SECURITIES ANDEXCHANGE COMMISSION

Washington, D. C. 20549(202) 755-4846

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INVESTOR PROTECTION--A SHARED RESPONSIBILITY

Address byJohn R. Evans

ConnnissionerSecurities and Exchange Comndssion

Banks and the SecuritiesLaws in 1977

Practising Law InstituteLos Angeles, CaliforniaSeptember 15, 1977

I appreciate the opportunity to participate inthis fifth annual presentation of "Banks and the SecuritiesLaws," which is designed to deal with practical problemsconfronted by banking officials and those who provide legaland accounting advice to banks and bank holding companies.During the next two days, there will be ample opportunity todiscuss the technicalities of various rules, regulations,guidelines, studies, enforcement actions, judicial decisions,and legislative matters. As the details are considered, itis important not to lose sight of the fact that the majorpurpose of the securities laws is to protect investors andeach of us has a role to play in the fulfillment of thatpurpose.

In 1933, Congress determined that the primaryregulatory mechanism through which investors were to beprotected was a requirement that all issuers of securitiesprovide full and fair disclosure of material informationwith respect to the character of the securities and theoperations and financial condition of the issuer. Thosewho participated in the preparation of disclosure documentsand the financial statements therein, were also givenimportant responsibilities to assure that these documents

The Securities and Exchange Commission, as a matter of policy,disclaims responsibility for speeches by any of its Commissioners.The views expressed herein are those of the speaker and do notnecessarily reflect the views of the Commission.

1 were properly prepared. For reasons t h a t a r e not completely

I c l e a r , s e c u r i t i e s issued or guaranteed by a bank were exempted

from the r e g i s t r a t i o n provisions and a l l but c e r t a i n of the

ant i - f raud provisions of the Secu r i t i e s Act. The next year

the Secur i t i e s Exchange Act was adopted i n order t o provide

f o r the regula t ion of s e c u r i t i e s markets. A s p a r t of t h a t

s t a tu to ry pa t t e rn , l i s t e d companies were made subject t o

per iodic repor t ing, proxy regula t ion and in s ide r t rading

requirements. Inasmuch as s e c u r i t i e s issued by banks were

not l i s t e d on s tock exchanges, a s a p r a c t i c a l matter banks

were exempt from t h i s s t a tu to ry p a t t e r n . I n 1964, based on

the Commission's "Special Study of the Secu r i t i e s Markets,"

Congress s i g n i f i c a n t l y amended the continuous d isc losure

requirements of the Exchange Act t o cover a l l publ ic companies

with a s se t s over a mi l l ion do l l a r s and more than 500 shareholders.

A t t h a t time, however, Congress provided t h a t the th ree federa l

bank regulatory agencies would be responsible f o r per iodic

repor t ing, proxy regula t ion and - in s ide r t r ad ing requirements

with respect t o publ ic ly owned banks. Thus, banks were

e f f ec t i ve ly exempted from a l l d i r ec t SEC regu la t ion , o ther

than an t i - f raud ac t ions .

In recent years the re has been a gradual erosion

of the spec ia l treatment provided i n the s e c u r i t i e s laws f o r

banks a s i s sue r s of s e c u r i t i e s . The advent and explosive

growth of bank holding companies i n the l a t e 1960's was one

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of the most significant factors in this change because bankholding companies are subject to all provisions of thefederal securities laws, including registration and continuousdisclosure requirements. Moreover. the special provisionadopted in 1964 for regulatory jurisdiction over publiclyowned banks has been amended so that the federal bank agenciesmust "issue substantially similar regulations" as thoseadopted by the SEC unless they specifically find that suchregulations are not necessary or appropriate in the publicinterest or for the protection of investors, and publish suchfindings. As a result of these changes, most major bankstoday are significantly affected by the SEC's continuouslydeveloping disclosure requirements.

There have been many recent developments in thedisclosure area that affect banks, some of which will bediscussed during this Conference. Foremost among thesedevelopments was the Commission's adoption last year ofGuide 61, entitled "Statistical Disclosure by Bank HoldingCompanies." When this guide was first proposed in October1975, it was vigorously contended by many parties, includingbank regulators, that increased disclosure by banks mightresult in withdrawal of deposits and the failure of particularbanks, and might even destroy confidence in the entire bankingsystem. I believe that the events of the past two years haveshown that the fears expressed were not well founded. It

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was also alleged that investors would be misled by detailedbank disclosure. In this regard, a recent report from theresearch department of a large retail brokerage firm statedthat Guide 61 is "probably the most important change in bankdisclosure ever" and the portion of the guide d_ea1ing withloan portfolios and requiring a breakout of non-performingloans is "one of the most valuable." In an effort to furtherimprove bank disclosures, the SEC has also proposed theadoption of Article 9 of Regulation S-X relating to comprehensivefinancial statement requirements for bank holding companiesand banks. As you are probably aware, these proposals havecreated much controve~sy, particularly with respect to thetreatment of gains and losses from sales of investment andtrading accounts securities.

