unfetter your ability to realize savings on the one hand and earn more on your scarce resources on the other. And, Mr. Chairman, I might note that this is an action that costs the Federal Government nothing. I appreciate the support of the mayors, finance officers, and others for both bills and look forward to working with the committee to enact these measures.

The CHAIRMAN. Mr. Silver, will you begin?

STATEMENTS OF DAVID SILVER, PRESIDENT, INVESTMENT COMPANY INSTITUTE; SAMUEL C. CANTOR, AMERICAN COUNCIL OF LIFE INSURANCE, ACCOMPANIED BY GARY HUGHES, CHIEF COUNSEL; ALFRED VAN LIEW II, SENIOR VICE PRESIDENT, RHODE ISLAND HOSPITAL TRUST NATIONAL BANK; AND ROBERT GARVER, PRESIDENT AND CHIEF EXECUTIVE OFFICER, CHARLESTOWN SAVINGS BANK, BOSTON

Mr. SILVER. I will summarize our prepared statement, if I may. [Laughter.]

The CHAIRMAN. If you had not, you would be here alone for a long time. [Laughter.]

Mr. SILVER. It is big enough so that we can beat the committee to death, if necessary.

I am David Silver, president of the Investment Company Institute, the national association of the mutual fund industry.

The institute appreciates the opportunity to testify before you on S. 1720, a significant legislative proposal that would substantially alter the structure of the Nation's financial institutions.

The provisions of S. 1720 would remove century-long restraints on bank securities activities. But let me state at the outset that the mutual fund industry is not wedded to the past, nor do we seek the shelter of exclusive franchises or special tax breaks. As an industry which is a leading innovator in the development of new investment products which serve over 12 million Americans, we recognize that legislative adjustments may be required to rationalize business and technological developments.

At this point, we cannot endorse the provisions of S. 1720 relating to the Glass-Steagall Act or the alternative proposal of Secretary Regan.

REGULATORY AND COMPETITIVE PROBLEMS

However, we can identify the two groups of problems-regulatory and competitive-which should be dealt with as an essential ingredient in any modification of the Glass-Steagall Act. Moreover, we can point in the direction where we believe solutions may be found.

In an effort to contribute to a constructive review of S. 1720, we have prepared a detailed position paper and formal written testimony. We have also submitted a paper by Prof. Lance Girton of the University of Utah, who is here today and would be pleased to respond to any questions.

The CHAIRMAN. Just by accident, somebody from my alma mater. [Laughter.]

Mr. SILVER. Professor Girton prepared this paper on the basis of work he had done some years ago.

The CHAIRMAN. I could not resist.

Mr. SILVER. I was waiting for it. [Laughter.]

Before dealing with the bill's specifics, three preliminary comments may be in order:

First, to the extent that the problems of savings and loan institutions require immediate attention, S. 1720 most assuredly deserves prompt consideration. But, to the extent that S. 1720 would permit bank re-entry into the securities business, prudence should be the watchword. Large banks are not in need of legislative help.

Second, it should be made clear that the portions of the bill dealing with mutual funds are not limited to money market funds; under these provisions, banks would be able to create and distribute mutual funds investing in corporate stocks and bonds-and this is precisely what the big banks have in mind.

Third, the portions of the bill permitting banks to create and sell mutual funds may, ironically, impair the financial stability of the very institutions Congress now seeks to promote.

To summarize our position on the merits, we believe that any legislative realinement that expands bank securities activities must be accompanied by a realinement of the regulatory structure. Moreover, competitive equity demands that changes should not be authorized by piecemeal legislation which addresses only one part of the problem.

The practical effect of considering only one aspect of change would leave banks their exclusive government franchise to conduct the business of banking, and thus aggravate the conditions which already give them an inherent and unfair advantage over all other financial institutions.

As demonstrated in Professor Girton's paper, banks are in the unique position to engage in a host of banking and nonbanking relations with customers which are denied to bank competitors. In addition, this paper vividly shows the startling degree of concentration of the holdings of America's largest companies in a few large banks and, indeed, the surprising degree to which these banks are interrelated to each other, increasing their economic leverage.

In short, we believe that those portions of S. 1720 dealing with the Glass-Steagall Act require careful study and considerable revision before Congress considers adopting them.

Our written testimony and position paper spell out in detail how the securities activities in which banks have engaged since GlassSteagall have repeatedly caused substantial disruptions in the normal banking operations of major banks, and have placed large sums of public savings at substantial jeopardy without adequate safeguards or adequate disclosure of investor risk. The natural tendency has been to sweep these episodes under the rug, to prevent an erosion of confidence in our banking system.

But when Congress considers removing fundamental safeguards and revising historic national policies, it is time to talk frankly and openly about the problems that these safeguards are designed to prevent to see how they may be safely relaxed. Therefore, we believe that a study of these recent and current abuses is necessary, not for the purpose of casting our banking system into disrepute, but to provide needed insight into the appropriate regulatory

pattern which should be adopted if the Glass-Steagall Act is modified.

