The regulatory system under H.R. 10, warts and all, is significantly superior to the current system for financial services consumers and firms alike.

Congress has the opportunity to build upon the momentum generated last year and act swiftly to pass legislation. To lose this opportunity would be highly unfortunate for the financial services industry, which is laboring under an antiquated and often counterproductive regulatory system. Moreover, it would be a loss for the American public, who, as consumers of financial products and services, are not receiving the benefits of competition and innovation that would result from financial services modernization legislation.

The need for prompt financial services modernization legislation is compelling. As I mentioned earlier, today financial institutions are affiliating with one another at a dizzying speed. What's more, these affiliations are occurring under a statutory system that originally was intended to ban such affiliations. These affiliations are the result of ad hoc decisions by banking regulators that have permitted banking organizations to acquire securities firms, while securities firms generally remain prohibited from acquiring commercial banks. This is the case, because, under current law, if a securities firm were to acquire a bank, the combined entity would become subject to the Bank Holding Company Act and the Glass Steagall Act, even though these laws were not designed to accommodate many of the ordinary and customary activities of securities firms (such as securities underwriting and dealing, the distribution of mutual funds, merchant banking, venture capital, commodities and various other activities). Also, many of the current restrictions on bank affiliates were imposed prior to the invention of computers, fax machines, ATMs, the Internet, and various other technological innovations that have transformed the financial services industry. Statutory impediments more than 60 years old make little sense in today's technologically sophisticated highly competitive and global financial world.

Still, financial services providers continue to affiliate under the current regulatory framework, despite outdated restrictions that unfortunately increase the cost of affiliations and limit the competitiveness of the combined firms. In the last two years, banks have acquired more than 50 securities firms. Financial services firms affiliate in response to their customers' and clients' demands and to remain competitive in the financial marketplace. The financial services industry will continue to evolve regardless of whether financial services modernization legislation is enacted. It is simply not desirable or possible to maintain the status quo. The fundamental policy question for Congress is not whether these affiliations should occur, but what regulatory system should govern the combined entities. Surely, it should not be the current patchwork regulatory scheme that gives some financial institutions unfair and irrational competitive advantages over other financial institutions. Paine Webber believes these combined entities should be regulated under a system similar to that contemplated under H.R. 10. Providing financial services in functionally regulated entities that may affiliate with one another in a holding company structure will enhance the competitiveness of all financial services firms, ensure investor protection, and assure the appropriate level of protection for depositors and the deposit insurance fund.

The U.S. securities industry is perhaps as competitive as any industry in the world. It is in part a result of that competition-including the ability to affiliate with entities other than banks-that the U.S. capital markets are the world's largest and most liquid. In the securities markets, one need only look at the vast choices in products, services, providers, and methods of compensation to see how competition has greatly benefited investors. Consumers can invest in stocks, bonds, and thousands of mutual funds. They can choose a full-service provider or a financial planner to receive advice on managing their assets. More independent and knowledgeable investors can use a discount firm to execute their transactions. Alternatively, consumers can make their trades electronically over the Internet for a fraction of the cost of just a few years ago. Investors can choose to compensate their broker in a traditional commission arrangement, a flat-fee basis, or as a percentage of assets under management. These changes greatly benefit investors and are the direct result of a highly diverse, competitive industry that is willing and able to invest the capital needed to meet the demands of its customers. Passage of financial services modernization legislation would bring the benefits of competition, including cost savings estimated at $15 billion over three years, to the entire financial services marketplace.

Mr. Chairman, Paine Webber generally supports H.R. 10 for several reasons. First, H.R. 10 has an appropriate definition of “financial in nature," which governs the types of activities in which financial holding companies may engage. Permissible activities also would include activities that are incidental or complementary to activities that are financial in nature, in order to permit securities, insurance and

other types of financial services firms to continue providing long-standing and important services to their customers.

Second, H.R. 10 would create a new regulatory structure that would enhance the competitiveness of financial services firms by permitting securities firms, insurance companies, and banks to freely affiliate in a holding company structure. This would increase competition between financial services firms, thus reducing costs and giving consumers more choices. It also would help the U.S. financial services industry maintain its preeminent status in the global economy. Under H.R. 10, the holding company would be regulated by the Federal Reserve Board. Each of the subsidiary financial institutions engaging in a securities business would be registered as a broker-dealer and would be functionally regulated by the SEC, thereby bolstering investor protection and fair competition.

