When Congress passed laws in 1999 to ease Depression-era restrictions on financial services providers, it wanted to promote competition among banks, securities firms, and insurance companies. By allowing all three to own one another, the legislators gave consumers the ability to obtain the broadest range of services at the lowest prices. Congress wanted free market forces rather than regulation to determine whether, for example, a securities firm should buy a bank or be bought by an insurance company.

Unfortunately, as the regulators drew up rules to implement the Gramm-Leach-Bliley Act, which modernized financial services laws, they upset the balance created by Congress. The regulations that the Treasury Department and the Federal Reserve issued to govern merchant banking activities — venture capital and other nonfinancial equity investments — make it more difficult for a securities firm to buy a bank and maintain its level of merchant banking activities.

Though the Treasury and the Fed made great strides in addressing concerns raised by their original proposal, their regulations impose severe limitations on merchant banking that are neither necessary for bank safety and soundness nor within the spirit of Gramm-Leach-Bliley. The regulatory agencies continue to operate on the faulty premise that merchant banking poses substantially greater risks than other permissible activities. But the regulators ignore the securities industry’s long record of successfully making and managing merchant banking investments. Even the recent large declines in U.S. equity and venture capital markets have not led to any breakdowns or significant problems at securities firms that are actively engaged in merchant banking.

Although the Treasury and Fed have issued final merchant banking rules that are now in effect, we have continued to press for fewer restrictions. Our hope is that the agencies will agree to revisit the necessity for rules after they have had some experience regulating merchant banking. There is a chance to change the bank regulatory agencies’ proposal that dictates how much capital must be set aside for each merchant banking investment. The proposal is now under review as the agencies wade through the comment letters, including ours, that have been filed.

Complex and burdensome regulations need to be reduced or even eliminated by the Fed and Treasury if we are to go back to Gramm-Leach-Bliley’s original intent. One example is the rule’s treatment of “private equity funds.” It sets out a five-part definition for such funds and then imposes different sets of operational, record keeping, and reporting restrictions to determine which funds meet this definition. Further, additional and different rules are placed on funds “controlled” by financial holding companies (FHCs).

Consider another example. The Fed and Treasury impose restrictions on the types of covenants and agreements that FHCs may use with their portfolio companies. Securities firms are rightly concerned about this, because these restrictions prevent the type of covenants commonly used by firms to protect their investments. Other parts of the rule define the involvement of FHC personnel in a portfolio company. Securities firms have no interest in running the day-to-day operations of the companies in which they invest, but they do need to have roles in these companies so that they can monitor the performance and be involved in decisions affecting the company’s prospects.

Most important are the proposed restrictions on capital, now under review by the banking agencies. Though the latest rules are a measured improvement over the original proposal released in March 2000, they remain onerous and affect the ability of bank-affiliated securities firms to maximize the use of capital. Two changes are needed. First, the bank regulators should allow firms to use their internal capital allocation models in controlling the risks of their nonfinancial investments. By doing so firms can measure the risks and capital needs based on the unique financial situation of the firm and its investments. Their own internal models can be fine-tuned to reflect economic and investment changes. Furthermore, any investments made before the day Gramm-Leach-Bliley took effect should not be subjected to the proposed capital charge. Retroactive imposition of capital charges to equity investments already on the books is unfair, unjustified, and unnecessary.

Securities firms have decades of extensive experience in prudently managing their exposure to risk. The industry will continue to push the Treasury and the Fed to reexamine rules and craft them to promote competition and advance financial services reform while ensuring the safety and soundness of financial institutions.

Mr. Sorcher and Mr. Spellman are, respectively, associate general counsel and director of corporate communiccations of the Securities Industry Association.

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