On Friday, November 12, 1999, President Clinton signed the Gramm-Leach-Bliley Act (the "Act") into law, setting in motion the process for completing the transformation of the nation's financial services industry that has been ongoing for at least the past two decades.
The Act consists of seven separate titles covering bank, insurance and securities firm affiliations (including partial repeal of the Glass-Steagall Act) (Title I), functional regulation of bank securities and mutual fund activities (Title II), preserving non-discriminatory State regulation of the insurance business (Title III), restrictions on commercial firm ownership of unitary savings and loan holding companies (Title IV), financial institution customer privacy issues (Title V), Federal Home Loan Bank System modernization (Title VI), and various other changes (e.g., ATM fees, CRA issues, etc.) not fitting in the other categories (Title VII).
The massive 385-page bill reflects many legislative compromises addressing various competing political, regulatory and business interests. While it is yet too early to present a complete picture of all of the Act's far-reaching ramifications, the following summary of selected highlights provides a preview.
What Does It All Mean?
By March 11, 2000, commercial and investment banks, insurance companies, and securities firms will be permitted to combine forces to offer a full range of financial services, free of the legal restrictions formerly separating the banking, insurance and securities businesses. Other changes affect the regulation of banks' securities activities, and alter the permissible relationship between banks and mutual funds.
This Alert summarizes changes that are likely to be of interest to our bank, broker-dealer, investment adviser and mutual fund clients and friends.
Functional Regulation of Bank Securities and Mutual Fund Activities
Banks currently enjoy blanket exemptions that generally permit them to engage in a wide variety of securities and investment advisory activities, free of regulation by the Securities and Exchange Commission ("SEC") and state securities authorities. Title II of the Act changes this regulatory landscape by repealing or cutting back existing statutory exclusions and exemptions for banks under the Securities Exchange Act of 1934 (the "Exchange Act") and the Investment Advisers Act of 1940 (the "Advisers Act").
- The Act repeals statutory exemptions under the Exchange Act that exclude banks from the definitions of "broker" and "dealer." However, the exemptions are replaced by a fairly extensive list of broker-dealer activities that a bank may still engage in without being required to register with the SEC.
- The SEC thus will have the ability to regulate some bank brokerage and investment advisory activities directly - at least potentially. If, for example, a bank engages in an activity that strays from the detailed statutory description of a grandfathered activity, or if the bank wishes to sell securities products not on the grandfathered list (i.e., a "new hybrid product"), the bank essentially will be left with three choices: (i) refrain from engaging in the activity, (ii) engage in the activity and register with the SEC as a broker-dealer, or (iii) the only practical alternative, "push out" the activity to an affiliate registered with the SEC.
By repealing key provisions of the Glass-Steagall Act, the Act paves the way for banks to become involved in mutual fund sponsorship and distribution through affiliates. However, as part of the "price to be paid" for Glass-Steagall reform, the banking industry is required to accept additional regulation of bank mutual fund activities. Accordingly, Title II also contains various amendments to the Investment Company Act of 1940 (the "Investment Company Act") and the Advisers Act that affect bank mutual fund and common trust fund activities.
- The Act requires a bank (or bank holding company) to register under the Advisers Act "to the extent that such bank or bank holding company serves or acts as an investment adviser" to a mutual fund registered under the Investment Company Act.
- The Act includes other changes designed to address perceived conflicts of interest that arise when a bank acts as custodian for, lends to, or has director or personnel interlocks with a mutual fund it advises. The Act also codifies guidelines for disclosing the lack of FDIC insurance, etc., for mutual funds sold through banks.
- The Act codifies certain long-standing SEC positions on the scope of existing exemptions and exclusions for bank-maintained "common trust funds." The Act also extends the scope of the exemptions - that thus far have been available only to common trust funds maintained by banks - to funds maintained by thrift institutions.
Title II also permits a securities firm that is not affiliated with a bank or a savings association to choose to be regulated by the SEC as an investment bank holding company ("IBHC"). These provisions benefit securities firm holding companies that control non-U.S. banks and that are not regulated by the Federal Reserve Board. By being regulated by a consolidated supervisor, an IBHC will better be able to meet the requirements of foreign jurisdictions that increasingly are requiring entities that control non-U.S. banks to have a consolidated home country regulatory supervisor.
The changes effected by Title II take effect May 12, 2001, except that the IBHC provisions were effective as of November 12, 1999, the date of enactment.
Affiliations Among Banks, Securities Firms and Insurance Companies
While a complete summary of the significant changes effected by Title I of the Act is beyond the scope of this Alert, key highlights are summarized below.
- The partial repeal of the Glass-Steagall Act paves the way for banks to affiliate - through bank holding companies ("BHCs") or bank subsidiaries - with entities engaged in underwriting and investment banking. Bank affiliates also will be allowed to sponsor and act as distributors for mutual funds (thereby eliminating the legal need for independent distributors and lifting restrictions on mutual fund "selling" activities) and to have personnel interlocks with mutual funds.
- The scope of permissible nonbanking activities of BHCs that qualify as "financial holding companies" ("FHCs") will be expanded to include activities that are "financial in nature." Financial in nature activities include, among other things, mutual fund sponsorship and distribution, securities and insurance underwriting, and "merchant banking" activities.
- National and state banks will be able to establish "financial subsidiaries" authorized to engage in many of the same financial activities (with some significant exceptions, such as insurance underwriting) permitted for FHCs.
- The Act establishes a new structure for federal and state "functional regulation" of financial services. The Federal Reserve Board will continue to be the "umbrella regulator" of BHCs and newly authorized FHCs. Direct regulatory jurisdiction over bank and other "functionally regulated" subsidiaries, however, will be allocated among federal and state banking regulators (banks), the SEC and state securities authorities (broker-dealers, investment advisers), state insurance authorities (insurance companies), and the Commodity Futures Trading Commission (commodities dealers).
The Act preserves existing barriers between banking and commerce. Thus, subject to a few notable exceptions, BHCs and banks still will be prohibited from affiliating with firms engaged in activities other than banking and newly authorized financial activities.