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other similarly situated entities. Unfortunately, this provision is not intent-based. It is based on the effect a law has on a particular party. Therein lies our concern. Section 104(c)(2), because it is effect based, provides a loophole which will permit banks to challenge state insurance laws even where there was no intention by the state of treating banks differently than insurance companies. We believe this is a path that will destroy the concept of functional regulation that the authors of H.R. 10 have tried hard to preserve.
Under H.R. 10 as currently drafted, the advantage is given to the banks. Banks gain because state laws are preempted simply because they are banks. Such preemption is not a two-way street, as insurers are not positioned to have banking laws preempted where a banking law would have an adverse impact on an insurer.
A concrete example of where a bank could have an unfair advantage in relation to the business of insurance involves accounting practices. Currently, under what are called Statutory Accounting Principles (SAP), insurers are required to report their financial results under what tend to be more conservative accounting rules than Generally, Accepted Accounting Principles (GAAP). Banks follow GAAP accounting. Would an insurer affiliated with a bank not be held to SAP, and not be as strictly regulated as an insurer without bank affiliation, since the imposition of differing accounting principles is an additional cost to the bank?
The problem with Section 104(c)(2) is that it is not directly tied to the intent of the state to adversely impact a bank. Section 104(c)(2) operates regardless of the state's intent. The only test of Section 104(c)(2) is if the impact on a bank is different because it is a bank. If that impact exists, then any such state law or regulation is preempted. This is not preemption based on a state passing a law intentionally to affect a bank in the context of insurance business. It is preemption by hindsight, as the state's action will be viewed in relation to what happens, potentially years down the line, to a bank. It will not matter that the state had absolutely no intention of adversely impacting a bank. It will not matter that the state law was reasonably related to proper governmental objectives. What will matter is that a bank need not comply with such a law. That is an unfair advantage to the bank.
Nor is it true functional regulation to give a bank this advantage, for by granting the advantage, there is an area where the function of the business of insurance not regulated by the states. It is likely, too, that under Section 104(c)(2), costly litigation will arise, for the bright line of functional regulation will become blurred as banks attempt to show that the effect, not the intent, of a state law adversely impacts the bank. In the context of these likely squabbles between banks and their regulators, and insurers and their regulators, under current Section 104(c)2), financial services modernization would not be controlled by functional regulation, but rather plagued by dysfunctional regulation. NAIC Amendments
The National Association of Insurance Commissioners recently submitted to the Committee a package of amendments which include a call for deletion of 104(c)(2). NAII supports this and other NAIC amendments, and strongly encourages members of the House Commerce Committee to seriously consider their adoption. Please note that while stating NAII's support for removal of Section 104(c)(2) from H.R. 10, the NAII strongly opposes any state law which is intended to have an adverse impact on a bank or which on its face singles out banks. Many NAII members have business relationships with banks, and would find affiliations with banks mutually advantageous.
In addition, NAII strongly supports the proposed NAIC clarification to Section 303 stating that all insurance activities, not just sales, are to be functionally regulated. This change is consistent with the deletion of Section 104(c)(2) in order to achieve with “bright line” functional regulation. Operating Subsidiaries
NAII applauds the language in H.R. 10, Section 304, stating that a national bank and the subsidiaries of a national bank may not provide insurance as principal. To do otherwise would make functional regulation virtually impossible. However, there are activities which are permitted to national banks and bank subsidiaries. These include "authorized products” or other insurance related activities. Because these products or activities are insurance related, consistent with functional regulation, these should be regulated by the states.
At this point, it is appropriate to cite an example of an activity in which national banks or subsidiaries of national banks are permitted to engage but which should be functionally regulated as insurance. National banks are authorized to enter into debt cancellation agreements providing for the cancellation of the borrower's outstanding debt upon the death of the borrower. The Office of the Comptroller of the
Currency ("OCC") recently extended that authority to include debt cancellation agreements pursuant to which debt is cancelled as a result of the borrower's disability or loss of employment. These products resemble insurance and should be functionally regulated by the states. This is not to prohibit the banks from offering the products, only to regulate the product as insurance.
A similar product is Guaranteed Auto Protection Coverage (“GAP Coverage”) whereby coverage is issued for the excess of the outstanding loan amount over any recovery from an insurer in the event of theft or total loss of a vehicle. For example, an individual may have a loan balance outstanding of $5000. The car is in an accident and totaled, but the appropriate payment by the insurance company is determined to be $4000. GAP coverage would pay $1000. National banks are permitted to offer this product. This product should be regulated by the state as insurance.