Third, H.R. 10 would give customers more choices. Many individuals and corporate customers worldwide are demanding to have all their financial needs met by a single firm. The ability of securities firms, insurance companies, and banks to affiliate would allow a single financial services firm to meet those needs. Individuals could choose a full-service provider because they value something as simple as a single monthly statement showing their checking account balances, securities holdings, retirement account investments and insurance policy values.

Fourth, the legislation generally provides for a two-way street, by permitting securities firms, insurance companies, and banks to freely affiliate with one another, on the same terms and conditions, and to engage in any activity that is financial in nature.

Fifth, H.R. 10 would create wholesale financial institutions (“WFIs”), which are banks that do not accept deposits that are insured by the federal government-that is, they generally do not accept deposits under $100,000. WFIs would provide commercial banking services to institutional customers without imposing any risk to the bank insurance fund or U.S. taxpayers.

Significantly, the legislation would require each financial institution to be functionally regulated. One regulatory agency should apply the same set of rules to the same activity engaged in by any financial institution, regardless of the type of institution it may be. Paine Webber strongly believes that the SEC, the securities selfregulatory organizations ("SROs"), and the state securities regulators should oversee securities activities regardless of what entity performs those activities. Similarly, the appropriate federal or state-banking regulator should regulate banking activities, and the appropriate state insurance regulator should regulate insurance activities.

Functional regulation assures that the most knowledgeable regulator is supervising a financial services institution's diverse activities. In the securities markets, all participants would be equally subject to the principle of complete and full disclosure and regulation by the SEC and SROs. The guiding principle of disclosure protects investors, encourages innovation, and promotes fair markets. Indeed, under this regulatory structure, the U.S. capital markets have set the global standard for integrity, liquidity, and fairness. Investors understand the protections they are afforded and market participants understand their obligations.

Moreover, functional regulation eliminates regulatory discrepancies and the resulting competitive advantages between financial services firms engaging in the same activities. Under H.R. 10, all securities activities would be performed outside of a bank, with the benefit of SEC, SRO and state securities administration regulation, except for a small number of carefully defined securities activities that traditionally have been conducted in banks.

After years of negotiation, the securities and banking industries developed a set of functional regulation provisions (1) that permit banks to continue to engage in certain limited securities activities that banks traditionally have provided to their customers as an adjunct to their banking services, but (2) require all other securities activities be conducted outside of the bank in an SEC- and SRO-regulated brokerage affiliate. Notably, Paine Webber is not aware of any significant opposition-in either the banking or securities industries to these functional regulation provisions. Paine Webber supports H.R. 10 in part because it incorporates the functional regulation provisions.

I would note that Paine Webber supports the holding company/affiliate structure. Importantly, however, although H.R. 10 allows for securities activities to be conducted in an operating subsidiary of the bank, the SEC is expressly authorized to regulate the securities activities of the operating subsidiary, as well as to regulate such activities if conducted elsewhere in the holding company. Paine Webber believes that this ensures that securities activities are regulated by the appropriate, experienced authority-the SEC, the National Association of Securities Dealers, Inc., New York Stock Exchange, and other securities regulators.

Mr. Chairman, last session Paine Webber and many other securities firms supported H.R. 10 and worked actively to pass it. That bill, while not perfect, represented a series of compromises by every sector of the financial services industry. Although there were a number of provisions that Paine Webber believed could be improved, we supported the bill because we were committed to maintaining the delicate compromise that had achieved consensus among all the participants. H.R. 10 represented a fair and thoughtful approach to balancing the competing interests of a wide range of financial services providers and regulators, and it is a vast improvement over our current regulatory system.

