on the economy. In layman's terms, could you maybe get into some analysis of the dif

ference between the effect of the House banking bill versus the effect of the bill that this committee passed last year in terms of the market and in terms of the average consumer in America?

Mr. LEVITT. Last year's bill, which we supported as a better alternative than something which we felt was pretty bad, was by no means perfect. The reason that we favor the Commerce Committee's approach to this bill is that it respects the primacy of consistent regulation. I no longer use functional regulation because that word has been so misused by people who have other reasons for using it. This committee, in terms of its approach has respected consistent regulation, and its proposal last time was intended to see to it that all securities activities that take place within the banks are supervised and regulated by securities regulators. That is the fundamental difference between the bill that came out of the House which creates a situation where banking regulators supervise virtually everything that goes on within the walls of the banks.

I have mentioned specific areas which we find the most dangerous from that point of view. If anything, this year's bill is more troublesome, but the bill that is winding its way around the Senate is probably the worst of all.

Mr. DEUTSCH. My understanding, and you have testified to this effect of negotiations that you are in the process of having with Secretary Rubin as well as Mr. Greenspan regarding the—and I will use the term, because I guess that is a term that we are still using, the "functional regulation" issue, can you give us any report on the progress of those negotiations?

Mr. LEVITT. I think I said before that intellectually I am sure that I know that both of them share the concerns for investors that we have expressed, but their interests in and their versions of the bill have other aspects, with other constituencies.

As far as I am concerned, our only constituent is the investing public, and whether their interest is in coming to some sort of a consensus arrangement which has the chance of legislative reality and executive passage, signature, I simply don't know. I think that they have expressed support for our position, but how far that support will go in terms of its tradeoff for other interests, only time will well.

Mr. DEUTSCH. Is it fair to say that you are continuing in this process?

Mr. LEVITT. Is it fair to say what?

Mr. DEUTSCH. That you are continuing in these discussions, these negotiations?

Mr. LEVITT. Yes.

Mr. DEUTSCH. So these discussions are ongoing?

Mr. LEVITT. Absolutely.

Mr. DEUTSCH. Is there anything we can do to be helpful?

Mr. LEVITT. I will think about that.

Mr. DEUTSCH. Let me ask you-and again you talked a little bit about it in your testimony, and this is just, you know, as I try to understand what is actually going on in the world today, my understanding is that, in fact, banks are using swaps, using derivatives in equities, which have the equivalent of basically sales of securities. That is going on today. Would you say that is accurate, and

if it is accurate, how does the SEC view that activity? My understanding is that it is going on without SEC interaction at all.

Mr. LEVITT. If there are derivative activities going on with securities involving fraud, the SEC would obviously have jurisdiction. I believe that the derivatives activities of banks are by and large being done with institutional investors. We have a much greater understanding of the nature and extent of those activities as a result of the establishment of the DPG which I mentioned before.

Mr. DEUTSCH. But again, if I can just follow up with just one final question, your answer seems to infer that only in cases of fraud would you be involved.

Mr. LEVITT. No, no, fraud in the swaps market is a rare occur

rence.

Mr. DEUTSCH. Right. So again, if in fact they are trading securities, equities, through swaps, in effect you have no jurisdiction today; or are you not using what you might infer as jurisdiction? In other words, I guess my point is, isn't this already occurring and it is occurring within the banking laws without the SEC really being involved in this today?

Mr. LEVITT. Most swaps, I would point out, don't represent securities, and those that do should follow the same rules as securities that are sold by brokers.

Mr. DEUTSCH. I don't-I am still not hearing the answer. My understanding is that is going on today, but you are not regulating it, you are not involved.

Mr. LEVITT. You are correct, there is a blanket exemption now. Mr. DEUTSCH. And if that is the case and we don't really see issues of fraud, then I mean why do we think there would be problems? I mean, in other words, it is already going on. Shouldn't all these parades of horribles that you described, shouldn't they be taking place already?

Mr. LEVITT. Because I think in the world as I see it developing, with more and more securities activities going into banks and the increasing likelihood of acquisitions of brokerage firms by banks, this will become far more important in terms of securities activities than it is today.

Mr. DEUTSCH. Okay. Thank you, Mr. Chairman.
Mr. OXLEY. The gentleman's time has expired.

The gentleman from Illinois, Mr. Shimkus.

Mr. SHIMKUS. Real quickly. Thank you, Mr. Chairman, and I welcome to the committee Chairman Levitt who graced us with his hospitality maybe 6 weeks ago at the SEC and I enjoyed that visit. I learned a lot too, and I think that is important.

I have been focusing on this issue, on safety and soundness, and now consistent regulation. Politicians—you have to be careful about changing words for us, because I am very comfortable with "functional," but I will use "consistent." And my focus has been on the operating sub and really the FDIC insurance and how that might impact safety and soundness.

Your predecessor, Richard Breeden, when asked about the operating subsidiary before the Commerce Committee made the following statement: "If government subsidies such as the operating subsidiary are introduced into the securities market, then the dulling narcotic effect of these subsidies and the related bureaucratic