The effect of a failure to regulate the above products as insurance if offered by a bank results in an unfair advantage to the bank in the sale of the product. If offered by a bank, these products are not subject to state regulation as are the same products if offered by an insurer. All of the additional cost of state regulation, and all of the additional state consumer protections, do not exist in relation to the bank's issuance of these products. These costs do exist if an insurer offers the same products. Thus, it is the insurer which is disadvantaged. Affiliations
Undoubtedly, mergers and acquisitions are a reality of the modern corporate world and are a proper subject for financial services modernization. It is wholly appropriate for banks and insurers to affiliate. Such affiliation, however, must be consistent with functional regulation. The current language of H.R. 10 in Section 104(a)(2) attempts to grant functional regulation of the transaction to the states as to the business of insurance, but in reality merely enumerates the information a state may require relating to the transaction. Indeed, under H.R. 10, a state may require that the insurer's capital be restored to a certain level, but that is the extent of state authority. There are factors other than capital that relate to insurer solvency. Thus, the state effectively does not have functional regulatory authority over the affiliation. The NAIC's proposed amendment goes far to restore functional regulation as applied to affiliations by permitting the states to collect, review, and take actions on such applications, provided that the state law does not discriminate against the bank. NAII supports this amendment as protective of the solvency of insurers in affiliations. Lee Amendment
The NAII urges the Committee to delete the so-called Lee Amendment in Section 6(b). The Lee Amendment would apply Fair Housing Act standards to insurance affiliates of banks and represents a backdoor attempt to implement federal regulation of insurance. The Fair Housing Act, which was initially enacted in 1968 and amended in 1988, prohibits discrimination in housing on the basis of race, color, religion, sex, familial status, national origin or handicap. It expressly applies to home sales and rentals and the service of home sellers, landlords, mortgage lenders and real estate brokers. The Act does not make any reference to the separate service of providing property insurance for the simple reason that Congress, in enacting the law, recognized that insurance is a state regulated business. The Lee Amendment runs counter to the McCarran-Ferguson Act of 1945 which mandates the state regulation of the business of insurance. Every state and the District of Columbia have laws that prohibit insurance redlining. The addition of a federal application in this area will, at best, lead to a system of dual state and federal regulation of insurance. Conclusion
NAII urges the Committee to adopt the NAIC amendments to H.R. 10 as consistent with and in furtherance of the concept functional regulation. It is clear that the intent of the drafters of H.R. 10 is preserving state regulation of the business of insurance. No better tangible evidence of Congressional intent in this area exists than the wording of Section 301 of H.R. 10 which states that the intent of Congress with reference to the regulation of the business of insurance as embodied in the McCarran Ferguson Act remains the law of the United States. It is to the benefit of banks as well as insurers that H.R. 10 draw a “bright line” to define insurance and regulate the insurance function. With that “bright line,” H.R. 10 will indeed be financial services modernization, streamlining the financial services sector.
PREPARED STATEMENT OF THE INVESTMENT COMPANY INSTITUTE I. Introduction
The Investment Company Institute is the national association of the American investment company industry. The Institute's membership includes 7,546 open-end investment companies (“mutual funds”), 457 closed-end investment companies and 8 sponsors of unit investment trusts. The Institute's mutual fund members have assets of about $5.730 trillion, accounting for approximately 95% percent of total industry assets, and have over 73 million individual shareholders. The Institute's members include mutual funds advised by investment counseling firms, broker-dealers, insurance companies, bank holding companies, banks, savings associations, and affiliates of commercial firms.
The Institute has been an active participant in the debate on financial services reform and has provided testimony to Congress on subjects directly related to such reform numerous times over the last twenty-three years. The Institute appreciates the opportunity to provide the Committee with its views on H.R. 10, the “Financial Services Act of 1999.”
Initially, we would like to commend the continued leadership of the House Commerce Committee in its effort to reform our nation's financial services laws. To most observers, it is now abundantly clear that the laws that separate mutual funds, banks, broker-dealers, insurance companies, and other financial services firms are obsolete in the face of technological advances, fierce competition, and dynamic and evolving capital and financial markets.
By permitting affiliations among all types of financial companies, H.R. 10 represents a major step forward in the effort to modernize the nation's financial laws and to realign the financial services industry in a manner that should benefit the economy and the public. It also includes one of the most important principles that underlie successful financial services reform: the establishment of an oversight system based on functional regulation.