Although it does not appear on the Conferenceschedule, another disclosure trend that may well be discussedbecause it is a topic of some interest to the banking communityat this time, is the disclosure of management remuneration.In November of last year the SEC proposed extensive amendmentsto the disclosure requirements relating to management backgroundincluding some changes with respect to compensation of managementDuring the first few months of this year the Commissioncommenced several informal inquiries and formal investigationsand filed three actions against public companies allegingthat the value of personal benefits received by management

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had not been appropriately disclosed. Because of manyinquiries on this general topic, just last month theCommission published an interpretive release emphasizing itslong-standing view that the securities laws and our rulespresently require disclosure of all forms of managementremuneration including salaries. fees, bonuses, and certainpersonal benefits popularly known as "perquisites." In itsrelease the Commission stated:

Among the benefits received by managementwhich . . . should be reported asremuneration are paYments made byregistrants for the following purposes:(1) home repairs and improvements; (2)housing and other living expenses (includingdomestic service) provided at principal and!or vacation residences of managementpersonnel; (3) the personal use of companyproperty such as automobiles, planes, yachts,apartments, hunting lodges or company vacationhouses; (4) personal travel expenses; (5)personal entertainment and related expenses;and (6) legal, accounting and otherprofessional fees for matters unrelated tothe business of the registrant. Otherpersonal benefits which may be forms ofremuneration are the following: the abilityof management to obtain benefits from thirdparties, such as favorable bank loans andbenefits from suppliers, because thecorporation compensates, directly orindirectly, the bank or supplier forproviding the loan or services to management;and the use of the corporate staff for personalpurposes. (emphasis added; footnote omitted)

As part of our review process, the Commission's staff hasbegun asking some-bank holding companies about favorable bankloans not only to officers and directors of banks and bank

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- 6 -holding companies but also to management of public companieswhich do business with the bank. The general topic of whethermore detailed or comprehensive disclosure of managementremuneration and transactions should be required is beingcarefully considered in the SEC's current re-examination ofrules relating to shareholder communications, shareholderparticipation in the corporate electoral process and corporategovernance generally, on which hearings are scheduled to beginlater this month in Washington followed by additional hearings

in Los Angeles, Chicago, and New York .

The application of the securities laws to banksis not limited to their role as issuers of securities. Infact, one of the major topics to be considered in thisConference is the regulation of bank securities activities.When the Exchange Act was enacted in 1934, to provide forthe regulation of securities markets, banks were singled outfor special treatment by means of an exclusion from thedefinition of a "broker" or "dealer." Despite the fact thatthey were able to engage in offering certain securitiesservices similar to those offered by securities brokers anddealers, banks which were subject to regulation by federal

bank agencies were excluded from regulatory requirementsestablished and enforced by the SEC. This treatment of banksecurities activities may have been necessary and appropriateat the time but the propriety of this regulatory approach hasbeen, and still is, subject to serious questions.

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In the past several years, major banks and majorsecurities firms have been expanding their operations inorder to become one-stop financial service institutions.Among the most controversial services to be offered by a bankwas Chemical Bank's now aborted program providing securitiesbrokerage services; equally controversial is Merrill Lynch'sannounced experiment to offer cash management accounts.Generally, I believe the opportunity for competing institutionsto develop and offer new services can be in the public interest.Nevertheless, there are many important policy issues involvedin these recent trends, not the least of which is the needfor a re-examination by Congress of issues relating to theapplication of the Glass-Steagall Act. The SEC's interest,however, is primarily to assure appropriate regulationprotecting all investors regardless of whether a bank or asecurities firm is offering the services.

In adopting the Securities Acts Amendments of 1975,Congress dealt with the regulation of certain bank securitiesactivities. Those Amendments granted the Commission "broadauthority to oversee the implementation, operation andregulation of a national market system for securitiestransactions." As part of this broad mandate, Congressdetermined that the Commission should have regulatoryjurisdiction over "every facet of the securities handlingprocess involving securities transactions within the United

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States" including the securities processing activities ofbanks. In recognition of the fact that the federal bankregulators would be examining banks and enforcing bankingrules and regulations, Congress provided that the inspectionand enforcement of Commission rules and regulations over banktransfer agent and clearing agency activities would beprimarily the responsibility of the bank regulators. However,the Commission's general investigative and enforcement powers,which extend to all Exchange Act provisions, are equallyapplicable to transfer agents and clearing agencies whichare organized as banks.

