Securities and Exchange Commission Historical Society

The Mechanics of Legislation: Congress, the SEC and Financial Regulation

Financial Modernization: Gramm-Leach-Bliley Act of 1999

SEC and "Functional Regulation"

“We have long accepted functional regulation; indeed, virtually every aspect of each of our various businesses is, and has been, heavily regulated. Since the new Citigroup will not be engaged in any ‘commercial’ activities, our regulators will all be very familiar to you – the Federal Reserve Board, FDIC, OCC, OTS and various state banking authorities to the SEC to the fifty state Departments of Insurance. Working with a variety of regulators in the most effective way is one of the challenges – one of the opportunities – created by our new company.”

June 3, 1998 Joint Statement of Citicorp and Travelers Group to the House Judiciary Committee

As the debate over Glass-Steagall heated up, the SEC became actively involved in the discussion of which agency would have control over the selling of securities. The SEC advocated that it should have the lead role in regulation over securities sales by any bank or any bank subsidiary. However, in 1982, the Comptroller of the Currency ruled that Section 16 of Glass-Steagall permitted a national bank to offer discount brokerage services to both banking and nonbanking customers. In 1984, the Supreme Court unanimously affirmed a Federal Reserve Board order authorizing BankAmerica, a bank holding company, to acquire Charles Schwab, a discount brokerage firm.

In 1985, the SEC adopted Rule 3b-9 under the Securities Exchange Act of 1934, which excluded from the term “bank” any bank that publicly solicited brokerage business in which it directly or indirectly received transactional related compensation. The exclusion also applied to banks that dealt in or underwrote securities. But in 1986, the District of Columbia Court of Appeals invalidated that rule as contravening the intent of Congress unambiguously expressed in the language of the 1934 Act.

From then on, the SEC fought an inconclusive legal battle with other regulatory agencies. The best the SEC could realistically hope for was to minimize bank securities exclusions for federal securities laws, and promote firewalls that “insulated banks from the risks of their securities affiliates.” SEC Chairman Arthur Levitt cautioned Congress that “over the last two decades, through expansive banking agency interpretations, banks have gained entry into a wide range of securities activities once thought to be foreclosed by the Glass-Steagall Act.” 35

These developments led the SEC to espouse a new approach called “functional regulation.” 36 In an effort to reassert the SEC’s power to regulate all institutions dealing in securities, the concept of functional regulation proposed that regulatory authority be determined according to different financial functions performed by the regulated entity, and not according to the species of financial institution as defined by its charter or even its primary function. The SEC wanted to retain its power to regulate securities activities, while bank depository activities would be handled by banking regulators.

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(35) Joel Seligman, The Transformation of Wall Street (Aspen Publishers: New York, 2003), 684-685.

(36) Ibid., 684.

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Oral Histories

20 June 2013

Arthur Levitt

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