Thus, H.R. 10, like S. 900, the “Financial Services Modernization Act of 1999," reflects a sound framework for reform of the financial services industry, and we urge Congress to enact it. We are concerned, however, that attempts will be made to weaken its commitment to functional regulation, to apply the Community Reinvestment Act (CRA) to mutual funds, or to affect the ability of mutual fund organizations and other service providers to share certain information that is necessary to effectively operate a mutual fund. Any of these actions would pose serious concerns for mutual funds and their shareholders. II. Background
Regulation of the Mutual Fund Industry. Since 1940, when Congress enacted the Investment Company Act, the mutual fund industry has grown steadily from 68 funds to over 7,000 funds today, and from assets of $448 million in 1940 to over $5 trillion today. In our view, the most important factor contributing to the mutual fund industry's growth and success is that mutual funds are subject to stringent regulation by the Securities and Exchange Commission (SEC) under the Investment Company Act. The core objectives of the Investment Company Act are to: (1) ensure that investors receive adequate, accurate information about mutual funds in which they invest; (2) protect the integrity of the fund's assets; (3) prohibit abusive forms of self-dealing; (4) restrict unfair and unsound capital structures; and (5) ensure the fair valuation of investor purchases and redemptions. These requirements and the industry's commitment to complying with their letter and spirit-have produced widespread public confidence in mutual funds. In our judgment, this investor confidence has been, and continues to be, the foundation for the success that the industry enjoys.
Our opinion concerning the efficacy of the mutual fund regulatory system has been confirmed by the General Accounting Office. In its report on mutual fund regulation twenty-four months ago, the GAO found that “the SEC has responded to the challenges presented by growth in the mutual fund industry.” It also noted that the “SEC's oversight focuses on protecting mutual fund investors by minimizing the risk to investors from fraud, mismanagement, conflicts of interest, and misleading or incomplete disclosure.” To carry out its oversight goal, the SEC performs on-site inspections, reviews disclosure documents, engages in regulatory activities, and takes enforcement actions. The SEC is also buttressed by “industry support for strict compliance with securities laws." I
Mutual Funds: SEC Adjusted its Oversight in Response to Rapid Industry Growth (GAO/ GGD-97-67, May 28, 1997) at pages 28, 5 & 29, respectively.
The mutual fund industry has always spoken out against developments that would impair this effective and time-tested regulatory system which is what would occur if aspects of banking regulation were imposed on the mutual fund industry.
Differences Between Bank Regulation and Mutual Fund Regulation. H.R. 10 recog. nizes that if financial services reform is to succeed in producing more vibrant and competitive financial services companies, it must provide a regulatory structure that respects and is carefully tailored to the divergent requirements of each of the business sectors that comprise the financial services marketplace. The mutual fund industry has historically and continues to be subject to extensive SEC oversight. And for reasons that continue to make good sense even in this era of consolidation and conglomeration, the regulations governing the mutual fund business rest on different premises, have different public policy objectives, and respond to distinct governmental and societal concerns.
Our securities markets are based on transparency, strict market discipline, creativity, and risk-taking. The Investment Company Act and federal securities laws reflect the nature of this marketplace and, accordingly, do not seek to limit risktaking nor do they extend any governmental guarantee. Rather, the securities laws require full and fair disclosure of all material information, focus on protecting investors and maintaining fair and orderly markets, and prohibit fraudulent and deceptive practices. Securities regulators strictly enforce the securities laws by bringing enforcement actions, and imposing substantial penalties in a process that by design is fully disclosed to the markets and the American public.
Banks, by contrast, are supported by federal deposit insurance, access to the discount window and the payments system, and the overall federal safety net. For these reasons, banking regulation imposes significant restraints and requirements on the operation of banks.
It may well be that this regulatory approach is prudent and appropriate when it comes to the government's interest in overseeing banks. But it would be fundamentally inconsistent with the very nature of the securities markets to impose bank. like regulation on mutual fund companies and other securities firms. To do so could profoundly impair the ability of mutual funds and securities firms to serve their customers and compete effectively. More worrisome, it could compromise the continued successful operation of the existing securities regulatory system.
Finally, and perhaps most importantly, imposing bank-like regulation on an industry for which it was not designed could even jeopardize the functioning of our broad capital markets. This would risk the loss of a priceless and valuable national asset. As SEC Chairman Arthur Levitt has stated, "[o]ur capital markets must remain among our nation's most spectacular achievements... Those markets, and investors' confidence in them, are rich legacies we have inherited, but do not own. They are a national asset we hold in trust for our children, and for generations of Americans to come.
."2 Thus, this Committee is wise to ensure that otherwise wellintended efforts to modernize financial services law and regulation do not compromise our capital formation system. III. Successful Financial Services Reform Should Not Be Undermined
Both H.R. 10 and S. 900 establish a new structure for the affiliation of financial services companies in the United States. The bills do not merely alter the nature of the banking system through banking reform, but instead propose a regulatory structure that reflects the new economic relationships. But because each of the industries in the new holding company is subject to extensive oversight under distinct regulatory systems, both bills appropriately adopt the concept of functional regulation as the proper regulatory oversight system for an integrated financial services industry. This fosters regulatory reliance and respect for the jurisdiction of the regulatory agencies that supervise these industries. The Institute strongly supports this result.
