Univers al Banking in the United States: Benefits and Risks
Julien P. Mathieu
Institute of Comparative Law Faculty of Law, McGill University Montreal, Canada
September 2003
A thesis submitted to McGill University in partial fulfillment of the requirements of the degree of Master of Laws (LL.M.)
©Julien P. Mathieu, 2003 Library and Bibliothèque et 1+1 Archives Canada Archives Canada Published Heritage Direction du Branch Patrimoine de l'édition
395 Wellington Street 395, rue Wellington Ottawa ON K1A ON4 Ottawa ON K1A ON4 Canada Canada
Your file Votre référence ISBN: 0-612-98805-8 Our file Notre référence ISBN: 0-612-98805-8
NOTICE: AVIS: The author has granted a non L'auteur a accordé une licence non exclusive exclusive license allowing Library permettant à la Bibliothèque et Archives and Archives Canada to reproduce, Canada de reproduire, publier, archiver, publish, archive, preserve, conserve, sauvegarder, conserver, transmettre au public communicate to the public by par télécommunication ou par l'Internet, prêter, telecommunication or on the Internet, distribuer et vendre des thèses partout dans loan, distribute and sell th es es le monde, à des fins commerciales ou autres, worldwide, for commercial or non sur support microforme, papier, électronique commercial purposes, in microform, et/ou autres formats. paper, electronic and/or any other formats.
The author retains copyright L'auteur conserve la propriété du droit d'auteur ownership and moral rights in et des droits moraux qui protège cette thèse. this thesis. Neither the thesis Ni la thèse ni des extraits substantiels de nor substantial extracts from it celle-ci ne doivent être imprimés ou autrement may be printed or otherwise reproduits sans son autorisation. reproduced without the author's permission.
ln compliance with the Canadian Conformément à la loi canadienne Privacy Act some supporting sur la protection de la vie privée, forms may have been removed quelques formulaires secondaires from this thesis. ont été enlevés de cette thèse.
While these forms may be included Bien que ces formulaires in the document page count, aient inclus dans la pagination, their removal does not represent il n'y aura aucun contenu manquant. any loss of content from the thesis. ••• Canada Abstract
The worldwide financial services industry has undergone in the past two decades an unprecedented wave of consolidation within and across its three main sub-sectors: banking, securities activities and insurance. Today's observers assert that in ten years, most of the financial sector will be controlled by a small group ofhuge diversified banks. By enacting the Gramm-Leach-Bliley Act in 1999, Congress repealed the depression-era "Glass-Steagall" Act of 1933 and thereby officially removed the longstanding legal barriers that insulated banks from securities firms and insurance companies. As promoters of financial convergence have long been c1aiming that the introduction of univers al banks in the United States would produce numerous benefits for themselves, but also for the economy and for their customers, these predictions can be assessed today in the light of empirical analysis. Now that "financial supermarkets" are totally legal in the United States, it is essential to assess whether they are economically and morally viable. Résumé
Dans un mouvement de consolidation extrême, les secteurs bancaires et financiers de la plupart des pays du monde ont été complètement bouleversés durant les vingt dernières années. A la suite d'une vague de fusions sans précédent, banques «traditionnelles », banques d'investissement et entreprises d'assurance sont aujourd'hui plus imbriquées les unes dans les autres qu'elles ne l'ont jamais été. Alors qu'aux Etats-Unis le nombre de banques a été divisé par deux en vingt ans, la majorité des experts prédisent aujourd'hui que d'ici dix ans, le secteur financier sera contrôlé presque totalement par une poignée de géants basés sur le modèle de «banque universelle». En détruisant, en 1999, les barrières érigées suite au Krach de 1929 par le « Glass-Steagall Act », le législateur Américain a ouvert la porte aux conglomérats financiers et à ses avantages largement mis en avant. Avantages pour les consommateurs Américains, pour la stabilité et la santé de l'économie, et avantages substantiels aussi pour ces entités aux spécificités marquées. Suite notamment aux scandales à répétition qui viennent de toucher l'économie Américaine au cœur, la crédibilité du modèle de banque universelle aux Etats-Unis semble gravement entamée. Eu égard aux risques majeurs que peut présenter une telle option, c'est sa validité qui est aujourd'hui à envisager.
II Acknowledgments
Je voudrais tout d'abord remercier une personne exceptionnelle que j'ai eu la chance de rencontrer et le bonheur de côtoyer durant ces derniers mois. Pour ses commentaires lumineux, pour la richesse de sa pensée et pour son soutien indéfectible, pour avoir fait preuve à mon égard d'une sollicitude et d'une disponibilité que je n'oublierai jamais mais qu'aucun mot ne peut restituer avec justesse, je remercie mon directeur de thèse, le Professeur Stephen Scott. Avoir eu le privilège de passer du temps aux côtés d'un homme d'une telle valeur est un bien qui m'est particulièrement cher aujourd'hui. Il me sera inestimable demain. Puissent ces quelques lignes lui exprimer la force de mon admiration ainsi que mon immense gratitude.
Je souhaite ensuite adresser mes remerciements à l'Institut de Droit Comparé de McGill pour m'avoir permis d'évoluer dans un environnement empreint d'excellence, mais aussi de diversité et d'ouverture sur le monde. Toute mon affection va à mes amis de Montréal et particulièrement Raul, Emilio et Fernando qui ont, avec moi cette année, découvert et appris.
A l 'heure où je quitte Montréal, je voudrais remercier des personnes rares, rencontrées ces dernières années et qui ont beaucoup marqué mon évolution personnelle. Elles m'ont appris ce que l'on ne trouve dans aucun livre ni Traité. Elles m'ont bien plus apporté qu'elles ne pourraient l'imaginer. Je remercie Henri Bybelezer, Olivier Fraticelli, Marc Lemieux, Gérard Orsini et Christian Atias.
Enfin, j'exprime ma plus profonde gratitude et mes remerciements les plus sincères à mes parents. Sans eux, cette année, la plus belle de toutes, n'aurait pu devenir réalité. Je les remercie pour leur soutien moral et matériel, pour m'avoir instillé le goût du savoir et donné la liberté d'apprendre dans des conditions merveilleuses. Je les remercie enfin pour m'avoir appris l'intégrité mais aussi la tolérance, et pour en faire preuve chaque jour en étant à mes côtés quels que soient mes choix.
III Table of Contents
Abstract ...... 1 Résumé ...... 11 Acknowledgments ...... III Table of Contents ...... IV
INTRODUCTION ...... 1
PART II HISTORICAL OVERVIEW OF BANKING AND ITS REGULATION IN THE UNITED STATES ...... 6
2.1 From 1782 to the Late 19th Century ...... 6 2.2 How it AlI Started: Banks' Pressure to extend their activities, the Crash and the Legal Response ...... 9 2.2.1 A First Extension: Bank Affiliates and Bank Holding Companies ...... 9 2.2.2 The Legislative Response: The Glass-Steagall Act of 1933 and the Separation of Commercial from Investment Banking ...... Il 2.3 More Pressure from Banks, Other Responses ...... 14 2.3.1 The Bank Holding Company Act of 1956 ...... 14 2.3.2 The Bank Holding Company Act Amendments of 1970 ...... 15 2.3.3 The Decisive Break-down of Legal Barriers: the Creation ofCitigroup ...... 16 Conclusion ...... 20
PART III "UNIVERSAL BANKING" IN THE UNITED STATES: THE AMERICAN MODEL ...... 21
3.1 The Gramm-Leach-Bliley Act of 1999 ...... 21 3.1.1 Overview ...... 21 3.1.2 Repeal of Glass-Steagall Act Provisions ...... 23 3.1.3 What are the New Activities? ...... 23 3.1.3.1 Amendments to the Bank Holding Company Act of 1956 ...... 23 3.1.3.2 The Regulatory Determinations ofNewly Permitted Activities ...... 25 The New "Financial in Nature or Incidental" Standard ...... 25 Complementary Activities ...... 26 Merchant Banking Activities ...... 27 3.1.4 Which Structures for the New Financial Activities? ...... 28 Financial Holding Companies ...... 28 Financial Subsidiaries ...... 29 3.1.5 Conclusion ...... 31
3.2 Univers al Banking? ...... 33 3.2.1 Defining "Univers al Banking": Different Meanings, Different Forms ...... 33 3.2.2 Bank Organizational Structures in the United States ...... 36 3.2.3 Universal Banking Abroad ...... 38 3.2.3.1 Germany ...... 38 Overview ...... 38 Four Features ofa Successful Deve10pment ...... 40 3.2.3.2 Switzerland ...... 41 Conclusion ...... 45
PART IV CLAIMED ADV ANTAGES OF UNIVERSAL BANKING ...... 46
4.1 Increased Profitability and Efficiency Due to Favorable Economies of Scale and Scope . .47 4.1.1 Economies 0 f Scale and Scope and Efficiency ...... 47 4.1.2 Definitions ...... 48
IV 4.1.3 Economies of Scale and Scope Applied to Univers al Banks ...... 49
4.2 Increased Safety and Soundness Due to a Greater Diversification ...... , ...... 50 4.2.1 Overview ...... 50 4.2.2 Rationales for Enhanced Safety and Soundness in Literature ...... 51 4.2.3 Stability versus Efficiency and the Ideal Corporate Structure ...... 53
4.3 Benefits for Consumers ...... 54 4.3.1 Introduction: Deregulation and Consumers, the Specificity ofConsumers' Benefits ...... 54 4.3.2 The Variety ofBenefits for Consumers ...... 55 4.3.2.1 Quantitative benefits: Lower prices ...... 56 Justification ...... 56 A Trustworthy Prediction? ...... 57 4.3.2.2 Qualitative Benefits ...... 59 "Improved Access to Financial Services": a Greater Convenience for Consumers ...... 59 New Products and Services ...... 60
PART V POTENTIAL PITFALLS OF UNIVERS AL BANKS ...... 61
5.1 Preliminary Section: Competition, Efficiency, Profitability and Consumers ...... 64
5.2 Global Risks ...... 71
5.2.1 SystemicRisk ...... 71 5.2.1.1 Definitions ...... 71 5.2.1.2 Systemic Risk and Univers al Banks ...... 73 Universal banks and Diversification: Increased Complexity due to Cross-Industry lnroads ...... 73 Universal Banks and Size: Concentrating Power within Hands of a Small Number of Entities ...... 75 5.2.1.3 Supervisory Policies over Financial Conglomerates ...... 76 Too Big Too Fail ...... 76 CUITent Risk-control Supervisory Measures ...... 78 - American Regulatory Approach to Financial Risk under Gramm-Leach-Bliley ...... 78 - The New Basel Agreement ...... 80
5.2.2 Conflicts of Interest ...... 81 5.2.2.1 Historical Perspective ...... 82 5.2.2.2 Potential Conflict Situations in "Tniditional" Banking Institutions ...... 83 5.2.2.3 Moral Hazard, Conflicts ofInterest and Universal Banking ...... 87 Foreword ...... 87 Conflict Situations in Univers al Banking ...... 88 - Informational Conflicts and Other Conflict Situations ...... 88 - Tying Situations ...... 91 General Observation ...... 97 5.2.2.4 Evidence of Recent ScandaIs and the New Evil of Wall Street...... 97 Overview and Se1ected Issues ...... 97 Who Are Analysts? What They Do and What They Should Not ...... 105 - The Traditional Role ofAnalysts ...... 106 - Potential Conflict Situations Involving Analysts ...... 108 Conclusion: New Rules, but What Does it Change? ...... 111
CONCLUSION ...... 118
APPENDICES ...... 122 Appendix 1: ...... 122 Appendix II: ...... 124 Appendix III: ...... 125
V À Albert Mathieu
VI INTRODUCTION
The worldwide financial services industry has undergone in the past two decades an unprecedented wave of consolidation. Along with deregulation, the reasons for this exceptional trend reside in the combined effect of new technologies and the creation of new financial products, hard competition, and the expansion of the global market. l To respond to this new environment and keep their competitiveness, U.S. financial institutions have adopted an aggressive consolidation strategy, seeking to improve their efficiency both by increasing their geographical reach and the range of products they offer. These efforts have resulted in an exceptional number of mergers which have deeply affected the structure of the U.S financial services sector. Between 1979 and 1999, the number of banking organizations declined by nearly half, falling from 12,500 to 6800 whereas the market share held by the ten largest banks more than doubled. 2 More than thirty "megamergers" among very large banks took place in the United States after 1990. 3 In particular, seven huge mergers were agreed to between 1998 and 2001, involving sorne of the large st U.S banks. 4 However, these mergers were not limited to the banking sector alone. Numerous examples of cross-industry transactions also occurred within the securities and insurance sectors, so that in 1999, aIl of the largest U.S. banks ended up
1 Alcides 1. Avila, Patricia M. Hernandez & Asnardo Garro, "United states" in Anne Crossfield & Manfred Heemann, ed., Banking Law Survey: 1999/2000, (Boston-Dordrecht-London: Kluwer Law International, 2001) at 243; H. Onno Ruding, "The transformation of the financial services industry", occasional paper Financial Stability Institute (2001), at 1, online: Bank for International Settlements (BIS)
5 Alan Levinsohn, "The Coming of a Financial Services Bazaar" Strategie Finance (April 2000) (referring to a study released in 2000 by PriceWaterhouseCoopers). 6 For instance, the Mac Fadden Act, which limited geographical expansion ofbanks on a national basis, was repealed in 1994. 7 In reality, at the end of2001, Mizuho Holdings of Japan moved ahead ofCitigroup as the world's largest banking organization in terms of as sets (with $1.3 trillion of assets, compared to $1.05 trillion for Citigroup). However, in mid-2002, Citigroup remained far ahead ofall other global banks based on its market capitalization. See "Top 1000 World Banks" The Banker (July 2003) [hereinafter Top 1000 banks 2003], online: The Banker
2 With the enactment of the Gramm-Leach-Bliley Act in November 1999, Congress inspired a dramatically different future for the U.S financial industry. Through the repealing of the depression-era "Glass-Steagall" Act of 1933, the abolition officially removed the longstanding legal barriers that insulated banks from securities firms and insurance companies. Even before 1999 though, financial giants had been pushing the existing limitations in such an aggressive manner that in reality, the "Glass-Steagall Act was already a de ad letter when the Gramm-Leach-Bliley Act was passed.,,10 This Act can be seen (as indeed it has been widely referred to) as a mere recognition of a preexisting factual situation, since numerous mergers had by various expedients been taking place between companies both within and across the three main sub-sectors of the financial services industry. However, it is worth noting that the United States remained until 1999 the only major economic power that prevented a full affiliation of the commercial and investment banking industries. As a result of the new Act, banks and asset managers, securities firms, and insurance companies can enter into each other' s business or merge together legally, embracing new businesses under the structure of a financial holding company. This is how the long-sought financial services supermarket was introduced in the U.S. economy. Congressional leaders and industry representatives have long been claiming that new diversified financial conglomerates would produce numerous benefits for themselves, but also for the economy and for their customers. Il These financial conglomerates were predicted to be more profitable due to economies of scale and scope. They have been expected to bring a higher measure of safety and soundness to the economy thanks to a larger diversification, and ultimately to offer lower prices and more convenience to their customers. 12 The recent wave of corporate scandaIs involving sorne of the largest financial institutions have led to various criticisms toward universal banks, notably with respect to the issue of moral-hazard behaviour. Furthermore, the profitability of the universal-
10 Jonathan R. Macey, "The Business ofBanking: Before and After Gramm-Leach-Bliley" (2000) 25 Iowa J. Corp. L. 691 at 692. Il See Senate Report No. 106-44, at 4-6 (1999); David Rogers, "Universal Banking, Does it Work?" in Edward L. Melnick et al., ed., Creating Value in Financial Services, Strategies, Operations and Technologies (Boston-Dordrecht-London: Kluwer Academic Publishers, 2000), at 39 [hereinafter Does if work?]. 12 Does it work? Ibid.