The Securities Acts Amendments of 1975 alsoincluded provisions to regulate the activities of municipalsecurities brokers and dealers. Because the industry iscomposed of commercial banks already subject to supervisionby federal and state bank agencies, diversified securitiesfirms already subject to regulation by the National Associationof Securities Dealers and the SEC, and independent firmsdealing solely in municipal and other exempt securities whichwere not previously subject to any form of federal regulation,Congress responded by establishing a new and uniqueregulatory framework. A Municipal Securities RulemakingBoard was established as the primary rulemaking authority forthe industry. However, Commission approval was required forsubstantive MSRB rules to become effective. The Commission

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was also granted authority to abrogate, add to, and deleteexisting Board rules in any respect consistent witn the Act,and the SEC's direct rulemaking authority to controlfraudulent, manipulative, and deceptive acts and practiceswas enhanced. Primary inspection and enforcement authorityover bank municipal dealers, which include banks andseparately identifiable municipal securities departments, wasvested in the bank regulatory agencies. Again, as in thecase of other securities activities, the amendments made itclear that the SEC has broad inspection and disciplinaryauthority over all municipal securities professionals,including banks.

In addition to subjecting these bank securitiesactivities to Commission jurisdiction, the 1975 Amendmentsdirected the Commission to conduct a study, commonly referredto as the "bank study," to determine the extent to whichpersons excluded from the ''broker''and "dealer" definitionsof the Securities Exchange Act were engaged in securitiesactivities and whether the exclusions are consistent withthe protection of investors and the other purposes of the Act.

The Commission's study examined various bank securitiesactivities including four bank-sponsored brokerage-typeservices, bank corporate financing services and trustdepartment securities trading activities of banks. In ourfinal report to Congress on the bank study, the Commission

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concluded that to remove the exclusion of banks from thedefinition of "broker" and "dealer" would result induplicative and unduly burdensome regulation, but that somechanges should be made to assure adequate investor protection.

Upon receipt of our report, Senator Harrison A.Williams, Chairman of the Securities Subcommittee of theSenate Comndttee on Banking, Housing and Urban Affairs,requested the Commission to draft a legislative proposalimplementing our recommendations and I understand our proposeddraft legislation will be transmitted to members of Congresstoday. Our proposal is consistent with the regulatory patternsestablished in the 1975 Amendments for the municipal securitiesactivities and securities processing activities of banks,which indicated that, while seeking to enhance investorprotection, Congress would like to maintain the regulation ofbank activities by the federal banking agencies to the extentpracticable.

In addition to certain definitions, we proposed toamend the Exchange Act by adding a new Section 15C whichwould require the federal banking agencies to establishpersonnel training and competency standards, recordkeepingrequirements, and examination procedures to regulate theconduct of banks effecting securities transactions for others,as necessary and appropriate in the public interest and forthe protection of investors. In performing their functions,

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the bank agencies would be required regularly to consult withand request the views of the Commission and coordinate witheach other in order to assure adequate investor protectionand uniform rules and procedures to the extent practicable.

Compliance with these rules and regulations would also beenforced primarily by the bank agencies. However, theCommission would have authority under Section 21 of theExchange Act, to conduct investigations to determine whetherany person has violated, is violating, or is about to violateany provision of Section l5C and rules and regulationsthereunder, to subpoena witnesses, take evidence and requirethe production of books and records, invoke the aid of anyU. S. court in conducting investigations, and seek the aid ofany U. S. court to ensure compliance with such requirementsas are established by the banking agencies.

The bank agencies would be required to advise theCommission quarterly of the banks for which examinationreports have been completed or received and upon requestwould furnish to the Commission those portions of examinationreports regarding a bank's securities transactions forcustomers. In addition, whenever a bank agency has reasonablecause to believe that there may be a violation of federalsecurities laws by a bank under its jurisdiction or anassociated person, the agency would be required to notify theCommission of that fact and the grounds for its belief.

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I support this cooperative approach to theregulation of bank securities activities on the theory thatit will result in comparable standards of investor protectionfor banks and other institutions offering competing securitiesservices, without unnecessary duplicative regulatory burdens.Hopefully, experience with the municipal securities legislation,the securities processing legislation, and the bank studylegislation if enacted, will prove that view to be correct.Otherwise, it may be necessary to subject all bank securitiesactivities to direct SEC regulation and enforcement.

