minimizing the potential for distortion of the marketplace through unnecessary, duplicative, artificial, or overly rigid regulatory requirements.

H.R. 268 contains important provisions that implement each of these principles. The Institute accordingly believes that H.R. 268 lays a firm foundation upon which Congress safely may build as it proceeds to craft and enact financial services reform legislation. My testimony today primarily will focus on considerations regarding an appropriate oversight model for the new financial services holding company.

H.R. 268 constructs an oversight system based on three critical concepts.

Functional Regulation. Functional regulation envisions that each subsidiary of the financial services holding company would be separately regulated by function with, for example, the Securities and Exchange Commission ("SEC") acting as the primary regulator of securities firms and the appropriate federal banking agency acting as the primary regulator of depository institutions. The functional regulator would have authority to set capital standards with respect to, to require reports from, and to perform examinations of, the particular subsidiary it oversees in the holding company complex. The functional regulator would not have authority, however, to set capital standards for, to impose reporting requirements upon, or to conduct examinations of, other entities in the organization.' The Institute supports the concept of strong functional regulation and these and other provisions of the bill that implement it.

Risk Assessment. H.R. 268 proposes the use of risk assessment mechanisms to protect depository institutions in a holding company from risks to which the activities of any non-banking affiliates might expose them. The risk assessment mechanisms, found primarily in Section 109 of the bill, are based on the premise that the functional regulator for a depository institution can use its supervisory and enforcement powers to

'See §§ 105(c), 109, 202(b), 204(c), 209.

protect bank subsidiaries in the complex from risks flowing from the activities of nonbank subsidiaries so long as the banking agency is able to obtain access to information about those activities. To this end, section 109 generally requires a financial services holding company initially, and the holding company's subsidiary depository institutions thereafter, to provide the banking agencies with information and reports designed to identify the impact that the activities of non-banking entities in the complex may have on the safety and soundness of any affiliated depository institutions. The Institute supports the use of these types of risk assessment mechanisms to protect financial service holding company banks.

Enhanced Regulatory Coordination. H.R. 268 also calls for enhanced regulatory coordination among the functional regulators of the various subsidiaries owned by a financial services holding company. Importantly, Section 114 of the bill creates a National Financial Services Committee ("NFSC") made up of the Secretary of the Treasury, the heads of all the federal banking agencies, the Chairman of the SEC and a designated insurance commissioner to perform a variety of functions, including conducting and authorizing studies, consulting with state regulators and making recommendations to Congress and others. In addition, Section 109 generally requires a banking agency to accept information and reports filed with the SEC or a state insurance commissioner when the banking agency is seeking information on the activities of a depository institution affiliate for which the SEC or the state insurance commissioner is the functional regulator. In the same vein, Section 320 requires the SEC and the banking agencies to share with each other upon request the results of examinations, reports, records or other information each may have with respect to the investment advisory activities of financial service holding companies and banks affiliated with financial services holding companies. In addition, Section 122(1) requires the SEC and each banking agency to establish programs for sharing information and enforcing compliance with the securities affiliate safeguards and broker/dealer registration provisions of the bill. The Institute supports each of these

measures.

The Institute believes that an oversight model for financial services holding companies based upon functional regulation, risk assessment and enhanced regulatory coordination carries the greatest potential for optimizing both public and private interests. The model leaves in place the regulatory mechanisms that now exist and that serve the public interest well. Securities firms in general and participants in the investment company marketplace in particular already are subject to extensive regulation and supervision by the SEC under the federal securities laws. Indeed, Congress only recently examined the statutory and regulatory scheme governing the

investment company industry and concluded that the system was functioning well. The success of the existing oversight system is also demonstrated by the renowned strength, depth and liquidity of the U.S. capital markets, including the mutual fund industry.

In addition, the model builds upon the existing regulatory framework in specific and targeted ways, and only as necessary to achieve defined and articulated goals. In this way, the model reduces the potential for subjecting regulated entities to duplicative or potentially inconsistent regulatory requirements, and for distorting the marketplace through unneeded, artificial or overly rigid governmental intervention.

Importantly, the model does not call for the imposition of safety and soundness regulation on the financial services holding company or its non-banking subsidiaries in order to protect holding company bank subsidiaries. As a result of the federal deposit insurance program and other factors, a major objective of banking regulation traditionally has been to attempt to control the risk of financial loss to banking organizations and the U.S. Treasury. The tools used to achieve this objective have ranged from limitations on the kinds of companies with which banks may affiliate, the nature of activities in which banks and their affiliates may engage and the manner in which banks and their affiliates may conduct these activities. Securities regulation, however, rests upon very different foundations.' The very nature of the securities markets in this country is based on risk taking, and the federal securities laws do not seek to protect investors by limiting risk taking but instead by requiring that its existence be disclosed. Any attempt to impose substantive safety and soundness regulation on securities firms affiliated with banks necessarily would interfere with the vibrancy of the securities markets and would clash with the governing regulatory scheme.

