An Agency to Oversee ILC Owners? Why Not 4?

WASHINGTON - Federal regulators have struck a deal on who will have authority over the parent firms of industrial loan companies, including formally recognizing four different regulators as consolidated supervisors, sources said Monday.

The deal represents something of a tactical retreat for the Federal Reserve Board, which fought tenaciously in the Gramm-Leach-Bliley Act of 1999 to be declared the financial umbrella supervisor and has complained that parent firms of ILCs are not subject to their oversight.

But the deal, which is expected to be announced Wednesday at a House Financial Services Committee hearing, would give supervision of ILC parents to several regulators, including the Securities and Exchange Commission, which has pushed for the past three years to be considered a consolidated supervisor. The other supervisors would be the Fed, the Federal Deposit Insurance Corp., and the Office of Thrift Supervision, several sources said.

They said the terms of the deal have already been incorporated into legislation by House Financial Services Committee Chairman Barney Frank, D-Mass., and Rep. Paul Gillmor, R-Ohio, which would ban commercial companies from owning ILCs.

Reps. Frank and Gillmor originally sought to grant the FDIC Fed-like powers to oversee the parent companies of any ILCs that were not already subject to consolidated supervision by the central bank or the OTS.

But securities firms then argued that the SEC was being left out. That agency persuaded its fellow regulators that ILC owners, such as Goldman Sachs & Co., Lehman Brothers, and Morgan Stanley should not face additional FDIC supervision.

The debate over which agencies are considered consolidated regulators is not academic.

Critics of ILCs have contended that such companies present a safety and soundness risk because they are not regulated like other banks, which are overseen at the holding company level by the Fed or the OTS. The FDIC has recently proposed to strengthen its oversight of ILCs without such supervision, and imposed orders on recently approved ILCs to beef up its authority.

The distinction of being a consolidated supervisor is also important internationally. In 2004 the SEC finalized a rule creating an alternative consolidated charter for a broker-dealer's holding company and affiliates. The new structure was meant to allow domestic securities firms that also operate in Europe to avoid duplicative oversight by local supervisors.

Observers called the recent deal a coup for the SEC, which has faced charges from the OTS and others that it was on legally dubious grounds in creating a broker-dealer holding company charter in the first place.

"This was a clear investment bank victory," said one lobbyist, who spoke on condition of anonymity.

Some said the new arrangement would make sense if the Frank-Gillmor bill is enacted.

"Having one agency you can know and get to know you is easier than having two or three," said John Douglas, a former FDIC general counsel and now a private attorney in Atlanta. "The advantage of the SEC would be that they would have much greater familiarity with the capital, operations, risks, and other things associated with a company like a Goldman, and the FDIC probably doesn't."

But Merrill Lynch & Co. Inc., which owns the largest ILC, would face two regulators at the holding company level. Under the deal, Merrill, which also owns a thrift in New York, would be overseen by the SEC and the OTS, which have agreed to share information, sources said.

But some observers questioned the decision to let the SEC play this role at all, arguing it is not well equipped to be a consolidated supervisor of a bank owner.

"The underlying concept of consolidated supervision is safety and soundness, which is well beyond the SEC's scope of expertise," said Joseph T. Lynyak 3rd, a partner at Buckley Kolar LLP.

"At the end of the day, it's apples and oranges. … The SEC simply doesn't have the expertise to function in that role. Traditionally, it's been something that's given to the Federal Reserve."

Karen Shaw Petrou, the managing partner of Federal Financial Analytics Inc., said there are fundamental differences between SEC and Fed supervision.

The SEC's "structure is based on capital and broker-dealer enforcement. It also doesn't have the clear standing in law that a bank holding company does," she said.

Some observers also questioned why the Fed, which until recently had defended its role as the umbrella supervisor, appears content to share regulation of parent companies with three other agencies. Bert Ely, an independent banking consultant based in Alexandria, Va., said that the central bank may just be recognizing reality, and noted that securities firms are not overseen by the Fed today.

"It sounds like the bill then would codify what existing practices are," Mr. Ely said. "This agreement sounds like it's a matter of clarifying turf versus substantially altering turf. It's a peace treaty."

A spokesman for Rep. Gillmor would not confirm that an agreement between the agencies had been set, but he did say that in a final bill Rep. Gillmor may opt for including the SEC as a consolidated supervisor.

"Once we have a chance to hear from all the regulators" at the hearing, "then I think it's possible there will be more movement on that," the spokesman said. "The congressman's point in this is to have the strongest regulator possible, and to make sure that they have the powers and the know-how to use them. If that means that we include the SEC, then that will be the position that he takes."

An FDIC spokesman declined to comment.

But Mr. Douglas said the agency likely supports allowing the SEC to be designated as the holding company overseer, since the FDIC already has substantial power as the federal regulator of the ILC itself.

"Were I at the FDIC, I would take the position that I have plenty of power to protect my interest, regardless of whether I am nominally named to be the consolidated supervisor," Mr. Douglas said.

For reprint and licensing requests for this article, click here.
MORE FROM AMERICAN BANKER