to their lower cost of capital. Securities firms do not have

such access.

Even without Regulation Q commercial banks will maintain their advantage in availability of funds and cost of capital. The securities firms will still have to turn to the banks for their needed funds, because of the banks' ability to take deposits and their unique access to other sources of funds.

Tax Advantages

While the deductibility of the carrying costs of municipal bond inventories is the principal tax advantage for commercial banks, it is not the only one. These advantages are described in Appendix B: the ability to gain tax advantages from the partial worthlessness of securities; a more favorable loan loss reserve calculation method, and, of course, All-Savers. (Their inclusion in the All-Savers legislation takes much of the benefit away from the suffering thrift institutions, of course.) Each of these

advantages gives the commercial bank an edge over the non-bank underwriter. Most certainly, these were not intended to provide a special benefit to banks in their competition with non-bank underwriters, but such is the result. These unfair disparities must be eliminated from the present area of bank and non-bank underwriting competition.

Captive Markets

tage.

Banks have their captive markets, which are another advan-
If an underwriting does not go as hoped, is there not a

temptation to fill trust accounts and correspondent accounts with the potential losers? And what about the temptation to put the winners in the bank's own investment portfolio? Why not? The carrying costs of that inventory are tax deductible but the income is real and non-taxable. Such advantages come replete with conflicts-of-interest. (See the conflicts discussion earlier in this statement.) The inadequacy of the so-called "safeguards" against self-dealing in S.1720, Title III, are thoroughly analyzed in Appendix A.

Tie Ins

Banks in the underwriting of bank-eligible municipal bonds have the advantages of tie-ins which also contribute to unfair competition. A bank, as an inducement or a threat, can offer short term debt, lines of credit, letters of

credit facilities

credit to gain entry into a managing underwriting group. Nonbank underwriters cannot do this. Packaging of banking and underwriting services has caused non-bank underwriters to be forced out of management groups already in place. This is a major competitive problem today. Questions of conflict of interest are also raised by these practices. The SIA has protested the use of these tie-ins to the Comptroller of the Currency in a letter dated March 27, 1981, a copy of which is Appendix C to this statement.

We believe that the multiple roles of a bank in these situations - providing key banking services and acting as a member of the managing underwriter group

raise serious

questions involving conflict of interests and unfair practices, to say nothing of unsound banking practice. An example may be helpful in an understanding of this problem.

In a $150 million underwriting of housing bonds in Florida,

a large national bank, for a fee estimated to be in excess of $20 million, provided a letter of credit to back a "put" of the

bonds, for substantially the full amount of the bonds; it had the right to invest all bond proceeds and reserves under an investment agreement; and it acted as a managing underwriter. (In contrast, the total underwriters' discount in this bond issue was $3.75 million.)

Conflicts between the

Each of the roles performed by the participant bank gives rise to a distinct set of interests. bank's interests in one role and its interests in another role could impair the bank's judgment as to important duties and create the perception of divided loyalties. Does a bank, acting as a managing underwriter with the potential of obtaining very large fees for providing a letter of credit, have an improper promotional stake in bringing issues to market?

The problems of conflict are real: Because of the bank's interests under the letter of credit, it has a disincentive to work with the issuer to produce the best available interest rates for its bonds: the lower the interest rates the greater the chance there will be a call on the letter of credit.

In negotiating the allocation of the letter of credit fee among bond proceeds, mortgage and investment revenues and excess funds, the interests of the bank providing the letter of credit

Commercial banks are powerful and possess "clout"; as an issuer develops dependency on a bank to meet short-term financial needs the line of least resistance is to succumb to requests of the bank for underwriting relationships - and even to support of revenue bond underwriting. Many state and local government officials find that, under certain market conditions, they have no alternative but to include their commercial bank, with whom they have short-term loans, as managing underwriters of their permanent bond financings.

Existing Bank Participation in Securities Markets is Not Needed Commercial banks are already in the securities business underwriting general obligation bonds and certain revenue bonds and government obligations. This limited commercial bank participation in the securities business is really an historic anomaly. It was an exception to the blanket prohibition from investment banking activity a squiggle in the Glass-Steagall

line

because the securities industry in 1933 was just beginning the separate and independent life ordained by the legislation and there was concern for the market for general obligation and government bonds. Piecemeal expansions of the exception have occurred from time to time since. If the line is to be redrawn today, no such exception is necessary because we now have a mature securities industry capable of serving these markets efficiently. And, as stated, the existing competition of commercial banks

other advantages

with their capital, tax and captive market and

is already inherently unfair. The elimination

banks which are capable of providing a letter of credit is imposing. The results could include unfair pricing of the fee as well as a linkage of unwanted services, such as underwriting and an investment contract, to the highly-desired letter of credit. Finally, playing multiple roles gives the very large banks an opportunity to vary the level of compensation for each individual service to foreclose competition because of the enormous leverage it gains from providing a letter of credit. Each of the services could be provided separately just as efficiently. If, however, a bank were assured of selection for the letter of credit role, it could also assure itself of the investment contract position by reducing its required compensation for the investment contract while increasing the letter of credit commission. It could do the same with respect to the managing underwriter fees. The potential for such manipulation is inescapable where the banks offer these discrete services as a package or where providing one service (i.e., the letter of credit) is conditioned upon getting the other business. The problem of tie-ins must be dealt with.

Multiple Relationships

A bank oftentimes seeks to be an all-service facility to tax-exempt issuers. It becomes its depositary, its short-term lender, its bond trustee, its paying agent and purchaser of its bonds for its own account and for its trust accounts. Not only do conflict of interest problems arise from these relationships, but also the crowding out of underwriting competitors.