Paine Webber remains committed to working with the Commerce Committee to pass a consensus version of H.R. 10. However, if changes are to be made to the bill, we recommend the following:

Increasing securities firms' ability to affiliate. Securities firms, insurance companies, and other diversified financial firms currently may affiliate with non-financial firms. Paine Webber believes that financial services modernization legislation should reflect current market practices and permit commercial affiliations to continue. Existing commercial affiliations have not weakened securities, insurance, and other financial services firms, and there is no reason to believe that permitting banks to similarly affiliate with commercial companies will endanger banks. Indeed, the experience under the unitary thrift charter, which currently permits commercial firms to own or affiliate with a thrift, is powerful empirical support for this view.

Broadening the description of permissible merchant banking activities to assure that current market practices are not inadvertently restricted. For example, because of the restrictions in H.R. 10 against a securities firm becoming involved in a company's day-to-day management operations, the securities firm might be unduly limited in its ability to interact with the management of a company it acquired in a merchant banking transaction. Similarly, the securities firm might be required to divest that company in a "fire sale" because of the bill's restrictions on the length of time the company could be owned.

Paine Webber has worked with you, Mr. Chairman, members of this Subcommittee, others in Congress, and many in the financial services community to reach a number of the compromise positions that were reflected in H.R. 10. The progress we made cannot be overstated. Passage of financial services modernization legislation is vital to the financial services industry in general and to the securities community in particular.

Mr. Chairman, we look forward to working with you, members of your Subcommittee, as well as the House, Senate, and Administration to enact financial services reform legislation this year.

Mr. OXLEY. Thank you, Mr. Sutton.

Let's go now to Iowa and hear from Mr. Arnold Schultz.

STATEMENT OF ARNOLD SCHULTZ

Mr. SCHULTZ. Thank you, Mr. Chairman, members of the committee. I am Arnie Schultz, Chairman of the Grundy National Bank, a $106 million community bank in Grundy Center, Iowa. We have been in business since 1934, serving the consumer, business and agriculture needs of our community. Thank you for giving me the opportunity to share my views on the financial reform legislation currently before your committee.

You asked that I testify on the operating sub issue. Let me say I support the position of Fed Chairman Alan Greenspan that risky, new activities that are authorized under this bill should be pushed out into separate capitalized affiliates of the holding company. Chairman Greenspan argues that the holding company structure is superior for two reasons. One of those reasons is to minimize the Federal subsidy arising from the Federal safety net that would flow to operating subs. The second is to protect the safety and soundness of our banking and financial system. I will limit my comments today to the safety and soundness issue.

One of the consequences of this bill will be for the emergence of large financial conglomerates. For example, a large commercial bank could merge with a securities firm that deals in derivatives which, in my judgment, is a risky line of business. If an op-sub incurred a rapid loss of capital from its derivative activities, it would immediately put pressure on the commercial bank to come to its rescue. The same reasoning applies to risky merchant banking activities. If trouble arises, and if the bank was also too big to fail, the Federal Reserve discount window would likely feel the pressure first, followed by the FDIC and ultimately, depending upon the size of the institution, the taxpayer.

Protection of the Federal safety net is crucial and is best served by the holding company structure. Shielding risky activities from the bank will provide maximum protection for the deposit insurance fund.

I would hate to see the failure of a large multinational bank jeopardize the solvency of the FDIC Fund because of its involvement in risky, nontraditional bank activities. As a community banker who is not protected by the "Too Big To Fail" doctrine, deposit insurance is the lifeblood of my operation. The bill that was reported out of the House Banking Committee would give the Fed some oversight over op-sub activities, but it doesn't provide maximum insulation of risky activities from the core bank and from the Federal safety net, as would the holding company structure.

Mr. Chairman, I would like to also briefly comment on the unitary thrift issue, which is a major significant public policy issue that risks getting lost in the shuffle as the most powerful men in the world fight over CRA and op-sub. How this issue is resolved will have a profound impact on our future economic and financial structure and on our diversified financial system.

Under current law, there are no restrictions on what a unitary thrift company can own or who can own a unitary thrift, including commercial firms. The case against mixing banking and commerce is well established.