3 banking model and assumptions as to its benefits toward its stakeholders have apparently been seriously underrnined, as evidenced by the disappointing financial results recently shown by sorne prominent financial organizations. 13 Moreover, due to their size, their structure and the crucial position they occupy in the economy, these financial giants also raise serious public policy concems, especially with respect to the issue of systemic risk. Rence, the potential risks inherent in the size and structure of these economic players affect our economies in a global way, implicating more than the issues of ethical conduct or shareholder value alone. As promoters of financial convergence have long been making numerous promises about the creation of diversified financial conglomerates in the United States, these predictions can be assessed today in the light of empirical analysis. Apart from the specific advantages or flaws that will be studied in this paper, the phenomenon of financial convergence also raises sorne considerable theoretical concems. The troubling power of economic giants of this new kind, their influence over policy makers, govemments, and regulators, or the dynamic interplay between law and the banking world are questions that are c10sely linked with the recent evolution of the financial industry in the United States. Although most of these theoretical issues are not primary national priorities, they nonetheless remain sorne of the most fundamental questions regarding the whole debate about financial convergence. In this study we intend to confront the benefits traditionally associated with the emergence of financial conglomerates as against their potential risks, through the recent evolution of the financial services sector in the United States. This analysis seeks two primary objectives. It first aims at evaluating the pertinence of the universal-banking model, through the prism of its adoption in the United States with the Gramm-Leach Bliley Act, by using the combined interests of the financial organizations, the interest of their stakeholders, and the integrity and safety of the economy as ultimate criterions. From a public-policy perspective, this study also intends to discuss sorne various critical
\3 See e.g. "The perils ofnot sticking to your knitting" The Economist (12 November 2002) (reporting that "Commerzbank has become the latest universal bank to produce dreadful results and announce a retrenchment from investrnent banking. Like other large financial institutions, it has found that it can be even easier to lose money in the securities business than in commercial banking asking", asserting that "In America, too, the one-stop-shop model has lost its shine", and asking "Has the universal-bank model had its day?"). See also Controlling, supra note 2 at p. 5.
4 questions that have arisen from the introduction of the universal-banking model in the United States, in order to draw general conclusions from this important experience.
This thesis is divided into five parts. Part II provides an historical overview of banking and its regulation in the United States, by presenting the evolution of the main U.S. banking policies and laws. Part III seeks to specify issues related to the notion ofuniversal banking and to address questions dealing with the different structures that can be adopted by univers al banking organizations. It particularly aims at assessing the position of the American model in relation with structures existing in other countries, by examining the new possibilities offered by the deregulatory initiative of 1999. Part IV discusses sorne of the most relevant touted benefits of financial conglomerates, with regard to American consumers, companies themselves and the economy, as they were claimed by promoters of universal-banking during the long debate that occurred in American public affairs. Part V will examine the risks of such an option, by evaluating the outcomes for customers of this new type of economic giants, for instance. Global risks presented by large diversified banks in the United States will then be studied through the buming issues of systemic risk and moral hazard, particularly with evidence of recent Wall Street scandaIs. Part VI contains public-policy conclusions that result from earlier parts.
5 PARTH 14 HISTORICAL OVERVIEW OF BANKING AND ITS REGULATION IN THE UNITED STATES
2.1 From 1782 to the Late 19th Century
The first U.S. bank, the Bank of North America, was chartered in 1781, by Congress under the Articles of Confederation. 15 Charters of early U.S. banks, modeled on the Bank of England, already reflected safety and soundness preoccupations by imposing various restrictions on the activities that banks could engage. These limitations were based on the fact that since banks were not only private entities but also constituted close partners of the government in terms of financing, their activities should hence be restricted in order to prevent potential riskS. 16 However, Thomas Jefferson heavily criticized the first Bank of the United States, arguing that this new institution was unconstitutionaL 17 These criticisms, which continued later on with the J acksonians, led to the point where Congress refused in 1811 to renew the bank's charter. 18 The situation nevertheless did not get any better once state-chartered banks were left alone without federal supervision. Many problems quickly occurred within the fast growing banking industry, notably due to the War of 1812, or as a consequence of unsound lending policies or cases of fraud. 19 In 1814, various bank failures took place among well-established state-chartered banks whose notes had been
14 See Bray Hammond, Banks and Politics in Americafrom the Revolution to the Civil War (Princeton, NJ: Princeton University Press, 1957) at 197-226 [hereinafter HammondJ; R. Timberlake, The Origins of Central Banking in the United States (Cambridge, Massachusetts: Harvard University Press, 1978). 15 See Herman E. Krooss & Martin R. Blyn, A History ofFinancial lntermediaries (New York: Random House, 1971), at 19 (noting that historians are quite sure that Bank of North America, located in Philadelphia, was the first U.S. money bank). 16 Bernard Shull, "Financial Modernization under the Gramm-Leach-Bliley Act: Back to the Future", in Benton E. Cup, ed., The Future ofBanking (Westport, Connecticut - London: Quorum Books, 2003) at 78 [hereinafter Future]. 17 Hammond, supra note 14 at 210 (reporting that in a letter, Jefferson once wrote concerning a national bank: "This institution ... is one of the most deadly hostility existing, against the principles and form of our Constitution"). However, the Supreme Court held that the United States had the implied power to create a bank and to protect it against state interference, in McCulloch v. Maryland, 17 U.S. (4 Wheat.) 316, 331 (1819). 18 See Carl Felsenfeld, "The Bank Holding Company Act: Has it lived its life?" (1993) 38 ViII. L. Rev. 2. at 7-8. 19 James L. Pierce, The Future of Banking (New Haven and London: Yale University Press, 1991) at 35 [hereinafter Pierce].
6 discounted, particularly affecting banks located in the District of Columbia, Baltimore, New York and Philadelphia,zo ln 1816, due to the terrible financial situation of the nation, federal government decided to establish the second Bank of the United States, stilliocated in Philadelphia and organized under the same hybrid structure as the first one.21 Criticisms that had been expressed with respect to the first Bank of the United States remained with the new institution. As a matter fact, its legitimacy rapidly became profoundly undermined. Most criticisms were directed at the bank's independence. Indeed a growing number of critics asserted that the federal bank dangerously privileged the economic interests of its private managers and owners, whose influence in the political sphere was undeniable. 22 In addition to traditionally long-opposing states, the rising banking forces from New York, helped by President Andrew Jackson, joined the fight against Philadelphia's bank, thus fostering New York as America's new financial heart. Exactly two decades after its creation, the second Bank of the United States expired.23 ln 1837, a few months only after the demi se of the federal bank, a new "financial panic and banking collapse with wide spread currency suspension" occurred in the United States, lasting unti11845.24 After this financial collapse which severely shook public's faith in banks, federal government decided to establish an independent, central and autonomous treasury system instead of creating a new federal bank.25 However, the new institution did not get the chance to prove its stabilizing effects over the U.S. economy. Following the banking crisis of 1857, the combined effects of the weak financial situation of the govemment, the war circumstances and the resulting concems regarding inconvertibility of bank notes led to a new wave of panic in 1861.26 The stability of the U.S economy was totally shaken and private-issue currencies were flourishing, thus undermining the credibility of government issued currency.
20 Ibid. 21 This same year also marked the creation of the first thrift institutions in the United States. 22 Pierce, supra note 19 at 36. 23 Ibid. 24 Pierce, supra note 19 at 37. 25 Ibid. (noting that "the U.S. Treasury had to hold aIl its funds in its own vaults in gold and silver", aIl payments to and from the Treasury being made in coins). 26 Pierce, supra note 19 at 38.
7 In the context of these crises, which left the U.S. banking and financial system in complete disarray, Congress passed the National Currency Act of 1863, also known as the National Banking Act.27 Described as "the first federal initiative of lasting consequence" in the banking sphere, this Act created the Office of the Comptroller of the Currency, within the structure of the U.S Treasury. The Act empowered this new authority to supervise the issue and regulation of a national currency secured by United States bonds.28 The National Banking Act permitted individuals to pursue the business of banking under federal charters, thus being the first federallaw to authorize individuals to incorporate banks?9 In effect, prior to 1863, a bank could only be established under state laws through charters that conferred on associations power to exercise the traditional bank powers of accepting deposits and lending money.30 Under the new system of federally chartered banks, the National Banking Act empowered the Comptroller to charter, supervise and regulate national institutions that were entitled to do banking.31 Although the Act profoundly designed the foundations ofbanking regulation and constituted a great step toward more safety and soundness for the country's banking industry, it nonetheless did not bring any clarification as to the definition of the business of banking. Congress only addressed the questions of banking powers through an incidental powers clause which stated, in a very broad manner, that banks had "such incidental powers as necessary to carry on the business ofbanking,,?2 Since banks were then still mostly doing traditional banking business, by receiving deposits and granting loans, Congress assumed that there were not many modem activities that needed to be regulated on top of these two well-established functions.
27 National Currency Act, 13 Stat. 99 (1863). Congress then adopted the National Banking Act, in 1864, National Banking Act, 12 Stat. 665 (1864) (codified as amended in scattered sections of 12 U.S.c. (1982)). 28 Sarkis Joseph Khoury, u.s. Banking and Its Regulation in the Po/itical Context (Lanham-New York Oxford: University Press of America, 1997), at 25-26 [hereinafter Khoury]. The second important federal intervention was the enactment of the Federal Reserve Act in 1913. It established a central bank empowered with strong monetary competencies, which could act as a lender of last resort to banks in order to provide with more safety for the economy. To ensure the efficiency of the mission of the Federal reserve Board, it was decided that aIl of national banks would join this new system and would have keep deposits on reserve. 29 See National Bank Act, ch. 106, § 8,13 Stat. 99,101-02 (1864) (codified as amended at 12 U.S.c. 8 (1982)). 30 See Carol Conjura, "Independent Bankers Association v. Conover: Nonbank Banks are not in the Business ofBanking" (1986) 35 Am. U.L. Rev. 429 at 433-434 [hereinafter Conover]. 31 Supra note 29. 32 In section 24 (seventh) of the National Banking Act. See supra note 29.
8 As the lawmakers had been deficient in defining precisely the boundaries of bank's prerogatives in 1864, U.S. banks started to use the incidental powers clause as a way to embrace nontraditional banking activities. In reality, no formallaw proscribed at this time a commercial bank from engaging in securities activities.33 Courts, and also regulators, hence intervened in the following years to precise the scope of banking powers. They notably rendered decisions and issued rules that prohibited banks from making mortgage loans or dealing in corporate stock.34 Becoming partner in a commercial activity with unlimited liability or operating a business was also prohibited "under any circumstances".35 In particular, the Supreme Court rendered several decisions that banned banks from engaging directly in securities activities.36
2.2 How it Ail Started: Banks' Pressure to extend their activities, the Crash and the Legal Response
2.2.1 A First Extension: Bank Affiliates and Bank Holding Companies
The real change in U.S. bank's activities occurred soon, when many commercial banks started, indirectly, to carry on investment banking. 37 In effect, securities markets were
33 See Jennifer Manvell Jeannot, "An International perspective on Dornestic Banking reforrn" (1999) 14 Am. U. Int'l L. Rev. 1715, at note 30 (reporting that in the evolution of commercial and investment banking activities in the United States although there was no statutory prohibition, judicial decisions effectively prohibited the intermingling of the two industries) [hereinafter International Perspective]. 34 See generally "Power of National Banks to Acquire Various Kinds ofProperty" (1920) Harvard Law Review 33, No. 5, 718-721. See especially Gress v. The Village ofFort Loramie, 125 N.E. 112 (Ohio) (stating that national banks' power to acquire real estate is strictly limited"); California Bank v. Kennedy, 167 U.S. 362 (1897) (asserting that "it is clear. .. that a national bank does not possess the power to deal in stocks], National Bank v. Hawkins, 174 U.S. 364 (1899); Barron v. McKinnon, 196 Fed. 933 (1912) (repeating that banks are "prohibited from purchasing stock as an investment, nor to deal in the same"). 35 See Merchants' Nat. Bank v. Wehrmann, 202 U.S. 295 (1906) (prohibiting banks from becoming "the absolute owner of certificates representing an interest in a partnership", by which they would incur the partner's risk ofunlimited 1iability). See Cockrill v. Abe/es, 86 Fed. 505 (1898) (holding that it is beyond the power of national banks to "engage directly in a rnanufacturing or business enterprise under any circumstances"). 36 See e.g. California Bank v. Kennedy, supra note 34 (holding that national banks may neither purchase nor subscribe to stock of another corporation); National Bank v. Case, 99 U.S. 628, 633 (1878) (holding that national banks may be held liable for stock owned in another bank by saying that "on default in the payment of the loan the pledge bank became the owner of the stock, and upon the failure of the bank whose stock was held, became liable as a stockholder"). 37 See generally Randall S. Kroszner, "The Evolution of Univers al Banking and its Regulation(s) in Twentieth Century America", in Anthony Saunders and Ingo Walter, Universal Banking, Financial System
9 booming in the 1920s and business es shifted consequently from traditionalloans offered by banks to new sources of financing offered by stock markets. As they felt that they had to respond to this new environment from which they had remained exc1uded so far, banks started to underwrite, distribute and hold securities.38 Banks primarily used two types of corporate organizational structures in order to obtain new opportunities.39 In effect, the creation of securities affiliates as well as holding companies permitted the entrance of banks in the securities sector, constituting the first massive exploitation of a loophole in the existing legislation by banks. In reality, these early affiliations between investment and commercial banking mark the first era for universal banking in the United States. As it has been noted, When the Comptroller of the Currency informed banks, as early as 1903, that they were not permitted to purchase or deal in corporate stock, sorne organized securities affiliates, principally owned pro rata by bank stockholders and controlled by bank management. The early affiliates were organized under state banking laws, but later ones were simply incorporated and thereby, permitted to engage in almost any kind ofbusiness.4o
Rence, large national banks were circumventing traditional restrictions on security activities by performing these activities through newly created state-chartered affiliates. Major institutions such as First National Bank of New York or J.P. Morgan & Co managed to invest in stocks, securities or even real estate, through the use of such affiliates, although this was not expressly allowed by the National Banking Act of 1864. Simultaneously, commercial banks used an alternative way of expanding their activities within the securities business, namely through the creation of bank holding compames. In 1927, the trend that consisted in pushing banks to the securities sector was greatly encouraged by the enactment of the McFadden Act, as commercial banks chartered by
Redesigned (Chicago-London-Singapore: Irwin Professional Publishing, 1996) at 70-80 [hereinafter Kroszner]. 38 Ibid. at 70. 39 Kroszner, supra note 37 at 77. 40 Ibid. note 6: F. Redlich, The Mo/ding ofAmerican Banking, Vols. 1 and II. (New York: Johnson Reprint Corp, 1968) (reporting that George Baker, Chairman of the Board of First National Bank of New York, testified in 1913 that the first Security Company was organized "for doing business that was not specially authorized by the banking act. We held sorne securities that in the early days were considered perfectly proper, but under sorne later decisions of the courts the holding ofbank stock or other stock was prohibited; at any rate the comptroller prohibited it"). See U.S. House, 1913, Hearings, 1424, 1432.
