BANKING REGULATION 101
From Washington
Kathleen W. Collins

Kathleen W. Collins is a partner in Morgan, Lewis & Bockius, and Washington Counsel of the Bank Insurance & Securities Association. She and Richard Starr write the "From Washington" column in alternate issues.

DEVELOPING A SYLLABUS and course material for a law school course that I'll teach for the first time this spring (Regulation of Banks in the United States) was like a step back in time. Class discussion topics, such as "Securities Powers of Banks" and "Insurance Powers of Banks," conjured up memories of the bad old days when finding a loophole or engaging in high-stakes litigation were the ways that banks frequently came to provide new services. The methods used to deliver those services were sometimes based on fitting through those loopholes, rather than providing convenience to the customer or profit to the bank.

Competition among industries and regulators culminated in the 1999 compromise that was the Gramm-Leach-Bliley Act. How the banking industry got to that point and what it actually got at the end of the decades-long struggle will be one of the more interesting lessons for this spring's aspiring, 23-year-old lawyers.

A 'security' or 'note'?

The list of litigants in the defining case law sheds light on the battles being fought at various times. In one corner we have the Securities Industry Association (SIA) litigating against the Board of Governors of the Federal Reserve System to determine whether commercial paper was a "security" or a "note" within the meaning of the Glass-Steagall Act-a round that went to the securities industry in 1984 when the U.S. Supreme Court found that commercial paper being sold by Bankers Trust was indeed a "security."

The Glass-Steagall Act, passed in 1933 in response to Congress' belief that commercial banks' involvement in the securities arena had contributed to (or even caused) the Great Depression, continued to serve as the basis for most of the 20th Century securities-related litigation regarding banks and also served as the backdrop for the securities-related concessions granted to banks in Gramm-Leach-Bliley.

Litigation enabled banks to begin making inroads regarding insurance and annuity sales.

Discount brokerage powers

An earlier match-up of heavyweights had the Investment Company Institute (ICI) suing the Comptroller of the Currency to overturn the Comptroller's decision to permit a bank to offer its customers the opportunity to invest in a stock fund created and maintained by the bank. In 1971, the U.S. Supreme Court sided with the ICI in its view that such action posed financial hazards and dangers for commercial banks-dangers that Congress (in passing Glass-Steagall) meant to avoid, according to the court. But as the underdog, the Comptroller of the Currency fought its way back to prevail over the Securities Industry Association on the issue of discount securities brokerage with a 1987 decision that resulted in Union Planters National Bank and Security Pacific National Bank being permitted to own and operate subsidiaries engaged in the brokerage business.

A similar sorting-out process occurred later in the century in regard to bank insurance powers, but the overlay of the federal 1945 McCarran-Ferguson Act, which generally left the business of insurance subject to state law, only served to increase the political stakes and complicate the litigation strategies of the pugilists involved. Many states had used their authority to legislate banks out of the insurance sales business, and forbade agents and agencies affiliated with banks from selling insurance. However, litigation enabled banks to begin making inroads in regard to insurance and annuity sales. The Variable Annuity Life Insurance Company (VALIC) was sent to the mat in 1995 when the U.S. Supreme Court upheld the Comptroller of the Currency's view that national banks could serve as agents in the sale of annuities; the Court found that an annuity was an investment and not an insurance product. A one-two punch was administered by the Comptroller when Barnett Bank was awarded a unanimous decision by the U. S. Supreme Court when it upheld the Comptroller's view that the federal statute permitting national banks to sell insurance in small towns pre-empted a Florida law that prohibited such activity. This 1996 decision and the deference the Supreme Court appeared willing to accord to the Comptroller's decisions sent those state insurance and independent insurance agents groups that opposed banks' entry into insurance and annuities sales to the sidelines vis-à-vis litigation.

Indeed, the difficult litigation posture the state insurance and independent agents groups found themselves in, followed by the Citibank-Travelers merger announcement in late 1998, all but guaranteed the change of venue from the courts to Congress, where a series of compromises in the Gramm-Leach-Bliley Act concerning the "functional" regulation of banks' securities and insurance powers have led banks back to their corners to contemplate how good or bad a deal 'financial modernization' really was.

Bankers might complain over the changes that will be wrought by the new Regulation R or scratch their heads, wondering why it is still so difficult to pocket part of the income from a completely appropriate, bank-based retail sale of an insurance product by a qualified, licensed agent. But they need simply review the tortured path from the Glass-Steagall Act and the McCarran-Ferguson Act to Gramm-Leach-Bliley. The truth is that while banks have partially recovered from the competitive disadvantages created by earlier legislation, diversified banks in the U.S. still have a long way to go.