Taking this issue to the community banking level, if a bank such as mine owned a grocery store, why would I want to lend money to someone else who wanted to open a competing grocery store in our community? While the bill before you partially closes the unitary thrift holding company loophole by prohibiting the chartering of new unitaries owned by commercial firms, it fails to close the loophole completely and allows each of the 600 or so grandfathered unitary thrifts, most of which are not currently owned by commercial companies, it allows them to be acquired by commercial firms. Chairman Greenspan has warned that these kinds of affiliations pose serious safety and soundness hazards. We believe it, and I think I heard Secretary Rubin state this morning that he would also concur. I believe strongly that the unitary thrift holding company loophole should be closed, and that grandfathered unitaries should not be allowed to be acquired by commercial firms.

Finally, Mr. Chairman, my written testimony spells out my concerns with the insurance language in the House Banking Committee version of H.R. 10. Community banks like mine will be facing cross-marketing competition from financial conglomerates like

Citigroup and it is important that our ability to retail insurance products not be undermined.

Mr. Chairman, that concludes my testimony. Thank you for the opportunity to present my views. I would be pleased to respond to questions at a later time.

[The prepared statement of Arnold Schultz follows:]

PREPARED STATEMENT OF ARNOLD SCHULTZ, BOARD CHAIRMAN, GRUNDY NATIONAL BANK

Mr. Chairman, Members of the Committee, my name is Arnold Schultz, and I am Board Chairman of The Grundy National Bank in Grundy Center, Iowa. I am also president and CEO of GNB Bancorporation, a two-bank holding company that owns 100 percent of Grundy National Bank and Ackley State Bank, a state-chartered bank in Ackley, Iowa. Both banks have multiple-line insurance agencies. In addition, Ackley State Bank recently formed an operating subsidiary that purchased Kastendick and Associates, which holds a general agents contract for the sale of Blue Cross and Blue Shield health insurance products directly and through 20 subagents in Iowa.

My bank, which is located in a farming community of 2,500 people in central Iowa, has approximately $106 million in assets and $85 million in deposits. We have two branches and 37 full time employees. We have been in business, serving the consumer, business and agricultural needs of our community, since 1934.

Thank you for giving me this opportunity to share my views on the financial reform legislation currently before this Committee. By way of background, I have just completed my second 3-year term as a member of the Board of the Federal Reserve Bank of Chicago-an elected position. I am also the first community banker to serve on FASAC, the advisory council to FASB, and I am the present chairman of the Bank Operations Committee of the Independent Community Bankers of America (ICBA).

You asked that I testify on the operating subsidiary issue, that is, what activities are appropriate to be conducted in an operating subsidiary of a national bank, versus what activities should be pushed out into an affiliate of the bank's holding company. I would be pleased to respond to this issue, and share with you my views on several other aspects of the legislation that is before you, H.R. 10, the Financial Services Act of 1999.

Op-Sub Issue

Mr. Chairman, I support the position of Federal Reserve Board Chairman Alan Greenspan that new, risky activities-those other than agency activities that are not now permissible for national banks but would be authorized under this billshould be shielded as much as possible from the national bank itself and conducted in a separately capitalized affiliate of the holding company.

The formation of a holding company is not that difficult and, in my case-like many other community banks-it was done originally for the purpose of maintaining a market for company stock which enables us to continue to operate as a locally owned community bank.

Chairman Greenspan argues that the holding company structure is superior for two reasons to minimize the federal subsidy arising from the Federal safety net that would flow to operating subsidiaries, thereby creating a competitive advantage over non-bank entities; and to protect the safety and soundness of our banking and financial system.

Mr. Chairman, I do not feel qualified to comment on whether or not the sovereign credit of the United States produces a subsidy that would accrue to an operating subsidiary to the competitive detriment of other corporate structures. There appears to be some disagreement on this subject.

As a national banker, I am more qualified to make observations on whether or not these risky new activities would pose a safety and soundness problem to the bank.

One of the consequences of this bill will undoubtedly be the emergence of more very large financial conglomerates combining various elements of the financial services industry and more cross-financial services industry mergers generally. For example, a large commercial bank could merge with an insurance company underwriting property and casualty insurance and a securities firm that deals in derivatives. Insurance underwriting and derivatives are very risky activities. If either the insurance component or the securities component got into financial trouble, it would immediately impact the commercial bank component that is in the universal bank