10 federal government were finally explicitly authorized to conduct securities activities.41 The Comptroller of the Currency, who had been empowered to define the scope of the authorization, permitted banks to underwrite aIl debt securities and moreover allowed their affiliates to underwrite both debt and equity securities.42 Over the first two decades of the nineteenth century, large conglomerates had been constituted throughout the country, combining interests in most financial sectors and controlling companies engaged in business es as diverse as insurance, real estate, gas, oil or construction. The use of both structure of affiliates and holding companies had allowed U.S. national and state chartered banks to overcome very largely the existing limitations that Congress, courts and regulators had successively been imposing on them. Meanwhile, banks also started to be heavily involved in real estate loans, accompanying the real estate as weIl as the stock market speculation that characterized the 1920s with grave consequence.43 The use of distinct and separate entities in order to engage indirectly in unauthorized businesses seemed to be unstoppable. It seemed to be so at least because -except in case of a crash that would then affect the economy in a global way- asking banks to dive st themselves of their various interests could have caused large failures and thus posed a serious risk for the whole financial system.
2.2.2 The Legislative Response: The Giass-Steagall Act of 1933 and the Separation of Commercial from Investment Banking
The great expansion of U.S. bank's powers ended disastrously with the stock market crash of October 1929 and the unprecedented depression that followed. Interestingly enough, banks nonetheless proved relatively sound in 1929 due to loans provided by the Federal Reserve Bank of New York and other stabilizing measures, whereas in the
41 The McFadden Act was finally repealed in 1994. 42 ln effect, section 2(b) of the McFadden Act implicitly allowed national banks to conduct investment activities under the authority of the Comptroller of the Currency. See Future, supra note 16 at 79. 43 It is instructive to note that such a dual involvement ofbanks in real estate as weIl as in the securities business has been perceived as the main reason why Japanese banks have faced the large st crisis in their history, in the 1990s. Indeed, no alternative was offered to them because ofthis double exposure to both markets, and imprudent and risky lending policies.
11 meantime sorne other sectors were almost completely ruined.44 In fact, banking crises occurred in three different waves, between 1930 and 1933, which constituted the year when the most serious point was reached. During 1930, more than 1,350 failures occurred in the US. banking sector. For 1931, 2,300 banks went down. In 1932, although the financial system seemed to get stronger, 1,450 banks ceased operations. FinalIy, sorne 4,000 banks closures among American banks took place in the terrible year 1933.45 From 1930 to 1933, around 10,000 banks tàiled in the United States: there were just a little more than 14,000 banks at the end of 1933.46 AlI types ofbanks were affected by the great depression, proving that both federal and state regulators proved to be unsuccessful in their efforts to provide proper safety and soundness to the U.S economy.47 Although there had been panics in the previous decades, confidence in the heart of the United States economic system had never been undermined in such a violent way. As part of the New Deal proposed to the American nation, newly elected President Roosevelt decided to break with liberal policies and the laissez-faire state. He wanted strong interventionism in private business affairs from a national govemment that would guarantee economic stability. President Roosevelt profoundly wanted amongst other things to reform the nation's financial system. However, the immediate priority for the new majority was to restore public confidence, so that closed banks and businesses could be reopened. In 1932, Congress enacted the Emergency Banking Act, which organized the reopening of solvent banks and the liquidation of the insolvent ones. Public trust was reassured. The next step was to redesign thoroughly the U.S. financial and banking framework. A year later, in an historic effort to make a clean break with previous laws, Congress decided to abandon regulation for prohibition, and enacted the Banking Act of 1933, commonly called the Giass-Steagall Act after the names of its congressional fathers, Senator Carter Glass and Congressman Henry Steagal1.48
44 Pierce, supra note 19 at 43. 45 Ibid. 46 Origins, infra note 48 at 34. 47 Ibid. 48 The Glass-Steagall Act commonly refers to sections 16,20,21, and 32 of the Banking Act of June 16, 1933, ch. 89,48 Stat. 162 (codified as amended in scattered sections of 12 U.S.C.) (partially repealed in 1999). See Helen A. Garten, "Regulatory GrowingPains: A Perspective on Bank Regulation in a Deregulatory Age" (1989) 57 Fordham L. Rev. 501, 510 (for a history of the Glass-Steagall Act) [hereinafter Regulatory]. See also George J. Benston, "The Origins of and Justification for the Glass-
12 The lawmakers of 1933 considered that U.S. commercial banks had helped fuel the stock market speculation, and thus had led to the 1929 crash, by improperly carrying on securities activities. Bankers were perceived as having speculated in stocks with depositors' funds, as having underwritten equities to help corporate borrowers, or as having been involved in conflicts of interest.49 In order to foster bank soundness, Congress' primary aim was to prevent the emergence of the "subtle hazards" resulting from the commingling of investment and commercial banks and which had been stigmatized duringthe congressional hearings on banking reform of 1933.50 The Glass Steagall Act thus separated the investment banking and commercial banking industries through solid legal barriers, which lied on four key provisions. 51 Sections 16 and 21 prevented commercial and investment banks from interceding upon each other's business, prohibiting national and state member banks from engaging in the securities business, and banning securities firms from commercial banking activities like the business of deposit-taking. Sections 20 and 32 moreover imposed limits on affiliations between commercial and investment banks. Section 32 proscribed employees, officers or directors from combining positions in commercial and in investment banks. Section 20 regulated affiliations between firms participating in commercial as weIl as investment banking. Although banks had been insulated from underwriting, dealing and brokering securities, whether directly or through their fast-growing affiliates, the new system was not perfectly impervious. First, Bank Holding Companies were not originally inc1uded within the definition of bank and banking "affiliate", so that it remained possible for commercial banks to indirectly undertake investment activities through the creation of such structures. 52 Furthermore, the Act explicitly did not apply to bank holding companies that owned only state non-member banks.53 Since bank holding companies' activities were not limited by the Glass-Steagall Act, banks increasingly created such
Steagall Act", at 31-65, in Anthony Saunders and Ingo Walter, Universal Banking, Financial System Redesigned (Chicago-London-Singapore: Irwin Professional Publishing, 1996) [hereinafter Origins]. 49 Origins, supra note 48 at 34-47. 50 International Perspective, supra note 33 at note 49. 51 With the National Banking Act of 1933, and in order to promote bank soundness, Congress also established the Federal Deposit insurance Corporation (commonly called FDIC), aimed at providing federal deposit insurance to banks. 52 Conover, supra note 30 at 72. 53 Conover, supra note 30 at 73.
13 entities to purchase commercial banks as well as investment banks, thus ultimately circumventing the existing limitations.54 As they has already done it in the past, banks yet again exploited loopholes in the legislation and thereby pushed Congress and regulators, ignoring extremely serious risks.
2.3 More Pressure from Banks, Other Responses
2.3.1 The Bank Holding Company Act of 1956
In response to the growth of these new entities and in order to close a major loophole in the Glass-Steagall provisions, Congress enacted the Bank Holding Company Act of 1956. 55 The Bank Holding Company Act required Bank Holding Companies, defined as organizations that controlled two or more banks, to dive st themselves of non-banking interests. Moreover, it generally prohibited such entities from acquiring direct or indirect control over a company that is not a bank. However, the Bank Holding Company Act qualified this general rule with multiple exceptions. Under section 4 (c) (8) of the Act particularly, the Federal Reserve Board was empowered to allow a Bank Holding Company to acquire a non-banking company if its activities were "so closely related to the business of banking or managing or controlling banks as to be a proper incident thereto". As a matter of fact, just as large banks had already circumvented existing limitations by owning state-chartered affiliates in the 1900s or by creating Bank Holding Companies fi ftY years later, they tried once again in the 1960s to make inroads in the securities business by converting themselves into one-bank holdings. 56
54 International Perspective, supra note 33 at note 1. 55 The Bank Holding Company Act of 1956, Pub. L. No. 84-511,70 Stat. 133 (1956) (codified as amended at 12 U.S.C. 1841-1850). 56 Future, supra note 16 at note 16.
14 2.3.2 The Bank Holding Company Act Amendments of 1970
In effect, during the 1960s, the exemption of one-bank holding companies caused a dramatic increase in the number of commercial enterprises which purchased one bank with the exclusive purpose ofremaining exempt from the limitations of the 1956 Act. Yet though sorne commercial giants such as W.R Grace and R.H. Macy took advantage of this exemption, notably in order to provide with financial services to their employees, one-bank holding companies were usually small firms that controlled equally small banks. 57 Criticisms of the abundant conversions into one-bank holding companies commonly claimed that this option constituted a dangerous concentration of banking and commerce
as economic and financial interests were colliding altogether. 58 Congress reacted to this conceming evolution by enacting the Bank Holding Company Act Amendments of 1970.59 The most important amendment brought in 1970 was the " extension of the scope of the Act in order to include one-bank holding companies. Congress granted to the Federal Reserve Board the competence to expand the li st of permissible non-banking activities. The Board was hence empowered to authorize activities that were "closely related to banking or managing or controlling banks". In exercising its approbation powers, the Board must apply a "public interest test". Based on this test, the Board thus was to determine whether the proposed new activity or proposed acquisition "can reasonably be expected to pro duce benefits to the public, such as greater convenience, increased competition, or gains in efficiency, that outweigh possible adverse effects, such as undue concentration of resources, decreased or unfair competition, conflicts ofinterest, or unsound banking practices".60
Within the Bank Holding Company framework, the Federal Reserve Board had largely expanded the list of non-bank permissible activities. Since 1970, the scope of securities
57 Ibid. 58 Future, supra note 16 at note 17. 59 Bank Holding Company Act Amendments of 1970, Pub. L. No. 91-607, 84 Stat. 1760, 1766-67 (codified as amended at 12 U.S.C. (1988)). 60 See "Bank Holding Company Nonbanking Activities - Lending", Iowa Banking Review (March 1996), online: Iowa Division of Banking (IDOB):
15 activities permitted to commercial banks has also been critically broadened due to favorable court rulings. Congress also brought its contribution to the expansion ofbanks' activities in the securities and insurance businesses. It is worth nothing that securities activities of commercial banks also expanded due to lenient interpretations of the Glass Steagall Act by the Office of the Comptroller of the Currency.6l Last but not least, in 1987, Federal Reserve Chairman Alan Greenspan started promulgating several orders permitting bank holding companies to have "Section 20" subsidiaries. In reality, this last possibility merely allowed banks to underwrite and trade in securities.62
2.3.3 The Decisive Break-down of Legal Barriers: the Creation ofCitigroup
In 1998, the Federal Reserve Board critically accelerated the existing wave of consolidation in the financial industry by approving a merger between Citicorp -an enormous bank- and Travelers- an insurance giant. 63 Before the Board's authorization, Travelers had nevertheless already tumed into a bank holding company and purchased Citicorp. The merger resulted in a global financial institution, Citigroup, which combined Citicorp's banking services, Travelers and Primerica's insurance business, and Salomon Smith Bamey's brokerage firm. 64 Rence, it gave Citigroup the possibility of cross-selling products to its customers. Travelers could for instance offer life or home insurance to Citicorp cardholders and branch customers while Citicorp could offer student loans and other banking facilities to Travelers clients or sell mortgage loans to Salomon Smith
61 International Perspective, supra note 33 at note 75 [J. Norton & Christopher D. Olive, "Globalization of Financial Risks and International Supervision of Banks and Securities Finns: Lessons from the Barings Debac1e" (1996) 30 Int'l Law. 301, 305-23, at 277 (observing that the Office of the Comptroller of the Currency's liberal interpretation ofwhat constitutes the business ofbanking enables national banks to engage in expanded securities activities). 62 See generally R. Nicholas Rodelli, "The New Operating Standards for Section 20 Subsidiaries: The Federal Reserve Board's Prudent March toward Financial Services Modernization" (1998) 2 NC Banking Inst. 311. Section 20 subsidiaries have been defined as investment banking [UffiS that "engage in activities associated with securities underwriting, making a market in securities, and arranging mergers, acquisitions and restructuring .... Investment banking also inc1udes the services ofbrokers or dealers in secondary market transactions"; See also James R. Smoot, "Bank Operating Subsidiaries: Free at Last or More of the Same?" (1997) 46 Depaul L. Rev. 651, 657 n. 24. 63 Controlling, supra note 2 at 3. 64 See Marcia Vickers, "Citigroup Boosts Financial Modernization on Wall Street" Business Week (1 May 1998); See also Jaret Seiberg, "Fed Expected to Act Soon on Citigroup Deal Approval" American Banker (18 August 1998) [hereinafter Seiberg].
16 Barney clients. 65 The terms of the approval provided that the merger remained subject to existing laws and that if appropriate financial services legislation did not pass, Citigroup would have to dive st itself of sorne of its activities.66 However, under the Bank Holding Company Act of 1956, companies resulting from banks mergers with securities or insurance activities were given two years to divest themselves of the prohibited lines of business.67 Furthermore, in this specifie case, the Fed used its discretionary power of aIlowing banks to take up to three additional years to complete divestitures that may be required. As a matter of fact, based on an exemption in Section 4(a) (2) of the Bank Holding Company Act, Citigroup was permitted to offer securities and insurance services for a period of five years without having to divest itself of any of its activities before this term. With more than 100 million customers in 100 countries, as weIl as $ 750 billion in assets under management, Citigroup became the world's largest financial services organization.68 Besides, Citigroup became the first modem U.S. "universal bank": it was the first time in 65 years that an American banking organization could embrace simultaneously the banking, securities and insurance businesses.69 However, the decision of the Federal Reserve Board was highly controversial and heavily criticized, since the merger resulted in a conglomerate of an unprecedented size and influence which raised unique concerns. Moreover, it is worth noting that even if the agreement was assorted with precise conditions, the Federal Reserve board in reality approved the merger between Citicorp and Travelers although such a decision was not undisputedly justifiable by existing mIes.
65 See Seiberg, ibid. 66 See "Citigroup: Historic Barriers Erode" Ins. Reg. (28 September 1998). For instance, Citigroup would eventually have to sell Travelers' insurance underwriting. The Fed stated that the securities and insurance activities conducted by Citigroup had, anyway, to represent 1ess than fifteen percent of the company's total assets and less than twenty percent of its revenues 67 See Susan Sirota Gaetano, "An Overview of Financial Services Reform" (1998) 5 Conn. Ins. L.J. 793 [hereinafter Sirota Gaetano]. 68 In fact, at the end of2001, Mizuho Holdings of Japan moved ahead ofCitigroup as the world's large st banking organization in terrns of as sets (with $1.3 trillion of assets, compared to $1.05 trillion for Citigroup). However, in rnid-2002, Citigroup remained far ahead of all other global banks based on its market capitalization. See "The Business Week Globa11000" Business Week (15 July 2002) at 62. 69 Controlling, supra note 2 at 4.