Three examples from our written testimony will suffice:

First, any impartial inquiry into whether the passage of time has rendered obsolete restrictions on bank securities activities must consider the problems of bank-sponsored real estate investment trusts during the 1970's. These REIT problems caused a substantial drain on major banking institutions. They involved large liabilities to bank REIT sponsors which often stemmed from classic conflicts of interests that the Glass-Steagall Act was designed to prevent. What is not generally understood is that there was a grave regulatory lapse associated with the creation and subsequent operation of bank REIT's. The banking agencies failed to impose the kind of prohibitions which exist in the Federal securities laws, and most particularly in the Investment Company Act of 1940, against self-dealing and similar conflicts of interest which have historically plagued bank securities activities.

Second, during the same decade, the activities of bank underwriters of New York City obligations involved a major segment of the country's banking system in massive potential liabilities flowing from questionable securities distribution practices.

The failure here was clearly related to the fact that bank securities distribution activities are exempt from the Securities Exchange Act of 1934.

Third, and coming to the present, banks and other depository institutions are selling billions of dollars of so-called retail repurchase agreements, which are uninsured debt obligations of the issuing banks.

If the normal SEC ground rules contained in the Securities Act of 1933 applied, a number of depository institutions issuing these obligations would be compelled to disclose their true financial condition to investors who remain unaware to this moment of the very substantial risks involved in purchasing debt obligations of institutions experiencing severe financial difficulties.

But because of the bank exemptions in the Federal securities laws, investors today are being deprived of full and fair disclosure. The lesson to be drawn from these and other recent events is that any legislation which would expand bank securities activities must vest the SEC with full securities law jurisdiction over all bank-sponsored pooled investment funds, all bank investment advisory services, and all bank retail distribution of securities.

Making the same point another way, the bank exemptions contained in the Securities Act of 1933, the Securities Exchange Act of 1934, the Investment Company Act of 1940, and the Investment Advisers Act of 1940 were all predicated upon Congress understanding that banks were barred from virtually every facet of the securities business by the Glass-Steagall Act. If the Glass-Steagall Act is obsolete, it follows that these exemptions are obsolete.

Our second major concern is that of competitive equity. Large banks that spearhead the drive to repeal the Glass-Steagall Act have stressed recent developments in the securities industry, arguing that fairness requires Congress to turn the clock back to the 1920's and permit banks to engage in expanded securities services.

But it is far from clear that developments in the securities industry to which the banks point present the competitive issues they claim.

In any event, as demonstrated by the statistical analyses in Professor Girton's paper, the tie-in relationships which banks enjoy with their customers present a public policy problem of considerably more import than the entry of Sears or American Express into the securities business.

What is clear is that if Congress permits large banks to expand their securities activities, it will not only be the securities industry, but those small banks and savings and loan institutions which cannot afford to expand into the securities business that will be materially injured. But the ability of giant banks to offer expanded securities services and products also will have a serious impact on the continuing viability of an independent securities industry in light of the fact that securities firms will be unable to compete with banks in the banking business.

The proposal made by the large banks for expansion into the securities industry is a legislative one-way street. Under the provisions of S. 1720, banks would continue to enjoy a banking monopoly while entering the securities business, but securities firms will remain barred from the banking business.

Banks will then be able to exploit the multifaceted relationships with their banking customers to develop and enhance their new securities activities. To prevent enhancement of the existing competitive imbalance, it is imperative that any modification of the Glass-Steagall Act should be coupled with legislation enabling securities firms to obtain full banking powers.

But, even conferring banking powers on securities firms would only be one step in the alleviation of the competitive dislocations the large banks would achieve under S. 1720 as it now stands.

NATIONWIDE CORRESPONDENT SYSTEMS

An additional problem is posed by the McFadden Act and the Douglas amendment, which generally prohibit banks and bank holding companies from operating banks in more than one State. These restrictions on geographical expansion have led to the development of nationwide correspondent systems through which the largest banks provide numerous services to the small banks and their customers.

As has been made clear through the legislative proposals sponsored by large banks and by testimony here this week, if the GlassSteagall Act is modified, large banks will utilize their correspondent relationships to distribute securities products and services through their well-established chains of local banks.

Securities firms stand outside of this correspondent system, which has grown and flourished in the protectionist shelter of the McFadden Act. This competitive disadvantage can only be ameliorated by permitting securities firms to engage in multi-State banking activities. There is no other way that the Congress can avoid competitive inequities created by addressing one statute at a time. Dismantling the Glass-Steagall Act can bring about the destruction of an independent securities industry, not because that industry is inherently unable to compete effectively, but because large

banks will continue to enjoy the privileged sanctuary of protectionist legislation. This legislation has sheltered the commercial banking function from competition, as big banks reach out to enter other financial businesses whose products they can then offer on a tie-in basis.

For these reasons, the institute believes that there should be no legislative changes in the Glass-Steagall Act unless and until the Congress first addresses and resolves issues of adequate protection of the investing public and competitive equity.

The basic changes needed in the regulatory system which governs the Nation's financial structure cannot safely be accomplished on the basis of a few weeks of hearings. Rather, changes that will serve this country well in the long run must be carefully thought out, and can only be accomplished through the diligent efforts of all concerned.

This work should begin immediately. It will be a difficult task, but we pledge you the full cooperation of the mutual fund industry in seeing it through to a successful conclusion.

[Complete presentation of the Investment Company Institute follows:]