When the Securities Acts Amendments of 1975 werebeing considered, there was considerable concern that theprovisions relating to the regulation of municipal securitiesbroke~s and dealers might indirectly result in the impositionof disclosure requirements on municipal issuers. In responseto these concerns, specific provisions were included in thelegislation to assure that the Municipal Securities RulemakingBoard would not be able either directly, or indirectly throughmunicipal brokers and dealers, to require municipal issuersto provide any information with respect to themselves or theirsecurities. Before the legislation was even enacted, however,events occurred in New York City which highlighted the factthat municipal securities were not without risk of defaultand thus, disclosure of material facts with respect tomunicipal securities and the responsibility on the part of

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participants in the offer and sale to assure appropriatedisclosure became important issues.

Federal legislation was introduced to apply thedisclosure requirements of the Securities Act to municipalissues. The SEC opposed that legislation but supported limitedfederal legislation that would establish minimum standardsof disclosure. There was general support for such legislationwhile crisis conditions continued, but as the crisis subsided,so did interest in the legislation.

As you know, late last month, the Commission releaseda staff report on its 19-month investigation of events thatoccurred in connection with the issuance and sale of New YorkCity securities prior to the time the public debt-market wasclosed to the city. Although the staff investigation has notbeen completed, and the Commission has not determined whetherto instigate enforcement actions against the city or otherparticipants in the distribution of city securities, the reportconcludes that thousands of investors purchased securitieswithout being adequately informed of material facts whichwere known to the issuer and others such as underwriters,bond counsel and rating agencies who participated in thedistribution process.

The Commission's staff report also concludes thatthe accounting practices used by New York City and the systemof internal controls were such that the City's financial

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information was unreliable and its real financial conditionwas obscured. It has been alleged that New York City'saccounting practices are no different than those of othercities. If these allegations are true, then it would appearappropriate to establish a requirement that municipalitiescomply with acceptable government accounting standards andthat their books be reviewed by an independent party.

The staff report concludes that the underwriters,most of whom were banks, had knowledge of the financialcrisis but failed to adequately disclose adverse informationwith respect to the citT's financial problems and the factthat the city might well be foreclosed from public marketsfrom which it was necessary to obtain funds to meet currentrevenue needs. It has been suggested that underwriters ofmunicipal securities do not have the same responsibility toinvestors as they have in underwriting an industrial issue.The law may not be as well developed with respect tomunicipal securities, but I believe it is clear beyond doubt,that when underwriters are aware of material informationwith respect to a municipal issue, they have a responsibilityto assure that investors are provided with that information.

In October of last year I publicly expressed theview, which I had come to reluctantly, that although thepublication of voluntary disclosure guidelines by theMunicipal Finance Officers Association nad been very helpful,

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there was an apparent need for federal legislation whichwould establish minimum required standards of disclosure formunicipal issuers. In addition, I recommended that thelegislation contain liability provisions for issuers,underwriters and experts patterned after Section 11 of theSecurities Act. Early this year, the Commission sentproposed draft legislation embodying those recommendations tomembers of Congress, and there have been recent indicationsthat such legislation will soon be introduced with possiblehearings later this year.

Another securities area in which banks are veryactive and in which eventually there may be a need for somelimited form of legislation is the government securitiesmarkets. At this time, the Commission has no evidence ofany significant abuses by major banks or other major governmentsecurities dealers in these large, important markets. We areaware, however, of serious abuses by some small broker-dealersengaged exclusively in the purchase and sale of governmentsecurities, particularly Government National MortgageAssociation modified "pass through" securities. Last monththe Commission filed an injunctive action against WintersGovernment Securities Corporation, an affiliated broker-dealerand seven individuals alleging violations of the anti-fraudprovisions of the federal securities laws. At this timeseveral other investigations pursuant to formal orders and

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other informal inquiries are being conducted by our staff.It appears that unscrupulous individuals, some of whom havebeen forced out of the municipal securities markets in thepast few years, have entered the government securities marketswhere there is a regulatory void, including the completeabsence of any margin requirements. and have engaged in adisturbing pattern of conduct such as: the utilization ofboiler room techniques; unauthorized trading, churning ofaccounts, excessive mark-ups and mark-downs, over-extendingcustomer positions and sham accounts. These perniciouspractices by a few unethical government securities dealershave jeopardized their customers. which are frequently smallbanks and credit unions. Moreover, such practices can havea significant impact on banks and other legitimate originatingdealers who do business with these unethical governmentsecurities dealers. Hopefully this problem will be adequatelydealt with by industry self-regulation, enforcement actionsby the SEC and by the bank regulatory agencies. Otherwise,legislation may be necessary and appropriate.

In conclusion, let me suggest that the trend towardincreased SEC regulatory impact on bank securities activitiesseems clear. It also appears that in an effort to minimizeduplicative regulation the responsibility to assure that banksprovide appropriate investor protection will be shared withthe bank regulatory agencies. unless this approach proves to

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ineffective. Finally, as bankers and professional advisersto banks and bank holding companies, you have the front lineresponsibility to provide investor protection.