17 As Arthur Wilmarth noted, The proposaI "challenged both the statutory letter and regulatory spirit" of existing law ... (as) "Congress had not yet acted on pending financial modemization bills". From a political perspective, Citigroup's leaders "boldly gambled that they [could] dragoon Congress ... into legalizing their transformation" before the exemption period expired.70
A year after the Federal Reserve Board approved the merger, Congress passed the Gramm-Leach-Bliley Act and thereby actually ratified the existence of Citigroup. The Citigroup episode raises serious concems about the political influence enjoyed by such a giant, and by financial conglomerates in general, both toward regulators and the legislator. 71 -This "landmark event" constituted anultimate attempt, of an unprecedented magnitude, to push Congress to adopt new legislation in order to serve the banking industry' s interests. The creation of Citigroup also triggers troubling questions about the relations among banking authorities in the United States. Indeed, this episode shed light on how the Federal Reserve Board has been intensely pushing and influencing Congress by approving an enormous and symbolic merger. In effect, it seems that Congress did not really have the choice of refusing to pass the reform bill, as doing so would have caused potential collapse or at least serious damage to a huge financial player, with great associated risks for the whole U.S. economy. In fact, this merger undermined the very significance of legislation in banking matters: though a reform by means of law was necessary or desirable for sorne, it appears that the market, by itself, was able to accomplish the result without a public legal intervention. Thus with the enactment of the Gramm-Leach-Bliley Act in November 1999, Congress considerably changed the framework of the U.S banking industry.72 Gramm-
70 Transformation, supra note 4 at 221. See also Edward J. Kane, "Implications of Superhero Metaphors for the Issue ofBanking Powers" (1999) 23 J. Banking & Fin.; Dean Anason, "Advocates, Skeptics Face Off on Megadeals" American Banker, Apr. 30, 1998, at 2 (reporting that Citigroup's formation "was widely seen as a bid to push lawmakers to enact a sweeping overhaul offmanciallaws", and quoting Rep. Maurice D. Hinchey's statement that Citigroup was "essentially playing an expensive game of chicken with Congress"). 71 Transformation, supra note 4 at 221. See also Khoury, supra note 28 at 111-145 and 163-250 [about the influence oflobbying over the legislative process in banking matters]; Sirota Gaetano, supra note 67 at 812 (stating that (the Citicorp-Travelers merger) "exemplifies the manner in which CUITent laws can be manipulated in an attempt to keep pace with the rapidly advancing marketplace"). 72 Gramm-Leach-Bliley Financial Services Modernization Act, Pub. L. No. 106-102, 113 Stat. 1338 (1999) (codified in scattered sections of 12, 15 & 19 V.S.C). About the GLB Act, see supra note 9.
18 Leach-Bliley repealed the Giass-Steagall Act of 1933 and removed barriers that insulated banks from non-bank entities such as securities firms and insurance companies. Yet in earlier decades, commercial and investments banks had been aggressively pushing aside the existing restrictions, helped by favorable Court decisions and lenient regulators, as exemplified by the Citicorp-Travelers' merger. Thus, as noted by Professor Jonathan R. Macey, " ... the Giass-Steagall Act was already a dead letter when Gramm Leach-Bliley was passed. AlI the Act did was to formalize the death.',73 Despite this moderation of the consequences of Gramm-Leach-Bliley, this Act nonetheless bears a strong symbolic value, as it constitutes the ultimate legal intervention on a long-debated fundamental question. Furthermore, the Act undeniably enhanced the consolidation trend in the financial sector. Indeed, within one year after its enactment, two rival huge Swiss banks, UBS and Credit Suisse acquired U.S. securities firms, namely Paine W ebber and Donaldson, Lufkin & J enrette. 74 Another large foreign bank, Netherlands based ING, acquired ReliaStar, a major U.S. insurance company, and investment firm Charles Schwab and insurance giant MetLife both purchased banks. 75
73 Supra note 10. 74 Transformation, supra note 4 at 223 note 22. 75 Ibid.
19 Conclusion
From the earliest times of banking in the United States, the same cycle of events has kept recurring. This play with two main characters, Congress and banking firms, keeps repeating itse1f. On the one hand, legislators have always imposed limits on banks, either with respect to their permitted activities specifically, or to the range in which these activities could be carried out. Although these restrictions may have various justifications, they are usually ultimately intended to promote more safety and soundness for banks and for the whole economy in general. On the other hand, financial institutions have always been pressing against limitations, by progressively overcoming the existing legal limits set by Congress. These actions, aimed at satisfying their own interests, have always been possible, in the past two centuries, owing to indulgent laws and accommodating regulators. In the end, U.S. banks have always been pushing both the legislator and federal regulators in order to have their interests satisfied, through the exploitation of loopholes in the rules or by acting in an outrightly illegal manner. Sooner or later, Congress has always ratified these factual evolutions. Then, after serious economic contraction, Congress has in response adopted strict legislation, reestablishing limits that were even more formidable than before their suppression, thus holding banks responsible for the crises. Finally, it would seem that market forces offer strong resistance to any type of legal barriers, whether these limits, which are often dictated by needs for economic stability and soundness, apply to the geographical reach of large banks or to the business lines that they can embrace. In this cyclical framework, Gramm-Leach-Bliley Act of 1999 hence appears as the most important legislative intervention of the 20th century in the American banking sector, next to the Glass-Steagall Act of 1933.
20 PART III
"UNIVERSAL BANKING" IN THE UNITED STATES: THE AMERICAN MODEL
This part seeks to discuss issues related to the notion of universal banking. It also addresses questions dealing with the variety of corporate structures that can be taken by univers al banking organizations. It particularly assessing and comparing the position of the American model with other possible structures. Relevant facts encountered in other systems will therefore be presented in order to apply elements or solutions to the American case. First, the Gramm-Leach-Bliley Act of 1999, which has modified the U.S. banking system, will be analyzed. Moreover, the main features of the banking "model" introduced in the United States by the Gramm-Leach-Bliley Act will be discussed. Finally, other forms of universal banking from countries such as Germany or Switzerland, which are usually regarded as nations of many of the largest and strongest banking organizations, will be briefly presented.
3.1 The Gramm-Leach-Bliley Act of 1999
3.1.1 Overview
The Gramm-Leach-Bliley Financial Modemization Act of 1999 (the Act) removes longstanding previous activity limits for U.S. banks, by allowing "financial holding companies" and "financial subsidiaries" to embrace all three sectors of the financial world: banking, dealing in securities and offering insurance.76 Moreover, the Act empowers the Board of Govemors of the Federal Reserve System, in consultation with the Secretary of the Treasury, to expand the list of permitted activities with new ones, if the new activities are "financial in nature or incidental to a financial activity". Interestingly enough, the Act does not authorize the still very controversial mixing of
76 Future, supra note 16 at 77.
21 banking and commerce. This boundary thus avoids the introduction in the United States of "real" universal banks as they have long existed in Germany for example or in other countries of Europe. Gramm-Leach-Bliley nonetheless permits Financial Holding Companies to enter into sorne commercial activities if considered by the Board as "complementary to financial activities".77 The main purpose of the 1999 Act is to foster competition within the financial industry by suppressing the longstanding barriers that insulated banks, securities firms and insurance services providers in the United States. As stated by Congressman James A. Leach in an address to the Symposium "Future of Law and Financial services" held at Fordham University School of Law in 2001, the legislative approach we took was that of a three-way street. That is, banks were given securities and insurance powers. Insurance companies were given banking and securities powers and securities companies were given banking and insurance powers. The approach taken was a very competitive approach that l believe is good for consumers and America's financial position in the world. By allowing each of the American companies to offer a wider variety of products, l think we are going to see America's position in financial services become much stronger. This is important because sorne of our European competitors have broader rights; but it is also important in and ofitself.78
The Gramm-Leach-Bliley Act constitutes a fundamental step since it ends a period of more than sixty years of restrictive regulation and two decades of intense debate about a potential reform of the U.S. financial industry. In effect, several proposaIs for reforming the financial sector by eliminating existing restrictions had been raised under the Reagan and Bush administrations particularly, but also afterwards. 79 Accordingly, the repeal of the Glass-Steagall Act is a major feature of the symbolic change embodied by this Act. However, the future of banking in the United States might be determined -or at least affected- even more by the Federal Reserve Board's use of its new powers in determining what the permissible banking activities are.
77 Ibid. 78 Hon. James A. Leach, "Keynote address" (2001) 6 Fordham J. Corp. & Fin. L. 9], at 12 [hereinafter Keynote). 79 See Bernard Shull, "Financial Modernization Legislation in the United States, Background and implications" (October 2000), UNCTAD discussion paper no 151 at 7, online: UNCTAD
22 Though the Act is divided into seven titles, most of the provisions dealing with the new activities allowed to financial holding companies and financial subsidiaries are contained in title 1. The redesigned affiliation of banks, insurance companies and securities firms is analyzed hereafter.
3.1.2 Repeal of Glass-Steagall Act Provisions
The legal barriers erected by the Glass-Steagall Act were based on four crucial provisions. The Gramm-Leach-Bliley Act repeals two of them. It repeals section 20, which prohibited banks from owning affiliates principally engaged in dealing in securities. 80 It also repeals section 32, which prevented securities firms and commercial banks from sharing staff, directors and officers. 81 However, the Act leaves unimpaired the two other provisions from 1933. In effect, Gramm-Leach-Bli1ey Act does not repeal section 16, which prohibits banks from selling, dealing in and underwriting securities.82 Neither does it suppress section 21, which bans securities firms from traditional commercial banking activities such as deposit-taking. As a matter of fact, there is still no direct integration of the securities business into a banking entity itself. Indeed, Congress rather chose to permit banks to exercise firiancial activities through distinct corporate entities like separate affiliates of holding companies or banks' subsidiaries. 83
3.1.3 What are the New Activities?
3.1.3.1 Amendments to the Bank Holding Company Act of 1956
Gramm-Leach-Bli1ey amends Section 4 of the Bank Holding Company Act by adding a series of new subsections which allow a set of new activities. In effect, under a new section 4(k) added to section 4(c) 8 of the 1956 Act, bank holding companies which qualify can tum into "financial holding companies", thus being given the possibility to
80 Title 1, section 101 of the Act. 81 Ibid. 82 With the exception of sorne specified securities, such as type C obligations of the Federal government and general obligations of states and political subdivisions 83 Title 1, section 102 of the Act.
23 engage in a wider range of activities. 84 The new activities permitted by the Act in its Title 1 deal with the insurance or securities business, but also with merchant banking. Moreover, financial holding companies are allowed to engage in activities defined by the Board as "financial in nature or incidental to a financial activity" or "complementary" to financial activities. This constitutes a very important provision. The li st of financial activities contained in section 4(k) inc1udes "lending, exchanging, transferring, investing for others, or safeguarding money or securities, insuring, guaranteeing, or indemnifying against loss, harm, damage, illness, disability, or death, or providing and issuing annuities, and acting as principal, agent, or broker for purposes of the foregoing in any State." These activities also inc1ude "providing any device or other instrumentality for transferring money or other financial assets" and "arranging, effecting, or facilitating financial transactions for the account of third parties." Generally speaking, the new list of permissible activities inc1udes securities underwriting, any activity that would have been considered permissible by the Board under section 4( c) (8), merchant banking, insurance company portfolio investments and also health insurance. 85 Activities undertaken abroad are also concemed since section 103 of Gramm-Leach-Bliley considers as "financial in nature" activities that a bank holding company may embrace outside of the United States and that the Board has determined under section 4(c) (13) as being "usual" in connection with the business ofbanking abroad. Finally, it is worth noting that section 4(k) (H) allows insurance compames and securities firms to have equity stakes in businesses which are engaged in "commercial activities" that the Act still does not authorize to carry on themselves. In effect, the Act permits financial holding companies to acquire or control entities engaged in any non authorized activity as long as the shares, assets or ownership are not acquired or held by a depository institution.
84 This new section 4(k) is added to Section 4 of the Bank Holding Company Act of 1956 and can be found in Title 1, section 103 of The Gramm-Leach-Bliley Act. 85 For a definition of the business of insurance, see Section 4(k)(4)(B) of the Act: "insuring, guaranteeing, or indemnifying against loss, harm, damage, illness, disability, or death, or providing and issuing annuities, and acting as principal, agent, or broker for purposes of the foregoing in any State".
24 3.1.3.2 The Regulatory Determinations of Newly Permitted Activities
The New "Financial in Nature or Incidental" Standard The Federal Reserve Board is responsible for determining the activities that are "financial in nature or incidental" to financial activities and that could thus be embraced by either financial holding companies or financial subsidiaries. The process of determination of the "financial in nature or incidental" criterion falls indeed under the Federal Reserve Board's competence, but with a consultation of the Treasury. In order to facilitate the interpretation of this new standard, the Gramm-Leach-Bliley Act provides with useful guidelines. ActuaIly, the Act enunciates four series of elements that the Federal Reserve Board and the Treasury must take into account when having to determine whether an activity is "financial in nature or incidental" or not. The regulators hence have to considet (A) the purposes of this Act (the Bank Holding Company Act) and the Gramm Leach-Bliley Act; (B) changes or reasonably expected changes in the marketplace in which banks compete; (C) changes or reasonably expected changes in the technology for delivering financial services; and finally
(D) whether such activity is necessaryor appropriate to allow a bank and the subsidiaries of a bank to- (i) compete effectively with any company seeking to provide financial services in the United States; (ii) efficiently deliver information and services that are financial in nature through the use of technological means, including any application necessary to prote ct the security or efficacy of systems for the transmission of data or financial transactions" and (iii) offer customers any available or emerging technological means for using financial services or for the document imaging of data. 86
Under these legislative guidelines, one can assert that the Federal Reserve Board and the Treasury seem to apply the "financial in nature or incidental" standard quite extensively in their proposaIs and rulings.87 In fact, two reasons may justify the use ofthis
86 Title l, section 103 of the Act. 87 See e.g., Board of Govemors of the Federal Reserve System, Proposed rule (31 July 2000), 12 CFR Part 225, Reg. Y; Docket No. R-1078 and Board of Govemors of the Federal Reserve System, Final rule (19 December 2000), 12 CFR Part 225, Reg. Y; Docket No. R-1078 (stating that acting as a "finder" to bring
25 new criterion in su ch profuse series of hypotheses. First of aH, the scope of the fonner "c1osely related to banking" standard does not exactly match the scope of the new one. In effect, the new standard is much wider than the previous one. As has been noted, "c1ose1y related" activities are a subset of those that are "financial in nature or incidental".88 Furthennore, the different agencies heavily rely on the legislative guidelines provided by the Act in order to justify their interpretations. As has been summarized, The methodology the Agencies have developed ( ... ) is step-wise and can be summarized as foHows: If the Activity is detennined to be "c1osely related to banking", it must faH within the set of activities that are "financial in nature or incidental". If it is not "c1osely related" but confonns to legislative guidelines (e.g., if it is "necessary or appropriate to aHow a financial holding company ... to compete effectively", it will be "financial in nature or incidenta1. 89
In reality, although the introduction of the "financial in nature or incidental standard" may seemingly greatly expand the scope of pennissible activities, there is no c1ear definition for such a standard.90 This lack of c1arity can result in various pitfaHs. Notably, the imprecision in the definition of the expression "financial in nature or incidental" generates serious legal insecurity for financial organizations dealing with concemed agencies. AIso, such a vague tenn gives to concemed agencies an extremely broad authority to decide which activities will fit into this standard or not. Ultimately, and as a consequence of this legal uncertainty, the safety and credibility of the whole financial and regulatory system may be undennined.
Complementary Activities As has already been pointed out, the Federal Reserve Board also bears the responsibility of detennining which activities are considered as "complementary". This third category which is added to "financial activities" and to "incidental activities" has to be fiHed by "commercial activities" that would be somehow re1ated to financial ones.9\ Rence, the Federal Reserve Board is empowered to detennine whether or not an activity together buyers and sellers of both financial and nonfinancial products is "incidental to a financial activity"). 88 Backgrounds and Implications, supra note 79 at 89. 89 Backgrounds and Implications, supra note 79 at 86. 90 Backgrounds and Implications, supra note 79 at 89 (reporting that "the term 'financial in nature or incidental to a financial activity', like the term 'c1osely related to banking', "has no c1ear meaning"). 91 Ibid. at 12.
