House Banking Committee Chairman Jim Leach has given the Federal Reserve Board an unconditional mandate to eliminate artificial regulatory barriers that have prevented section 20 subsidiaries of bank holding companies from competing fully in the securities underwriting business.

The Iowa Republican urged the board to use its "clear and unquestionable" authority to address marketplace changes that have blurred distinctions between investment and commercial banking.

Rep. Leach specifically urged the board to increase the gross-revenue limit, under which only 10% of the business of section 20 subsidiaries can be devoted to "ineligible" activities - that is, underwriting and dealing in any securities other than U.S. government securities and general obligation bonds of states and municipalities.

But Rep. Leach's letter also gives a green light to the Federal Reserve to eliminate numerous other artificial restrictions that hamper section 20 subsidiaries:

Underwriting mutual funds. For example, the board could approve underwriting and distribution of mutual funds. Nothing in the Bank Holding Company Act of the Glass-Steagall Act precludes the board from authorizing bank holding companies to engage in such activities.

The board's staff in the past has been unwilling to entertain applications for such activities, arguing that control of the distributor would result in control of the mutual fund itself. This argument was contradicted by the board's 1993 approval of Mellon's acquisition of Boston Co.

Moreover, to the extent that mutual fund distribution and underwriting involves only brokerage activity and does not involve the purchase of fund shares by the distributor or underwriter for its own account, a bank holding company should be allowed to engage in this activity through an ordinary 4(c)(8) subsidiary.

Best efforts underwriting. The Federal Reserve also could authorize bank holding companies to engage in best efforts underwriting, currently treated as an ineligible activity.

Because this is essentially a brokerage activity, there would be no need for a bank holding company to establish a section 20 subsidiary to engage in the activity; the company could do so through an ordinary 4(c)(8) subsidiary with no gross revenue limit.

Municipal revenue bonds. The Glass-Steagall Act does not mandate that municipal revenue bonds be treated as ineligible. Indeed, in 1963 the comptroller of the currency ruled that such bonds are eligible to be underwritten by national banks.

The Federal Reserve disagreed with the comptroller, however, resulting in an adverse court ruling.

In view of the broad deference accorded to the regulatory agencies by the courts since 1963, however, it would be appropriate for the board to revisit this question and allow bank holding company section 20 or other subsidiaries to engage in this activity.

Asset-backed securities. The board has refused to treat revenue from underwriting of asset-backed securities as eligible, even though national banks are permitted to underwrite such securities. The board has no excuse for continuing this position in light of the Leach letter.

Firewalls. The board in 1990 proposed to modify certain of the section 20 firewalls but has never acted to do so. In particular, the board said it would eliminate the prohibition against cross-marketing and interlocks with bank affiliates. The Leach letter clears the way for the board to relax these and other firewalls that have proved onerous.

Securities dealing. Securities dealing has been treated by the board as an ineligible activity, but it is not ineligible under the language of the Glass-Steagall Act itself. Accordingly, the board could permit section 20 or 4(c)(8) subsidiaries to engage in securities dealing activities without any gross revenue limit.

The board has been exceedingly deferential to previous congressional demands that it restrain bank holding company securities activities. Hopefully, the board will be equally deferential in complying with this latest congressional mandate to remove the artificial regulatory burden on bank holding company securities activities.

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