It also is relevant to consider the experience of other agencies under comparable regimes. As the Committee is aware, Section 109 and related provisions are very similar to -- indeed, are based on the holding company risk assessment

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See, e.g., H.R. Conf. Rpt. No. 864, 104th Cong., 2d Sess. 2-3 (September 28,

1996); H.R. Rep. No. 622, 104th Cong., 2d Sess 16-17 (June 17, 1996).

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See, e.g., Board of Governors v. Investment Company Institute, 450 U.S. 46, 61 (1981); Testimony of SEC Chairman William Cary before the Senate Subcommittee of the Committee on Banking and Commerce, SEC Legislation 1963: Hearings before a Subcommittee of the Committee on Banking and Commerce, 88th Cong., 1st. Sess. 20 (1963).

provisions of the Market Reform Act of 1990, pursuant to which the SEC monitors risks to broker-dealers flowing from affiliate activities, and of the Futures Trading Practices Act of 1992, pursuant to which the CFTC assesses dangers to futures commission merchants posed by affiliate activities. After six years of experience with the Market Reform Act, the SEC informed Congress last year that it found the risk assessment provisions to provide a "significant complement" to its existing statutory authority. There also has been no indication that the CFTC has expressed any dissatisfaction with the reach or operation of the risk assessment provisions it administers. This experience does not provide any reason to believe that the holding company risk assessment procedures embodied in Section 109 and related provisions would not constitute valuable tools enabling banking regulators to monitor systemic risk or would not otherwise work well in the financial services holding company context."

In sum, H.R. 268 focuses on the key ingredients -- tough functional regulation, effective risk assessment mechanisms, and close interagency coordination -- that we believe are necessary to provide effective oversight of the new financial services holding company. The proposal lays a promising ground work and we look forward to working with the Committee as it considers ways to enhance and strengthen this approach.

Hearings before the House Committee on Banking and Financial Services on H.R 1062, The Financial Services Competitiveness Act of 1995, Glass-Steagall Reform, and Related Issues (Revised H.R. 18), 104th Cong. 1st Sess. 274 n.30 (March 7, 1995) (Statement of SEC Chairman Levitt). See also Hearings Concerning H.R. 1505, H.R. 6 and H.R. 15 Before the Subcommittee on Financial Institutions Supervision, Regulation and Insurance of the House Committee on Banking, Finance and Urban Affairs, 102d Cong., 1st Sess. 241-44 (April 30, 1991) (Statement of SEC Chairman Breeden).

Other legislation proposes that the Federal Reserve Board ("FRB") act as superregulator of the new financial services holding company and its component firms pursuant to a statutory scheme addressing, and often granting the FRB broad discretion over, a host of matters ranging from capital standards and prior notice and approval obligations to direct reporting requirements. For the reasons explained in the Appendix to this testimony, however, the Institute believes that an oversight system based on a consolidated bank holding company supervision oversight model is inappropriate in the context of a financial services holding company owning both bank and a wide range of non-bank subsidiaries.

B.

Suggested Amendments To H.R. 268's Oversight Model

In order to fully implement the regulatory oversight model described above, the Committee should refine H.R. 268 to ensure that the NFSC's role is that of a coordinating and advisory body. To accomplish this, certain provisions of the bill that grant the NFSC broad substantive authority over its member agencies, in effect placing the NFSC in the role of overseeing existing functional regulators, should be revised." These provisions may threaten the autonomy and independence of the subject agencies and are in conflict with the principles of functional regulation. Other provisions that grant the NFSC substantive authority over the activities of companies in the financial services holding company complex similarly should be revised because they also are inconsistent with functional regulation as well as risk assessment.'

In addition, the Committee should revise a number of the bill's provisions which either do or may be misconstrued to grant substantive regulatory authority over the financial services holding company and its non-banking subsidiaries to the federal banking agencies. These provisions are at odds with the bill's oversight model and create the potential for many of the dangers associated with the consolidated bank holding company supervision model of oversight.

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See, e.g., §§ 114(h)(1), 102(m)(2), (4), (5) (authorizing NFSC to establish principles and standards applicable to reporting, examination and supervision of all "financial services institutions" (defined to include broker-dealers, investment companies and investment advisers) that are regulated by NFSC member agencies); 104(c) (NFSC oversight of affiliate transaction rules and exceptions); 121(c)(7) (NFSC oversight of securities coverage exceptions); 122(0) (NFSC oversight of securities affiliate rules and exceptions).

See, e.g., 88 104(d) (bank extensions of credit to non-financial affiliates); 123 (unregistered bank retail securities sales).

'See, e.g., §§ 104(b) (affiliate transaction restrictions); 109 (exclusivity of reporting mechanism); 109(e) (enforcement against financial services holding companies); 110 (divestiture); 111(c) (false statement in financial service holding company records); 112(1)(4), (1)(5) (securities affiliate examination); 122(c),(i), (1),(k) (securities affiliate safeguards).

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