26 undertaken by a financial holding company is "complementary" to a financial activity. It is worth noting that in the process of determining whether or not the activity assumes this characteristic, the Federal Reserve Board has to prove that the so-called "complementary 92 activities" pose no risk to the safety and soundness of the financial system .
Merchant Banking Activities Capacity to conduct merchant banking activities can be defined as the capacity for a bank or a bank holding company to have stakes through investments in stocks or assets in non-financial firms, and thus, at a certain point, take "control" of such entities. Though Gramm-Leach-Bliley legislation definitely modifies the previously existing line between banking and commerce, it still prec1udes a mixing of these two sectors. In effect, prior to 1999 and from a general point of view, banks and bank holding companies could not "control" companies that were engaged in non-financial, and hence non-permissible, activities. The Act allows financial holding companies to invest in any type of company engaged in any non-financial activity, without limitation conceming the amount of the stake he Id in the company. For these "merchant banking" investments, no limit of time is assigned to the investing entities, which can hence hold their commercial stakes for very long periods of time. However, in an unequivocal effort to withhold the integration of banking and commerce, Congress has refused to provide financial holding companies with the possibility of enjoying a day-to-day management of their merchant-banking investments, nor of operating them on a daily basis. In order to further define the rules goveming merchant baking activities and to implement additional measures to protect the line between banking and commerce, the Act has empowered the Federal Reserve Board and the Secretary of the Treasury to jointly issue regulations.93 A few months after the Act was passed, the two agencies announced an interim rule conceming merchant banking activities that could be undertaken by financial holding companies.94 This rule notab1y contains measures dealing with risk management practices, that is to say provisions aimed at limiting risks on banks' exposure through their merchant banking
92 Ibid. 93 Ibid. 94 See supra note 87 and Department of the Treasury, Bank Holding Companies and Change in Bank Control, Interim Rule and Proposed Rule (17 March 2000) 12 CFR Part 1500.
27 investments.95 It also prevents excessive connections of banks with their commercial stakes, by restricting interaffiliate transactions for instance.96
3.1.4 Which Structures for the New Financial Activities?
Financial holding companies constitute a redesigned kind of bank holding company through which new financial activities permitted by Gramm-Leach-Bliley can be undertaken. These activities can also be embraced, with sorne exceptions, however, through a "financial subsidiary" of a national or a state-chartered bank. 97
Financial Holding Companies In order to constitute a financial holding company, a bank holding company is required to meet various conditions. First, it has to notify the Federal Reserve Board ofits intent to adopt such a structure. Then, a bank holding company wishing to become a financial holding company has to meet various regulatory criteria. AlI of the bank's subsidiaries must be "well-capitalized" and "well-managed", and aIl insured depository institution subsidiaries must have a satisfactory or better Community Reinvestment Act rating on its most recent examination. This rule nonetheless constitutes a main shortcut in Congress' will to eliminate potential threats to the stability of the economy. Indeed, if a subsidiary of a bank does not get a satisfactory rating after receiving the Board's approval to tum it into a financial holding company, the financial holding company will then only be prohibited from engaging in new activities, while the activities already undertaken will remain without any compulsory divestiture or limitations.98 Being forced to divest itself ofbusinesses can be very harmful for a financial institution, as it may engender disruptive effects upon its operations. However, allowing a financial holding company wide financial powers to carry on activities that do not meet the regulatory requirements may aiso affect the safety and soundness of financiai organizations, but on an even larger scale.
95 Ibid. 96 Ibid. 97 See sections 121 and 122 of the Act. 98 Future, supra note 16 at 43.
28 Once all required conditions are met, financial holding companies can engage in all activities determined by the Board as being financial in nature, incidental or complimentary. More precise1y, a financial holding company can engage in any activity listed in Section 4(k) of Gramm-Leach-Bliley or in any other activity after approval by the Board. However, the Act does not require any prior notice from the financial holding company in order to engage in the newly permitted activity. In effect, notice must be given to the Board a posteriori only, within a period of 30 days after the beginning of the new activity or the acquisition of a new entity.
Financial Subsidiaries In 1996, the Office of the Comptroller of Currency adopted new rules permitting national banks to engage in a broad range of activities through operating subsidiary.99 Although these activities were not accessible to the bank itself, the subsidiary could engage in these businesses if they were determined by the Office of the Comptroller of
Currency as being "incidental" to "the business of banking". 100 Through the creation of "financial subsidiaries", which are a new type of operating subsidiaries, Gramm-Leach Bli1ey enlarges the scope of activities which can be undertaken indirectly by national or state-chartered banks, as they may greatly exceed the former deemed activities "incidental to the business ofbanking". However, the regime allowed to financial subsidiaries is not as extensive as the one corresponding to financial holding company and it contains sorne important restrictions. In reality, through financial subsidiaries, national banks do not have access to the same range of activities as they would through financial holding company. Insurance or annuity underwriting, insurance company portfolio investments, real estate investmertt or merchant banking constitute the main activities that cannot be undertaken by national banks. IOI Following previous recommendations of the Office of the Comptroller of Currency from 1996, and as is the case for financial holding companies, national banks willing to
99 Backgrounds and Implications, supra note 79 at 7. \00 Ibid. 101 Ibid. at note 22.
29 engage in new activities through financial subsidiaries also have to be well-managed, well-capitalized and have a satisfactory rating by the Community Reinvestment Act. Among other restrictions, Congress has decided, for instance, that the aggregate consolidated assets of aIl of a national bank' s financial subsidiaries cannot be greater than 45 per cent of the bank's consolidated assets, or $50 billion, whichever is less and that national banks that belong to the nation's top 100 largest banks must have long-term unsecured debt that is rated in one of the highest three investment grades. J02 In order to protect consumers' interests as weIl as to prevent risks for concemed national banks, Congress has decided to control financial transactions between national banks and their financial subsidiaries. It thus transposed sections 23A and 23B of the Federal Reserve Act, which originally sought to limit inter-affiliate transactions occurring between depository institutions and their affiliates. Section 23A aims at limiting credit extensions, advances, guarantees issued on behalf of an affiliate. Section 23B states that circumstances under which financial transactions between an insured bank and its affiliates are made must be at least as favorable to the bank as in comparable transactions that would occur with non-affiliated entities. Moreover, it is worth noting that Congress also decided to apply the anti-tying provisions of the Bank Holding Company Act to financial subsidiaries of national banks. Indeed, Congress enacted, in 1970, section 106 of the Bank Holding Company Act in order to prevent tying, reciprocal and exclusive dealing agreements that could be made into between depository institutions and their affiliates. J03 Finally, it is important to note that aIl of the new activities allowed to financial subsidiaries can also be undertaken by insured state-chartered banks, under the same conditions as national banks.
102 Backgrounds and Implications, supra note 79 at Il. 103 A tying agreement can be defined as an agreement by which Bank Holding Companies and their subsidiaries would offer an extension of credit, lease or sell property, or fumish services only under the condition that the customer may obtain sorne additional credit, property or service from the bank, its holding company or subsidiaries. Backgrounds and Implications, supra note 79 at 20.
30 3.1.5 Conclusion
By providing a redesigned framework for the affiliation of banks, securities firms and msurance companies, Gramm-Leach-Bliley represents a symbolic and substantial legislative initiative. It is worth noting that another important example of the liberalization trend affecting banking affairs had already occurred a few years before Gramm-Leach-Bliley was passed. Indeed, by enacting the Riegle-Neal Interstate Banking and Branching Efficiency Act in 1994, Congress repealed the McFadden Act of 1927 and thus caused the suppression of longstanding geographical limits that prevented national expansion for U.S. banks. 104 Since 1994, aIl fifty states have allowed banks to expand on an interstate basis by purchasing another bank. 105 These two landmark events can be seen jointly as the latest legal interventions that have, in a significant modemization effort, characterized the deregulation of the U.S. financial services industry. As a matter of fact, Congress has allowed financial players to enter into the twenty-first century within a liberalized, open environment, in order to permit a higher level of competition. Even so, several traditional American specificities remain in this modemized framework. After having analyzed what the Act has done, it is important to state, even briefly, what the Act has not done. In effect, the progress embodied by the adoption of Gramm-Leach-Bliley can be considered to be limited with respect to sorne crucial points or expected evolutions that it has not settled. Sorne of these remaining questions are the following. Although the 1999 Act slightly modifies the traditional segregation between banking and commerce, it still formally precludes the intermingling of these two sectors. The American system thus keeps it own specificity to that extent, while other countries like
104 Riegle-Neal Interstate Banking and Branching EjJiciency Act of 1994, Pub. L. No. 103-328, §§ 101-03, 108 Stat. 2338,2339-54. 105 See e.g. Testimony of Governor Mark W. OIson before the Subcommittee on Financial Institutions and Consumer Credit of the Committee on Financial Services, Financial Services Regulatory ReliefAct of2003, U.S. House of Representatives (27 March 27 2003) online: Federal reserve Board
31 Germany or Japan have long had a tradition ofmerging comprehensively commerce with banking. 106 Second, even after the modemization bill has been passed, the regulatory framework of the U.S. banking world still seems as complex and seemingly potentially unsafe as it used tO. 107 In effect, in the past decades, many criticisms have been directed toward the American banking regulatory structure for being broken up into too many different bodies. In the United States, according to the dual structure of the banking system (which constitutes one of its most prominent features), the banking sector is regulated at a federal level -for aIl nationally chartered banks and for state-chartered banks that are members of the Federal reserve System- and at astate level for state-chartered banks. 108 In addition to this, regulation at the sole federallevel belongs to several banking agencies. Three federal regulators share responsibility for banks. The Federal Reserve Board, which is independent, regulates state-chartered banks that are members of the Federal Reserve System, and also regulates companies which own banks, i.e. bank holding companies and, now, financial holding companies. The Office of the Comptroller of the Currency (OTC), which is part of the Department of the Treasury, regulates national banks. National banks usually correspond to the largest banks in the country. The Federal Deposit Insurance Corporation (FDIC), an independent agency, whose main function is to in sure deposits in almost all banks and savings associations (formerly savings and loans associations, also called "thrifts"), also regulates state-chartered banks that do not belong to the Federal Reserve System. The Office of Thrift Supervision (OTS), an agency of the Treasury Department, regulates savings associations. Things become more complicated under a holding company structure since under such a structure, the holding company is regulated by a certain body but the banks or banks are placed under the control of other regulators. As a matter of fact, the U.S. banking industry is subject to on an incredibly complex
\06 In Germany with financial-industrial alliances, and in Japan with "Keireitzu". \07 See Eilis Ferran, "Do Financial Supermarkets need Super Regulators? Examining the United Kingdom's Experience in Adopting the Single Financial Regulator Model." (2003) 28 Brooklyn J. Int'l L. 257 (discussing the case of the United Kingdom where a single regulator for the financial services sector has been created, the FSA). 108 See generally Arthur E. Wilmarth, Jr., "The expansion of state bank powers, the federal response, and the case for preserving the dual banking system" (1990) Fordham L. Rev. 1133 (about the role of states on the expansion ofbanking powers particularly).
32 regulatory framework. 109 The Gramm-Leach-Bliley Act has done little to c1arify the existing complexity of the situation. The only significant contribution was in fact that of the' introduction by the Act of "functional regulation" to banking matters. 110 This new approach nevertheless does not rea11y enhance cooperation between the agencies, nor does it reduce the potential risks of inefficiency of a regulatory system shared by too many agencles. Finally, Gramm-Leach-Bliley legislation does not really provide any remedy to the hazards inherent in the "too-big-to-fail" policy. In effect, by boosting bank's ability to grow faster and by facilitating cross-industry consolidation, the Act increases risks which can derive from the attitude of authorities toward financial giants.
3.2 Universal Banking?
3.2.1 Defining "Univers al Banking": Different Meanings, Different Forms
Many different approaches have been taken with respect to the consolidation trend that has occurred in the financial services industry of most developed countries. However, although expressions that are used to describe these considerable changes may vary, they refer to situations which have one common feature. Indeed, they are a11 related to the diversification strategy of commercial banks, securities firms and insurance companies, which is primarily aimed at cross-selling each other's products. 111 Various expedients can be used in order to achieve such objectives. As a matter of fact, in sorne cases there is a very high level of integration of products, marketing strategies, or even production and
109 See e.g., David S. Rolland, When Regulation Was Too Successful-the Sixth Decade of Deposit Insurance (Westport, Connecticut: Praeger Publishers, 1998) at xiii (stating that "the banking industry is not only one of the most pervasively regulated sectors of the economy; it is also subject to one of government's more complex regulatory schemes"). 110 See Backgrounds and Implications. supra note 79 at 13 (saying that "Functional regulation under the GLB me ans that, to the extent possible in financial holding companies, banking activities should be regulated by bank regulatory agencies, securities activities by the SEC, and insurance activities by state insurance commissioners"). III See L.A.A Van den Berghe and K. Verweire, Creating the Future with Al! Finance and Financial Conglomerates (Boston-Dordrecht-London: Kluwer Academic Publishers, 1998), at 5 [hereinafter Creating].
33 management processes. 112 In other cases financial institutions will do the strict minimum to enjoy expected benefits of diversification. Generally speaking, the trend consisting in the combination of more than one segments of the financial services industry, i.e. commercial banking, investment banking and insurance services, refers to the phenomenon of financial consolidation or "financial services integration". In this context, terms like bancassurance, assurfinance, alljinanz and "financial conglomerates" are used in order to reflect such an idea of combination. The French term bancassurance refers to the strategy of a bank to cross-sell insurance products. Assurfinance is used to characterize the opposite diversification strategy, whereby an insurance company cross-sells traditional financial products. Alljinanz or al! finance constitutes a somehow "more product and market oriented approach, whereby products produced in different factories are unbundled and rebundled to tailor them to the needs of specifie client segments in order to offer them an integrated personalized solution."I13 Large diversified organizations that have emerged these past years are mostly referred to as financial conglomerates. The term financial conglomerate is generally used to define a group of companies, operating under a single corporate umbrella, whose activity is exclusively or predominantly to offer services in at least two of the three main financial sectors. 114 According to this definition, a group of companies that would contain one or more financial institutions but which would be principally commercially or industrially oriented would not constitute a financial conglomerate. 115 Rather, such a composite organization is commonly defined as a mixed conglomerate. 116 In recent times, and mostly in Europe, "universal banking" has been widely but indiscriminately used to describe entities that were also referred to through expressions such as "conglomerate banking" or, in the business press, "financial supermarket".117 Yet to be accurate, universal banking ought to be used with a slightly more technical and
112 Ibid. 113 Ibid. 114 See "The Supervision of Financial Conglomerates," A Report by the Tripartite Group of Bank, Securities and Insurance Regulators (July 1995), online: Risk Institute or BIS
34 specific meaning than other expressions which have been used in similar contexts. In searching for a general definition of universal banking, it seems once again that there is no single unanimously accepted general definition of this notion. However, most authors define the univers al banking model in a similar way. For instance, univers al banking has been defined as "the ability of one organization to provide a full range of financial services, inc1uding the products of commercial banks, investment banks and insurance companies".118 Authors usually see this "full" range of financial services as comprising "deposit-taking and lending, trading of financial instruments and foreign exchange, underwriting of new debts and equity issues, brokerage, investment management and insurance".119 In an effort to sum up this rather functional approach, another definition qualifies universal banks as entities which "can perform a wide variety of financial services inc1uding taking deposits, making loans, underwriting securities issues, dealing in precious metals and collectible coins, and brokering real estate".120 In this paper, according to the definition we use, a universal bank constitutes a "single organization which can engage, either directly or indirectly, in aIl aspects of the banking, securities and life insurance businesses".121 It is important at this point to keep in mind that this last depiction remains general by nature, since it does not reflect the variety of categories of univers al banks which exist today.122 Indeed, as explained hereinafter, univers al banks can bear a wide variety of forms. The most far-reaching form of universal banking, which is sometimes called "true univers al banking", would allow all financial activities to be fully and directly undertaken by a single organization, among its different departments. It has not been adopted by any country yet. The model which is the c10sest to this paradigm can be found in the German universal-banking model, which historically constitutes the first form of universal banking in the world. Other forms of univers al banking have emerged and exist today in
Ils Saunders & Walter, supra note 8 at 9. 119Saunders & Walter, supra note 8 at 84. 120 See Amy Chunyan Wu, "PRC's Commercial Banking System: Is Universal Banking a Better Model?" (1999) 37 Colum. J. Transnat'l L. 623. 121 Supra note 8. l22 In some rare hypotheses, some scholars, marking the specificity of the German form of univers al banking, have distinguishèd "true" universal banks from other financial institutions based on the equity positions and voting power that such in non-financial companies.
