Fed's Meyer Looks at Gramm-Leach-Bliley Experience: BankersOnline.com BOL Vendor Gurus

Fed's Meyer Looks at Gramm-Leach-Bliley Experience

By James Hamilton, J.D., LL.M., Senior Writer Analyst, CCH Federal Securities Law Reporter; Co-Author, CCH Federal Privacy Rules for Financial Institutions and Financial Services Modernization - Gramm-Leach-Bliley Act of 1999 - Law and Explanation; Contributing Author, CCH Focus.

The challenge of implementing the large and hugely complex Gramm-Leach-Bliley Act has occupied federal regulators since the passage of the Act in late 1999. In the intervening months much has been accomplished, said Federal Reserve Board Governor Laurence H. Meyer, but much remains to be done. In remarks before the American Law Institute and American Bar Association in Washington, D.C, he outlined the challenges in managing the Act's privacy expectations, dealing with the issues surrounding foreign financial holding companies and working with functional regulators such as the SEC.

Since the Act's passage, almost 500 financial holding companies have been formed, twenty or so by foreign banking organizations. But the surprise is that three-quarters of the domestic FHCs have assets of less than $500 million, and half of these have assets of less than $150 million. He also noted that no FHC has acquired a large U.S. insurance company since the Citi-Travelers merger before GLB. To date, only one broker-dealer, Charles Schwab, has purchased a commercial bank and become an FHC; only two other broker-dealers, both relatively small, have applied to the Fed to buy a small bank. Except for two foreign FHC acquisitions of large U.S. securities firms, there have been no cross-industry mega-mergers under GLB. Meyer believes that the modest pace of financial restructuring can be explained by institutions' taking the time to choose the businesses, markets, and structures that best fit their individual strategies.

These financial holding companies are no longer banks or securities firms or insurance companies, he reminded. They are something different, and it will take all the skills and best intentions of regulators to reflect the public interest in supervising them. He warned that the natural inclination of the agencies to protect and expand their jurisdiction must be reined in if "we are to retain the spirit of this important legislation."

Privacy
One of the more passionately debated issues in the law was the extent to which any financial institution could share information about its customers with unrelated third parties. GLB requires that all financial institutions tell customers what information will be shared both with affiliated and with unrelated third parties. An institution may choose not to share information about its customers with either group, but GLB provides that, if the organization does share information with non-affiliates, consumers must be given the option to exempt themselves from such sharing.

Gov. Meyer said that translating these seemingly straightforward congressional instructions into regulations was, "at best, an interesting exercise and, at worst, a nightmare.'' The resulting initial effort was just that, he emphasized, "our best start.'' Obviously, he continued, the regulators could not anticipate every question that might be raised by the myriad of privacy policies employed by the private sector. He promised that they will revisit privacy over time and refine the rule as they gain experience.

An interesting side note on the privacy provisions of GLB is that they cover an expanding universe. The Act applies the privacy rules to any financial institution. While that may sound like a banking term, observed the Fed official, GLB actually defines a "financial institution'' to be any institution engaged in activities that have been determined to be financial in nature under the Bank Holding Company Act. There is no requirement that the company be a bank or be affiliated with a bank. As a result, every time the Fed and the Treasury determine that an activity is financial in nature and therefore a permissible activity for a financial holding company, a side effect is that the privacy rules cover a new industry.

For example, all securities brokers and dealers, even those that are not affiliated with a bank or thrift, are covered by the privacy rules because securities brokerage and dealing has been determined by GLB to be financial in nature. In his view, this is an example of Congress using one part of GLB to do double duty to ensure that customers of like companies receive the same privacy protections, regardless of whether or not the company is affiliated with a bank.

Foreign FHCs
Congress said that foreign FHCs had to meet standards "comparable'' to domestic organizations. The quandary created by the desirability and necessity to maintain competitive equity within the United States required some trade-off in areas where foreign and U.S. standards differ. A key issue is that foreign financial institutions typically have no minimum home market leverage ratio while U.S. institutions do. If "comparable'' were taken too literally, Meyer reasoned, the Fed could find itself denying FHC status to foreign institutions with high ratings, because of these differences in U.S. and foreign regulatory capital rules, and being accused of imposing U.S. rules on foreign regulatory authorities.

To deal with these differences, the Fed last March adopted an interim rule that established a two-tier process. First, if a foreign institution's capital ratios met the threshold levels on a risk-based and leverage basis, it was presumed to meet the regulation's well-capitalized standard. If one or more of its capital ratios did not meet the screening level, the foreign institution could use a pre-clearance process to request a determination by the Fed that it had capital comparable to that of a well-capitalized U.S. financial institution.

In the comment period on this interim rule, foreign institutions objected to use of the leverage ratio even as a screening device. After review of the comments, and based on the Fed's experience with the interim rule's pre-clearance process, the Fed decided to eliminate the leverage ratio from the screening test.

In making comparability determinations, the Fed will consider such factors as:

the market ratings of the long-term debt issued by the foreign institution,
its leverage ratio,
the composition of its capital,
other measures of financial strength, and
the views of the home country supervisor.

This approach achieves comparability among organizations without penalizing foreign institutions for their natural response to their own home country supervisor's capital requirements or allowing them an advantage over domestic institutions that must meet the U.S. leverage ratio.

Gov. Meyer believes that the Fed's decision represents a template of how to reach the congressional intent of competitive equity while adjusting to international institutional differences. It is an example of the application of agency expertise to fulfill congressional direction. Large U.S. financial institutions were in full support of this decision, he added, both on equity grounds and in hope that the template would be applied by the Europeans to U.S. bank activities abroad in similar cases.

Functional Regulation
Gramm-Leach-Bliley confirmed the Federal Reserve as the umbrella supervisor of FHCs. However, it explicitly limited the Fed's role as umbrella supervisor, reflecting concerns of securities and insurance firms that might become FHCs and their functional regulators. The former were concerned about the intrusiveness of a regulator with a different historical responsibility and focus than they were used to, and the latter about the undermining of their authority. Briefly, the Act limited the authority of the Fed to examine, impose capital requirements on, or obtain reports from those subsidiaries of FHCs that are also regulated by the SEC. The role of the consolidated supervisor continues to be as the monitor of holding company risks that could affect the health or viability of affiliated banks.

The Federal Reserve has initiated several efforts to enhance interagency cooperation, consistent with both the letter and the spirit of GLB, which calls for the Fed and the other agencies to cooperate on supervision and in some cases requires joint rule and decision-making. The Fed has aggressively sought ways to facilitate the sharing of crucial information concerning bank examination and other matters with the SEC.

Formal Memoranda of Understanding
The Fed shares information through writing formal memoranda of understanding (MOU) with the functional regulators. It is working with the SEC to develop an MOU covering the sharing of information about broker-dealers in FHCs. In the meantime, while awaiting the completion of the MOU, agency staffs have worked out arrangements to ensure that critical information is shared on a case-by-case basis.

Communication, Cooperation, Coordination
The bilateral relationships between different supervisors are obviously critical, but as the umbrella supervisor for FHCs, the Federal Reserve is in a unique position to facilitate multilateral relationships among supervisors. The Fed believes that GLB requires communication, cooperation, and coordination among the banking agencies, the SEC and the state regulators. This matter is not only one of congressional intent, concluded Gov. Meyer, it is a necessity for effective supervision and regulation of the small number of increasingly large, complex banking organizations. If there is no cooperation, he warned, the financial system may be put at risk.

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First published on BankersOnline.com 4/2/01