Importantly, both bills protect the domestic banking and international financial system as well as insured depository institutions and the deposit insurance funds by providing the banking agencies with authority to take appropriate action when necessary. At the same time, they prevent the imposition of a banklike regulatory approach on the mutual fund industry by avoiding conflicting and duplicative regulation. This is accomplished without creating any regulatory gaps in the structure.3 We would like to take this opportunity to urge the Committee to oppose amendments that would (1) change the provisions in the bill that carefully proscribe the authority of bank regulators with respect to mutual funds and securities firms; (2) seek to apply aspects of the Community Reinvestment Act to mutual funds; and (3) limit, by statute, the ability of mutual fund organizations and other service providers to share certain information regarding fund investors that is necessary to effectively operate a mutual fund.
2 “A Declaration of (Accounting) Independence,” Remarks by Arthur Levitt, Chairman, U.S. Securities and Exchange Commission, before The Conference Board, New York, New York (Oct.-8, 1997).
3 For these reasons, the Federal Reserve Board (FRB) has indicated that this functional regulation oversight system would maintain the safety and soundness of our financial system in gen
In addition, we recommend three changes to H.R. 10: (1) clarification of the supervisory authority of the OTS and OCC over regulated nonbank entities to strengthen functional regulation; (2)allowing companies to engage in limited commercial activities; and (3) extending the “grandfather date” for companies with commercial activities to control a thrift.
Each of these points is discussed below.
To implement this oversight system, the FRB would be assigned regulatory responsibility over all holding companies, including any financial services organization that owns a bank. Both bills also would refine the authority of the Federal Deposit Insurance Corporation (FDIC), the Office of the Comptroller of the Currency (OCC) and the Office of Thrift Supervision (OTS) in this same manner to ensure that they could not assert broader authority than that of the FRB with respect to regulated nonbank entities.
In adopting this approach, both bills recognize that in the process of merging banks with various industries, it is necessary to adjust the present statutory authority of the banking agencies. This adjustment is needed because the statutory schemes applicable to these agencies did not envision that a bank might be affiliated with several, significant regulated nonbank entities like mutual fund companies and broker-dealers. These nonbank entities each have regulators with the expertise to supervise their operations and these regulators may be relied upon to coordinate their supervisory efforts with the banking agencies.
Thus, H.R. 10 strikes an appropriate balance between preserving the authority of the FRB, OCC, FDIC and OTS to protect the safety and soundness of the banking, financial, and payments systems, and avoiding the potential for supervisory intervention into a regulated nonbank entity's day-to-day affairs that are the responsibility of its primary supervisor like the S&C for mutual funds.
In this connection, the Institute suggests that Sections 115(a)(4)&(5) and 118(b)(2)&(3) of H.R. 10 be deleted as inconsistent with this functional regulation framework. These Sections grant the OCC and OTS authority beyond that which is granted the FRB. Eliminating these provisions would pose no safety and soundness concerns. Such action will also reinforce an oversight system that relies on and defers to the expertise and supervisory strengths of different functional regulators (in the investment company case, the SEC). It would also reduce the potential for inconsistent and contradictory actions concerning investor protection, for overlap of regulation and for conflict among regulators.
As indicated by the FRB, a proper oversight system for these new financial services organizations is enhanced by “relying on the expertise and supervisory strengths of different functional regulators, reducing the potential (for) burdensome overlap of regulation, and providing for increased coordination and reduced potential for conflict among regulators."
Unless the bill is amended, OTS and OCC will be able to assert the power to take discretionary supervisory action based on their judgment about business risk. This would allow them to claim the authority to apply a bank-like regulatory approach and/or impose activity or operational restrictions on mutual fund complexes in particular or the securities markets generally. This could profoundly impair the continued successful operation of the existing securities regulatory system and damage our capital markets. This is why we suggest that certain changes be made to clarify the role of the OTS and OCC—and to grant these agencies no greater authority then
eral and the banking system in particular. See generally Hearings before the Senate Committee on Banking, Housing and Urban Affairs on H.R. 10, the Financial Services Act of 1998, Written Statement of Alan Greenspan, Chairman of the Board of Governors of the Federal Reserve System on H.R. 10 at 5 & 13-15.
4 This section addresses the socalled “Fed Lite” oversight provisions in Subtitle B of Title 1 of H.R. 10 that relate to the functional regulation of mutual funds, securities firms and insurance companies in a holding company system.
s See Hearings before the Subcommittee on Finance and Hazardous Materials, Committee on Commerce on H.R. 10 and Financial Modernization, Testimony of Alan Greenspan, Chairman of the Board of Governors of the Federal Reserve System at 10.