35 different countries, depending on the degree of concentration and penneability of the structures under which financial activities are undertaken. Finally, it is worth noting that although universal banking generally meets perfectly the notion of financial conglomerate, it actually often implies a higher degree of integration. This is particularly true when univers al banking refers to the ability of a single financial finn to offer aIl types of financial services and insurance products within a single corporate structure, as in the Gennan variant.
3.2.2 Bank Organizational Structures in the United States
By repealing key provisions of the Glass-Steagall Act, Gramm-Leach-Bliley has removed the traditional barri ers that insulated banks from securities finns and insurance companies. In effect, section 20, which prohibited banks from having affiliates principally engaged in the securities business, and section 32, which fought the interlocking of directors and officers of banks and securities finns, were repealed in 1999. 123 However, the Act did not repeal section 16 or section 31 of the Glass-Steagall Act, which prohibits banks from selling, dealing in and underwriting securities and bans securities finns from traditional commercial banking activities such as deposit-taking. As a matter of fact, in the United States, banks are still prec1uded from dealing in and directly underwriting securities, and reciprocally, securities finns still cannot directly accept deposits. As examined previously, surviving provisions of the Glass-Steagall Act continue to prevent the existence of a "true universal-banking model" in the United States, in which securities business would be fully and directly integrated into commercial banking entities themselves. 124 On the contrary, typical banking and securities activities must be conducted through distinct corporate entities, either in separate affiliates of financial holding companies, or in financial subsidiaries. The current American structure for banking organizations, which was bom with the modemization refonn of 1999, prompts various reflections. First of aIl, it is important to note that the American banking organization structure does not constitute a very sophisticated type of univers al banking variant. Activities in the
123 Supra notes 80, 81, 82 and 83. 124 Backgrounds and Implications, supra note 79 at 9.
36 United States cannot be undertaken within a sole corporate entity but rather through a holding company or separately capitalized subsidiaries of a baille However, a single organization still benefits, through equity stakes, from the proceeds of financial activities. In reality, this situation perfectly suits the "universal banking" definition used in this study, which explicitly refers to the case of an organization engaged "indirectly", and thus through separate corporate entities, in the banking, securities and life insurance businesses. The American form of univers al banking has been called the "subsidiary" form of universal banking, as opposed to the "integrated" form of universal banking which constitutes the most complete form of such an option. 125 Second, the shift to this American form of univers al banking represents a very prudent change, which Congress has assorted with a series of substantial measures that characterize a very precautious move. As seen before, Gramm-Leach-Bli1ey Act notably requires bank's subsidiaries to be "well-capitalized" and "well-managed" in order to ensure the safety and soundness of the financial system. The combination of this organizational form with such measures offers a significant remedy against the risk . exposure traditionally linked with universal banking. Besides, several provisions of the 1999 Act seek to prevent specific risks associated with the existence of relations between banks and their affiliates, by extending anti-tying provisions to financial holding companies for instance. Finally, the choice by Congress of the subsidiary form of universal banking has to be assessed in connection with the distinctiveness of the U.S. regulatory environment. The adoption of a new banking model inevitably implies redesign of regulatory competences of the supervisory authorities having jurisdiction in a defined territory. Consequently, the introduction in the United States of the true universal banking model would potentially have caused serious trouble in reaching agreement on the identity of a single regulator for the new entity.126 This prognosis appears particularly pertinent in historical perspective, owing to the multiplicity of regulators at the federal level and to the characteristics of the U.S. banking system, such as its dual structure. This concem is even more significant in the light of the incessant struggles between federal bank regulatory agencies that have
125 Saunders & Walter, supra note 8 at 233. 126 Ibid. at 234.
37 been taking place in the past years. 127 As we have seen, the Gramm-Leach-Bliley Act has not been able to bring much c1arity to the complex frame of banking regulation in the United States. In its modemization efforts, Congress has nonetheless addressed this inextricable situation in two different ways. First, the Federal Reserve Board is designated as "umbrella regulator" for financial holding companies. It hence has general supervisory and regulatory powers over these entities, while it keeps its supervisory powers toward other bank holding companies. 128 FinaIly, The Federal Reserve is the regulatory agency that goes out of the modemization reform process with the largest powers. Furthermore, Gramm-Leach-Bliley establishes a functional regulation under which, in financial holding companies, different federal agencies are responsible for regulating activities, depending on the area of financial activity concemed. Banking activities are thus regulated by bank regulatory agencies, securities activities by the SEC and insurance activities are placed under the control of state insurance commissioners. 129
3.2.3 Universal Banking Abroad130
3.2.3.1 Germany
Overview German banks traditionally operate under a universal system. This system allows German banks to perform virtually aIl types of financial activities, inc1uding taking deposits and making loans, underwriting securities issues, or brokering real estate. 131 The concept of "universal" bank in Germany has essentially been used to distinguish financial institutions with wide prerogatives, which constitute the most common type ofbank in the country, from "specialist" entities which do not enjoy the same powers and are therefore restricted to only one type of financial activity.132
127 Supra note 79 at 82. 128 Supra note 79 at 84. 129 Supra note 79 at 13. 130 See e.g. Bill Shaw & John R. Rowlett, "Reforming the U.S. Banking System: Lessons from Abroad" (1993) 19 N.e. J. Int'l L. & Corn. Reg. 91, 113. 131 See William L. Rorton, Jr., "The Perils of Univers al Banking in Central and Eastern Europe" (1995) 35 Va. J. Int'l L. 683 at 692 [hereinafter Horton]. 132Saunders & Walter, supra note 8 at 86.
38 Within this first dissection, German universal banks can be subdivided into three additional different categories. 133 These categories are savings banks, cooperative banks and commercial banks. Among these three types of universal banks, commercial banks, or grossbanken ("big banks"), which include German giants such as Dresdner Bank or Deutsche Bank, reflect the quintessential image of powerful German universal banks. In historical perspective, German-style univers al banks appear as the most advanced and characteristic examples of this banking model, although, as seen before, American banks have also been organized under a univers al structure from 1812 through the end of the 19th century.134 In reality, although German univers al banks were bom in 1848, the y only started to acquire significant influence as financial institutions in the 1870s. 135 With assets of over $1.4 trillion, the three grossbanken control more than half of aIl German bank assets and are among the very largest banks in the world. 136
German Univers al Banks: a Comprehensive Structural Form As depicted in Appendix 1, Figure 2, the German universal banking variant gives banks the freedom to undertake banking and securities activities within a single corporate structure. However, it requires separate subsidiaries (controlled and owned by the "univers al bank") for other activities like insurance or mortgage business. Banks can hence take deposits and trade in securities within distinct departments of a single entity, while they will have to offer insurance through separately capitalized insurance subsidiaries. 137 The German grossbanken ("big banks"), including Deutsche Bank, Commerzbank and Dresdner Bank, as weIl as several regional banks, are the main entities which are organized under this structural form of integration.
J33 Ibid. 134 Saunders & Walter, supra note 8 at 85. 135 See Horton, supra note 131 at 692. 136 See Hazel J. Jolmson, Global Positioningfor Financial Services (Singapore-New Jersey-London-Hong Kong: World Scientific, 2000) at 17 [hereinafter Global]. 137 Saunders & Walter, supra note 8 at 89.
39 Four Features of a Successful Development Describing the main characteristics of the German banking system, William L. Horton, Jr. has identified four specific features which according to him can justify such a success. 138 First and foremost, the German model features the presence of a longstanding alliance between premier German banks and large German industrial conglomerates. 139 These close ties can primarily be justified by the omnipotence of univers al banks in financial matters. This observable fact actually resides above aIl in two main characteristics of the German banking industry. Underdeveloped securities market combined with a small number of banks have greatly reinforced the importance of lending relationships in Germany. Indeed, loans constituted the only alternative available to finance businesses' needs in an area of very rapid industrialization. Moreover, the traditionally limited number of German banks forced companies to stick with their usual financial partner, thus engaging in multi-services relationships. These interactions quickly evolved into tighter affiliations, with banks having seats at boards of directors of their customers and enjoying a significant influence over these businesses by taking large equity stakes in their clients. The interplay between banks and industry which emerged more than one hundred years ago is still a predominant feature of the German system. Sorne authors have analyzed these links as presenting great advantages for both parties and as offering significant benefits for the economy.140 As discussed hereafter, these close ties between banks and industry nonetheless also trigger serious concerns, especially regarding the economic and political influence enjoyed by financial conglomerates. A second justification for the successful development of German banks is the independence and quality of allocative decision making. 141 In effect, German banks were born as, and are above aIl, private economic players, which are independent from the govemment. They have managed to remain free from any excessive influence of their clients. This independence, coupled to an unparalleled advance in financial knowledge, a
138 Horton, supra note 131 at 692. 139 Ibid. 140 See Helen A. Garten, "Universal Banking and Financial Stability" (1993) 19 Brook. J. Int'l L. 159, 163 (even stating that this intermingling is one of the reasons why less bank failures have occurred in Gennany, France and Italy than in the United States). 141 Horton, supra note 131 at 692.
40 high level of expertise and a great experience of risk managing in banking matters, has permitted German banks to always stay focused on their company' s interest in the conduct of their business and to prove the efficiency of their system for numerous decades. 142 Besides, specialization of functions within German universal banks has also brought strong barriers to these entities against adverse financial effects in times of distress. 143 Finally, the presence of a strong and competent central regulator, the German central bank or Bundesbank, has facilitated the success of universal banking in Germany. Through preventive actions aimed at avoiding potential failures before they actually required an intervention, the Bundesbank has decisively he1ped to preserve the safety and 144 soundness of the German financial system. It is also important to note that in contrast to the U.S. system, the Deutsche Bundesbank does not restrict the scope ofbank activities undertaken by large German financial instit~tions.145
3.2.3.2 Switzerland
Switzerland occupies a highly envied place as one of the world's leading financial centers. As reported by banking scene's observers and rankings, such as the one elaborated each year by "The Banker" for instance, two of the top ten banks in the world, namely Credit Suisse and UBS, are Swiss banks. With its tremendous national economic importance and a very international nature, Switzerland's banking sector enjoys a remarkable position on the worldwide banking scene. Swiss banks are indeed very important financial players which have always been greatly respected for their expertise and their efficiency. There are Swiss banks in all financial centers, especially through subsidiaries of the two Swiss financial giants, Credit Suisse and UBS. This international influence is particularly striking with respect to the economic or demographic weight on the international scale of this country of 7 million
142 Ibid. at 696 (reporting notably the astonishing Deutsche Bank-Siemens relationship). 143 Ibid. 144 Horton, supra note 131 at 701. 145 Global, supra note 136 at 15.
41 people. Switzerland, from that perspective, remains a unique country, whose name is often intuitively associated with the banking activity itself. The global wave of consolidation that has affected financial industries worldwide has had a great magnitude in Switzerland, where a rapid concentration has occurred in the past decade. Between 1990 and 1999, a multitude ofmergers and acquisitions reduced the number of Swiss banks by 40.5 %, decreasing from 625 to 375 institutions. 146 In Switzerland, the five largest financial institutions control close to 50% of all Swiss bank assets. 147 The struggle between the two main Swiss banking competitors, UBS and Credit Suisse, exemplifies this trend which has resulted in the surfacing of two of the largest financial conglomerates in the world. Indeed, the merger in 1997 between Union Bank of Switzerland and the Swiss Bank Corporation created a new UBS, which immediately ranked as the third largest bank in the world. 148 UBS' s main domestic competitor, Credit Suisse, decided to acquire Winterthur Insurance during summer 1998 in order to evolve into a more global financial group, following the bancassurance type banking (which is basically modeled after the German allfinanz form). During summer 2000, UBS took over US securities firm PaineWebber, hence becoming a true global financial player. A month after this colossal transaction, the Credit Suisse Group decided to respond by acquiring US investment house Donaldson Lufkin & J enrette. Factors which are commonly cited as having led Switzerland to become such a successful financial center include the presence of strong and efficient banking organizational system. 149 In effect, a particularity of the Swiss banking industry is that it foIlows a univers al banking structure, which includes aIl banking and securities transactions. ISO As it has been noted, the Swiss banking system is characterized by "the fact that every bank is allowed to, though not obliged to, carry out aIl banking transactions", and that these institutions moreover can offer non-banking services like insurance. 151 According to
146 See Teodoro Cocca, "The Future of Swiss Banking", in Benton E. Cup, ed., The Future of Banking (Westport, Connecticut - London: Quorum Books, 2003) at 272 [hereinafter Cocca]. 147 Global, supra note 136 at 17. 148 Cocca, supra note 146 at 280. 149 See Banking Law Survey: 1999/2000, (Boston-Dordrecht-London: Kluwer Law International, 2001) supra note 1, at 181. 150 Cocca, supra note 146 at 272. 151 Ibid.
42 the variant of univers al banking implemented in this country, Swiss banks can engage in insurance activities but they may only do so indirectly, that is through separate subsidiaries. This qualifies the Swiss form of univers al banking, which is quite far from the most developed forms of universal banking such as the "integrated" one for instance. Despite their ability to undertake insurance activities, most Swiss banks preferred not to do so until the late 1980s, however. 152 This former characteristic feature of the banking sector in Switzerland has been vanishing in the past years, while banking giants such as Credit Suisse or UBS have made significant inroads in the insurance business. As a result of the broad range of activities which they can enjoy, most banking entities of significant importance in Switzerland are univers al banks, while banks which do not operate on this model are essentially investment banks and foreign banks. 153 If the Swiss banking system shares undeniable similarities with the German one, especially regarding their successful development and their organizational structure, the former nonetheless has one important particularity which is briefly presented hereinafter. A major aspect of the Swiss banking system deals with the question of the intermingling of commerce and banking in this country. As noted, "in contrast to the United States, Japan, and Germany, the debate on the social value of bank universality whether banks can be engaged in both commerce and banking without adverse social consequences-is not an issue in Switzerland".154 In effect, there is no such alliance between banks and industrial conglomerates in Switzerland as in other countries which have a banking system involving universal banks. With the exception of Credit Suisse which owns significant industrial interests, there is no concentration of economic powers within the Swiss universal banking system. 155 This situation thus contradicts one of the main concems that emanate from universal banking. Indeed, the Swiss avoidance of industrial controls refutes the usual argument predicting that univers al banks are likely to have negative effects on national interests, due to their great influence over the economy taken as a whole. 156 The example of universal banking in Switzerland seems to prove the
152Saunders & Walter, supra note 8 at 111. 153 Cocca, supra note 146 at 274. 154 Saunders & Walter, supra note 8 at 112 (reporting about the Swiss perception ofbanking that "bankers should be bankers and industrialists should be industrialists"). 155 Ibid. 156 Saunders & Walter, supra note 8 at 125.
43 contrary, although in banking matters, the notion of national interest in Switzerland has a quite different meaning from that in the United States or in Germany for instance, owing to the unsurpassed importance of Swiss banks in their national economy.
44 Conclusion
International evidence of univers al banking demonstrates that each country has its own specificities regarding its financial system and banking experience. From a structural perspective, the German and Swiss variants of universal banking appear as being more developed and going weIl beyond the American one. Indeed, the American form does not go as far as it could have had, since it does not permit "true universal banking". In fact, it has been implemented with great vigilance, due in great part to the newness of this change for the U.S. financial world. This represents a limited change which may therefore lead to sorne frustration for those who sought a more radical evolution. This prudence nevertheless minimizes potentlal risks which could have been imported into the United States had the radical German form of universal banking been adopted, for instance. This vigilance also justifies the second notable difference between the banking structure recently adopted within the United States and the existing banking systems of its counterparts. 157 In effect, whereas Germany, France or other major developed countries feature very close links between banks and industrial groups, the United States still reject the intermingling ofbanking and commerce. These two important characteristics of the American model help ensuring the safety of the banks, and also the stability of the whole financial system. AIso, these particularities meet the predictions of universal banking advocates, who have extensively claimed that the transposition of sorne type of universal banking in the United States, in addition to being done at reasonable costs for the U.S economy, would provide various substantial benefits. This q~estion is examined in the forthcoming part.
157 Keynote, supra note 78 at 19 (c1aming that considerable risks rnay result from a "keiretsusization" of the US. economy).
45 PART IV
CLAIMED ADVANT AGES OF UNIVERSAL BANKING
"With this bill, the American financial system takes a major step forward the 21st century-one that will benefit American consumers, business, and the national economy.,,158
Promoters of univers al banking have long stated that the adoption by the United States of this new organizational structure would pro duce numerous benefits. For instance, William L. Horton, Jr. has written that the introduction of univers al banking generates five main advantages: more profitable banks through economies of scale and scope, decreased costs of regulation due to a smaller number of banks to monitor, increased probability of reaching private solutions to economic crises in bank/client relations, ability to absorb losses from securities activities as a result of a larger and more diversified structure, and, finally, improved corporate govemance in industry by putting banks in a position to monitor the action of management. 159 Other commentators or authorities have extensively described other benefits which would result from a modemization of the U.S. financial services industry. In fact, in order to classify these predictions, the various advantages of univers al banking can be divided into three categories. They can be sorted depending on whether they profit the newly created financial giants themselves, their economic environment through themselves, or their customers. As a matter of fact, and because of size limitations, only a subset of the advantages claimed by supporters of financial conglomerates is discussed within the frame of this thesis. Financial conglomerates have been expected to be more profitable due to economies of scale and scope, to provide more safety and soundness thanks to a larger diversification, and ultimately to offer lower priees and more eonvenienee to their
158 Treasury Secretary Lawrence H. Summers, cited by Alan Levinsohn in "The Coming of a Financial Services Bazaar", supra note 53. 159 Horton, supra note 131 at note 14.
46 customers. 160 These are the three advantages which have been the most expansively predicted to result from the introduction of huge diversified financial institutions in the United States. They are successively examined below.
4.1 Increased Profitability and Efficiency Due to Favorable Economies of Scale and Scope
4.1.1 Economies of Scale and Scope and Efficiency
One of the most quoted advantages related to the creation of financial conglomerates is that it would allow a higher efficiency and profitability for these entities. These improvements would result from economies of scale and scope obtained through reduced average costs and the creation of synergies. 161 Synergies seem to constitute the paragon behind diversification strategies of large banks. Synergies can be explained in a seemingly basic but in fact rather accurate way through the 2 + 2 = 5 effect, "which indicates that the portfolio of business is worth more than the sum of the respective parts". 162 In reality, the two elements which are at the very basis of the notion of creation of value in the financial sector, namely economies of scale and economies of scope, are c10sely related to the concept of efficiency. The rather broad concept of efficiency can be analyzed through a wide range of criteria. 163 However, efficiency can be defined appropriately through the notions of economies of scale and scope. In effect, the quest for the ideal business model underpins the link between these two types of economies and, consequently the concept of efficiency. An ideally efficient company would thus be a
160 See e.g. Joao A.C. Santos, "Connnerciai Banks in the Securities Business: A Review" (1998) 14 J. Fin. Serv. Res. 35, 37-41; James R. Barth, R. Dan Brumbaugh Jr. & James A. Wilcox, "The Repeal of Glass Steagall and the Advent of Broad Banking" (2000) Journal of Economic Perspectives 191, 198-99. 161 Supra note 130. 162 Creating, supra note 111 at 36. 163 See Dean Amel, "Consolidation and Efficiency in the Financial Sector: A Review of the International Evidence", (2002) Paper, Federal Reserve Board, Finance and Economic Discussions Series at 6 [hereinafter Amel].
47 company "that reaches its optimal size for its industry (scale) and that produces the optimal mix ofproducts given the price oftheir production factors (scope)".164
4.1.2 Definitions
- Economies of scale have long been at the heart of debates about the optimum organizational size for players in the financial services industry.165 The notion of economies of scale is based on the idea that banks which significantly increase their size would be able to gain access to cost-saving technologies and to spread their fixed costs over a broader base. 166 As a matter of fact, these banks could thus have the opportunity to reduce their average costs and eventually improve their profitability.167 The idea is that in banking as in all industries, sorne tasks are totally independent and do not vary depending on the department or activity they work for. These typical "back-office" functions inc1ude advertising, information technology, human resources or accounting, for instance. In the banking industry specifically, risk appraisal, which can be applied to loans as well as to securities, constitutes a characteristic back office function. 168 Within a single organization which would be based on the univers al banking model, these skills could be used expansively, for investment banking and commercial banking or even for the insurance activities. 169 It is worth noting that the notion of "economies of scale" is c10sely related to the notion of critical size. Indeed, a firm will benefit from economies of scale up to the point
164 Ibid. 165 Ingo Walter, "Univers al banking: A Shareholder Perspective", in Edward L. Melnick et al., ed., Creating Value in Financial Services, Strategies, Operations and Technologies (Boston-Dordrecht-London: Kluwer Academic Publishers, 2000), at 57 [hereinafter Shareholder]. 166 Creating, supra note 111 at 37 (defining economies of scale as "the phenomenon that an increase in output can be realized with a disproportionate (lower) increase in input costs due to the decreasing effects of fixed costs and/or the beneficial effects of the learning curve"). 167 Amel, supra note 163 at 18. Contra, Gary A. Dymski, The Bank Merger Wave, The economic causes and social consequences offinancial consolidation (Armonk, New York-London, England: M.E. Sharpe, 1999), at 55 (reporting that the most comprehensive study examining whether scale economies are a determinant ofbank profitability, released in 1995, has found that scale economies do not explain bank profits, and that most studies come to the conclusion that "bigger does not mean more profitable, either for the large st U.S. banks or for the largest") [hereinafter Dymski]. 168 Horton, supra note 131 at 688. 169 See Jonathan R. Macey, "The Inevitability of Univers al Banking" (1993) 19 Brook. J. Int'l L. 203, at 214-16 (contending that once a bank has a1ready invested in such costs as hardware, software and training resources, it should be able to alter its excess capacity in other financia1 areas to increase efficiency).
48 where it reaches its critical size. Once the firm has reached this critical point, opposite effects occur and diseconomies of scale are observed. The fundamental question here, which can only be answered by economists on the basis of empirical studies, is to determine what would be the optimal size that should not be exceeded in order to benefit from economies of scale. The answer to this question is provided in subsequent developments. - Economies of scope are derived from the notion of "synergies" (or complementarities). Such synergies can first be obtained from a geographical perspective, by allowing financial players to reach a wider consumer base through unions with firms who are based in different geographic areas. Moreover, banks may be entering new markets as a result of mergers between institutions which are specialized in different market segments. 170 In this last case, banks' interest is to try to find synergies in order to cross-sell their products to a larger customer base. This particular type of synergies, based on "cross-selling", refers to economies of scope "on the demand-side".171 As examined further, these synergies are largely inherent to the concept of one-stop shopping, which allows financial supermarkets to offer a variety of products and services to their clients under a same sign.
4.1.3 Economies of Scale and Scope Applied to Univers al Banks
Advocates of big banks repeatedly argue that "bigger is better" from a shareholder value perspective, and use economies of scale and economies of scope as underlying princip le for their assertion. Supporters of large diversified financial conglomerates assert that such entities can benefit from economies of scale and scope by selling a wide range of consumer financial products, such as credit cards, home mortgages, securities brokerage accounts or mutual funds. 172 Furthermore, they claim that univers al banks can benefit from favorable economies of scale and scope residing in the activities of
170 Amel, supra note 163 at 18-19. 171 Shareholder, supra note 165 at 59. 172 Transformation, supra note 4 at note 282 (reporting c1aims by big bank executives that "size does matter", or acadernic authors' beliefs that, especially with regard to the mass marketing of consumer loans and investment products, "size ... has become a major competitive advantage in banking").
49 syndicating loans or underwriting and trading in securities and derivatives. 173 For example, it has been contended that univers al banks will benefit from important informational efficiencies through the combination of traditional lending activities and capital markets services to the same companies. 174 Overall, "management of universal banks often argue that broader product and client coverage, and the increased throughput volume this makes possible, represents share-holder value enhancement".175 However, it is important to note that such benefits are not expected to be achieved exclusively through the adoption of the most sophisticated forms of universal banking, such as the German form or "integrated form". In effect, even though the investment banking affiliate is not allowed to have recourse to the commercial banking affiliate's assets, both entities can still benefit from their mutual expertise since the two affiliates can share the same offices, the same back-office functions or even the same staff, directors or officers. From this angle, the U.S. Gramm-Leach-Bliley seems to offer financial organizations which embrace the new structural possibilities the perspective of gains of efficiency and profitability.
4.2 Increased Safety and Soundness Due to a Greater Diversification
4.2.1 Overview
Among other benefits of diversification for commercial banks, the argument based on minimized risks and improved stability constitutes a commonly supported one. In effect, promoters of the univers al banking model have long been predicting that the creation of financial conglomerates would lead to more safety and soundness, as a result of a significant diversification of business lines. The starting point of this avowal is the idea that under a universal banks model, big banks wou Id not just offer loans and traditional banking products to their customers, but rather an extremely diverse variety of products and services, ranging from life insurance to corporate-finance advice. This diversification would thus lead to a higher safety since even in case of a failure in one of the activities of
173 Ibid. at note 286. 174 Ibid. 175 Shareholder, supra note 165 at 59.
50 the bank, the other sectors would remain safe and exempt from instability. Ultimately, national economies, and in a certain way, the worldwide economy, would benefit from this advantage since an increased soundness for a full-service bank, due to its size, would affect the stability of the financial system as a whole.
4.2.2 Rationales for Enhanced Safety and Soundness in Literature
For David Rogers of New York University, "those favoring diversification for commercial banks, most of which is related-diversification into other financial services businesses, cite such potential benefits as smoothing income flows, thereby minimizing risk by protecting the firm from losses in any particular businesses.,,176 Alfred Steinherr said about risk diversification that "it is (also) reasonable to expect that failure among highly diversified banks, such as univers al banks, is more sel dom", due notably to "diversification of risks and better access to information."I77 Alfred Steinherr further emphasized the role of relationship lending in providing a role for monitoring. 178 From this perspective, the size and informational advantages enjoyed by financial conglomerates are such that insolvability risks associated with loan-making are significantly reduced. Interestingly enough, supporters of financial conglomerates have also used the argument that the "tradition al" bank lending activity itself often constitutes a ri skier activity than securities dealing or insurance underwriting for instance. 179 This last argument follows counterarguments about the circumstances of the passage of the Glass Steagall Act, which have been refuting the common explanation based on the risks associated with banks' inroads in the securities business and focusing on the considerable dangers which can emanate from with bank loans. Other authors have gone beyond the most common explanations relying on risk diversification by providing other justifications. In effect, in his effort to analyze the
176 Does it Work?, supra note Il. 177 See Alfred Steinherr, "Performance of universal banks: historical review and appraisal", in Anthony Saunders and Ingo Walter, Universal Banking, Financial System Redesigned (Chicago-London-Singapore: Irwin Professional Publishing, 1996). 178 Ibid.
179 Saunders & Walter, supra note 8 at 125.
51 causes and consequences of financial consolidation, Gary A. Dymski analyzes usual rationales related to banks' increased safety and divides them into two different categories. 180 First, enhanced safety and soundness for big banks can be realized through the absorption of weak or failing banks by stronger financial players 181. Mergers corresponding to this explanation have notably taken place in the savings and loan industry in the 1980s, allowing prosperous commercial banks to acquire failing thrifts, but have also occurred within the strict commercial banking sphere. 182 Whatever the nature of the banks may be, consequences for the concemed entities, and depending on their size, for the economy, remain unaltered. Indeed, by remedying a situation with potentially disruptive effects, these mergers' effects have been said to ensure a higher degree of safety and soundness. Second, financial conglomerates can benefit from increased soundness owmg to diversification into new markets. 183 Entering into new markets can strategically be done in two different ways. A bank can first merge with another financial player in order to exp and its geographical reach. Even before the passage of the Riegle-Neal Interstate Banking and Branching Efficiency Act of 1994, however, banks had started to press against limits based on state boundaries through numerous mergers. 184 In this case, banks' wider geographical presence has shown a reduction of risk and a subsequent inèreased safety and soundness. As noted by Gary A. Dymski, a given volume of bank loans of any type (say, construction loans for commercial real estate) made injust one location is ri skier than the same volume of bank loans made in two locations with different economic fundamentals. Any given economic downtum ("shock") is unlikely to affect the two locations to the same extent-so the potential extent of loss from any one shock is less than when all loans are made in one or the other location."... "Sorne advantages for geographic expansion are indisputable. The potential for risk reduction from the geographic expansion ofloan asset portfolio is rea1. 185
Risk reduction through diversification into new markets, for financial conglomerates, can aiso be obtained as a result of product-line diversification. As explained before, a
180 Dymski, supra note 167 at 50-54. 181 Dymski, supra note 167 at 51. 182 Ibid. 183 Ibid. 184 Dymski, supra note 167 at 52. 185 Ibid.
52 banking finn can thus reduce its risk by expanding its activities toward product lines which would not be affected by the same shocks as the one that may affect its traditional activities. This last argument constitutes the most frequently quoted risk-reduction related justification for financial conglomerates.
4.2.3 Stability versus Efficiency and the Ideal Corporate Structure
ln order to conclude on this point, it is important to note that the notion of risks depends significantly on the type of corporate structure adopted by financial institutions. ln effect, as examined previously, univers al banking can take a number of various fonns. Among other implications resulting from the fonn of universal banking adopted, risks incurred by concemed entities constitute an important issue. This question played a significant role in the debate which led to the enactment of Gramm-Leach-Bliley.186 The bank holding company fonn and its underlying theory of separating bank affiliates to ensure safety and soundness illustrates the subtle dialectics existing between stability and efficiency. Ifplacing non-bank- insurance or securities- activities in separately capitalized subsidiaries of a holding company undeniably insulates the bank from possible risks, it may also reduce or even altogether annihilate benefits deriving from the universal banking option, such as potential economies of scope or synergies. 187 The interplay illustrated through this example is essential to the debate about financial conglomerates. Indeed, it highlights the difficulty for the choice of the most adequate, the optimum organization fonn within an economic framework that allows sufficient stability. On the one hand, corporate structures must remain useful tools that help companies perfonn their activities in a convenient, efficient and competitive way. On the other hand, exigencies of safety and soundness must be respected in the process of de ci ding which fonn of organizational structure best fits.
186 See e.g. the Committee Reports on the Gramm-Leach-Bliley Act which noted the importance of "enhancing safety and soundness ... by requiring that banks may not participate in the new financial affiliations unless the banks are weIl capitalized and weIl managed." H.R. Conf. Rep. No. 106-434, at 151- 52 (1999). See also S. Rep. No. 106-44, at 4 (about the fact that the modemization was necessary "to preserve the safety and soundness of our financial system"). 187 Saunders & Walter, supra note 8 at 128.
53 4.3 Benefits for Consumers
My goal is to put together a bill that will provide greater diversity and financial services at a lower price to American consumers. If this bill does not meet the test of providing benefit in terms of a greater diversity and availability of product, if it does not meet the test of providing a lower co st for those products, for the people who do the work and pay the taxes and pull the wagon in America, then it would be my view that we have failed in this bill. That, 1 think, is the test that we need to use in order to judge our success or lack thereof on this bill. 188
4.3.1 Introduction: Deregulation and Consumers, the Specificity of Consumers' Benefits
Claimed advantages dealing specifically with consumers occupy a véry special place among the various benefits which can be predicted to occur in the context of a deregulated industry. In effect, consumers' benefits constitute the most appropriate -at least the most commonly advertised- prism for the representation of public interest when a significant reform affecting a specific industry is to be undertaken. In any concemed industry, whether it is telecommunication, air transport or electricity for instance, the impact of deregulation on consumers constitutes the ultimate objective to be achieved. Any major deregulatory reform has indeed to be carried out with a clear intent conceming its potential benefits and adverse effects on consumers. Furthermore, once implemented, the outcomes of a deregulatory initiative can fundamentally be assessed at the light of the resulting situation for its final beneficiaries, namely the consumers of the modemized industry. Opening competition on a specific market segment or an entire sect or thus inevitably aims at, and forecasts, lower prices and better service for customers. Within the particular case of the last great American deregulatory legislative effort, namely Gramm-Leach-Bliley, consumers' benefits enjoy an even more singular place among other advantages which have been expected to result from the modemization of the U. S. financial sector. If the financial services modemization law enacted in 1999 can in great part be seen through a costlbenefit analysis, it is notably with respect to the
188 Statement of Senator Phil Gramm, in The Gramm-Leach-Bliley Act: Financial Services Modernization: Hearings Before the Senate Comm. on Banking, Housing and Urban Affairs, l06th Congo 1 (1999) at 1.
54 predicted advantages for customers that such a perspective may be considered. 189 Benefits for consumers have been described as the "the most frequently touted benefit of the legislative decision to deregulate particular markets".190 However, in addition to constituting the ultimate benchmark for any deregulatory process within a specific sector, consumers were truly at the center of the 1999 Act. Indeed, consumers' benefits were indisputably the most important benefits contended to result from the passage of Gramm leach-Bli1ey.191 Since the main objectives of the 1999 Act primarily reside in competition reasons, consumers are at any rate at the very heart of this last modemization effort. Other commonly alleged advantages of financial conglomerates, such as increased profitability or enhanced safety, are benefits that concem the members of the industry themselves. Asking whether the recent deregulation step also anticipated substantial benefits for consumers introduces a public policy element into the discussion. In reality, not one specific advantage but, rather, various benefits to consumers have been asserted by advocates of financial convergence. They are studied hereinafter.
4.3.2 The Variety of Benefits for Consumers
The introduction of the univers al banking model in the United States has been foreseen as a source ofvarious significant advantages for customers. Fundamentally, these benefits have been predicted to derive from the "increased competition" that would take place in the U.S. financial services industry. These benefits have also been attributed a priori to an "increased efficiency" of financial players. Both Committee reports and Committee hearings on the Gramm-Leach-Bli1ey Act which have preceded the enactment of the modemization Act actually referred on many occasions to these two rather vague
189 See generally Vincent DiLorenzo, "Cost-benefit Analysis, Deregulated Markets, and Consumer benefits: a Study of the Financial Services Modemization Experience" (2002/2003) 6 N. Y. U. J. Legis. & Pub. Pol'y 321 [hereinafter DiLorenzo]. See also Mark W. OIson, "Implementing the Gramm-Leach-Bliley Act: Two Years Later" (speech before the American Law Institute and American Bar Association, Washington, D.C., 8 February 2002), online: Federal Reserve Board,
55 concepts, without really defining them or illustrating them with tangible examples. 192 Benefits for consumers which are actually derived from consequences of deregulation are threefold. In effect, promoters of universal banks have asserted that consumers would benefit quantitatively from lower prices. They have also stated that they would benefit qualitatively from a greater convenience notably due to the concept of "one-stop shopping" and from new products and services.
4.3.2.1 Quantitative benefits: Lower prices
Justification The idea of having larger economic players may suggest that it would allow cost savings for customers. The economies that financial institutions would have been able to produce may thus logically give them the opportunity to lower their prices. Ultimately, customers would be the final beneficiaries of the economies realized by these larger entities. This idea was one of the biggest issues discussed within the frame of the thousands ofbank mergers'which started to take place in the early 1980s. 193 However, with respect to specific cases of mergers occurring between large U.S. commercial banks, several studies have shown that the so-called price reductions for consumers never occurred and that on the contrary, adverse effects took place following these mergers. 194 Bank customers were indeed charged with higher fees by big banks after they merged. Conclusions show that these consumers were charged with higher fees at large banks than at small ones, and with higher fees at out-of-state owned banks than at in-state owned banks. 195 In the different context of large diversified financial conglomerates that have resulted from the passage of the 1999 bill, it has also been predicted that consumers would benefit from significantly lower prices. More precisely, the Committee hearings predicted lower
192 DiLorenzo, supra note 189 at 328-336. 193 Dymski, supra note 167 at 97 (stating that "perhaps no dimension ofbanking change has drawn as much heat over America's kitchen tables as rising bank fees, and large merging banks are often the market leaders in this respect"). 194 Dymski, supra note 167 at 97-100. See also Controlling, supra note 2 at note 14. 195 Dymski, supra note 167 at 101.
56 costs to emanate from increased competition. 196 Such an assertion can seem perfectly valid or at least very likely to be achieved since increased competition may reasonably lead to increased efficiency. Based on the mechanisms of economies of scale and economies of scope presented previously, it was not naively idealistic for experts and congressional leaders to expect large banks to reflect their cost reductions in the prices proposed to consumers. Numerous reputable experts representing the various segments of the financial services industry confidently stated that the proposed Act would create savings of $ 15 billion per year for consumers. 197 This assertion was made by authorities such as David H. Komansky, Chairman of financial giant Merrill Lynch, and industry representatives like Roy J. Zuckerberg, Chairman of the Securities Industry Association and Michael E. Patterson, Chairman of the Financial Services Council. 198 This claim was repeated by Congressman James A. Leach, during the legislative process as weIl as in academic presentations about the Act that he fathered. 199
A Trustworthy Prediction? In reality, this salient number of $ 15 billion was not the conclusion of studies undertaken privately by financial players nor was it based on the work of industry associations' experts,zoo The only basis for this remarkably appealing figure was testimony that then Treasury Secretary Robert E. Rubin had given before the Housing Banking Committee in 1997, two years before the Act eventually came to be enacted. 201 The fact that "Secretary Rubin never reiterated that $ 15 billion cost saving figure in his 1999 testimony" nor "was never asked about it by Committee members when he testified in 1999" triggers sorne troubling concems about the way in which what constitutes the
196 DiLorenzo, supra note 189 at 327. 197 The Grannn-Leach-Bliley Act: Financial Services Modemization: Hearings Before the Senate Comm. on Banking, Housing and Urban Affairs, 106th Congo 1 (1999) at 204 (statement of Michael E. Patterson, Chairman, Financial Services Council) [hereinafter Senate Hearings]; The H.R. 10 - Financial Services Modemization Act of 1999: Hearings Before the House Comm. on Banking and Fin. Services., 106th Congo 143 (1999) at 8 (statement of David H. Komansky, Chairman, Merrill Lynch) at 316 (statement of Roy J. Zuckerberg, Chairman, Securities Industry Association) [(hereinafter House Banking Hearings] , in DiLorenzo, supra note 189 at note 52. 198 Ibid. 199 House Banking Hearings, supra note 197 at 1-2; Keynote, supra note 78 at 12. 200 DiLorenzo, supra note 189 at 337. 201 Financial Modemization - Part II: Hearings before the House Comm. on Banking and Financial Services, 105th Congo 128 (1997) (Statement of Robert E. Rubin, Secretary, o.S. Department of the Treasury).
57 main benefit of the U.S. financial modemization was assessed during the legislative process.202 More importantly, the actual way in which the repeatedly-quoted number of $ 15 billion per year of savings for consumers was bom is extremely conceming. The full text of Robert E. Rubin's testimony before the Banking Committee in 1997 is reproduced here: [The] Bureau of Economic Analysis has estimated American consumers spent nearly $ 300 billion on brokerage, insurance and banking services in 1995. While it would be hard to judge exactly what would result from financial modemization, if you take 1 percent of that, you've got $ 3 billion. If you take a number we consider not to be unreasonable, 5 percent, you have $ 15 billion - and that just refers to consumers, it does not refer to business users of financial services. The people who prepared the statistics say that the inclusion of business uses of financial services would very substantially increase that number, perhaps as much as double it. 203
Following his testimony, Robert E. Rubin was asked essential questions by several Congressmen about the reality of such a figure, but he did not offer further tangible justification to support his statement.204 Moreover, in the concluding Committee Hearings which took place in 1999, various experts showed evidence of the disappointing financial results of big bank mergers for consumers, notably with respect to the issue of increased prices.205 No attention was apparently given to these important facts. The conclusion of this episode is quite disturbing from a public-policy perspective. The $ 15 billion of savings for consumers which were predicted to result as a consequence of Gramm-Leach-Bli1ey Act were in reality no more than a mere guess, with no significant justification and no tangible basis to support it. Despite its weakness though, this figure has been repeatedly used by proponents of financial conglomerates, hence serving in a disquieting way the interests of industry leaders. This questionable number, surprisingly, remained unchallenged. This undisputed rough assumption even refuted contrary documented evidence. Today, it nonetheless continues to appear as an
202 DiLorenzo, supra note 189 at 337-338 (providing a very instructive explanation ofhow the number of$ 15 billion per year of cost savings for consumers was born). 203 See Statement ofRobert E. Rubin. supra note 201 at 129 [emphasis added]. 204 DiLorenzo, supra note 189 at 337-338. 205 Ibid. at 339.
58 emblematic figure for the most symbolic benefit predicted to result from financial modemization in the United States.206
4.3.2.2 Qualitative Benefits
"Improved Access to Financial Services": a Greater Convenience for Consumers Another forecast made by the supporters of financial convergence was that customers would benefit from a greater convenience. More precise1y, proponents of Gramm-Ieach Bliley have alleged that consumers would have an "improved access to financial services.,,207 The notion of improved access to financial services for American consumers can actually be considered as a benefit for American consumers in three different ways. First, improved access was said to take the form of an increased choice of services for small banks located in isolated rural places, which usually do not offer an exten~ive range of products to their customers.208 Through a full affiliation of banks with securities firms and insurance companies, an insurance agent for instance, or a securities broker of a previously underserved geographic area would hence be able to provide its clients with a full display of services. Second, improved access to financial services has been contended to result through institutions providing products or services that would be "otherwise unavailable because they are uneconomical without affiliation".209 In this case, maybe more than for other benefits, and as with price reductions, this claimed benefit presupposes an authentic will and a real commitment of financial institutions to have their affiliation tum into an existing gain for consumers. Finally, it is above all the concept of "one-stop shopping" that most commonly exemplified the promise of a greater convenience for consumers. The concept of one-stop shopping, which corresponds to what are commonly called "financial supermarkets", refers to the capacity for consumers to find a broad variety of financial products and
206 See e.g. Congressman James A. Leach, Keynote, supra note 78 at 12. (stating that "from the consumer perspective, the Department of Treasury estimates that there will be a savings of about $ 18 billion a year") (sic). 207 DiLorenzo, supra note 189 at 329. 208 Ibid. 209 Ibid. at 341.
59 services within a single place. From a seller' s perspective, the idea of large diversified financial conglomerates implied the possibility of cross-marketing and cross-selling financial products. Various studies highlighted the great potential for banks and other financial players to be affiliated altogether by shedding light on the behaviour of consumers of financial services. For instance, the cross-marketing and cross-selling of banking and insurance products was predicted to reach high levels since marketing and sociological studies showed that for instance, an individual consumer actually went to his bank ten times more often than to his insurance agent. From a consumer's perspective, the benefits associated with the concept of one-stop shopping had been fostered throughout the past years by advocates of universal banking. Hence, Congressional leaders and representants of the financial services industry foresaw the reunion of a full range of financial products under a same sign as a real revolution for consumers. The convenience resulting from this alliance was told to go far beyond aIl that these consumers have previously been offered.
New Products and Services A final benefit for consumers which has been predicted to occur consequently upon the repeal of the long-standing barriers between banks, securities finns and insurance companies, is the creation of new products and services within the financial sphere. This specific advantage has been justified by an historical assessment of the fact that, in previous years, increased competition in the various segments of the financial services industry had indubitably encouraged the creation of new financial products and services.2lO Deregulation within a given industry may stimulate innovation, thus allowing the players in the market to stay profitable and survive in a highly competitive environment. However, this rather commonsensical explanation does not offer consistent support for such an outcome. What may have happened within a specific industry may not happen again in a different one. What has occurred in a defined economic sector may not occur mechanically with the same effects in a different one.
210 Supra note 189 at 342.
60 PART V
POTENTIAL PITFALLS OF UNIVERSAL BANKS
Now that large diversified banks are legal in the United States, it is essential to assess whether they are economically and morally viable. Financial conglomerates may offer various potential advantages, but they also present a series of significant downsides. The scope of potential effects deriving from the existence of big banks in a given country is extremely broad. As a matter of fact, the outcomes of a key reform of the banking and
61 financial sector can be evaluated through a wide range of criteria, depending on the standpoint that is adopted to analyze such results. Generally and from a pure public policy perspective, the assessment of reforms of the banking sector, with the unchanging target of meeting national interest, is done through four benchmarks. These are safety and soundness for the national economy, competitiveness, efficiency and equity. In the more precise context of deregulatory initiatives, benefits for consumers are commonly regarded as the main standards through which such action is appraised, whether before its realization or a posteriori. However, this last approach may seem too broad, or rather, can appear as being based on excessively general principles, which thùs need to be refined through a narrower series of criteria. These sub-criteria are plentiful. They can be sorted depending on the general standard they seek to characterize. For instance, "pure" business performance and competitiveness of financial institutions can be judged upon their efficiency, profitability or the evolution of their shareholder value. Safety for the economy can be evaluated through financial risks of large banks, in accordance with existing supervision mechanisms, assumed by regulatory bodies, aimed at ensuring stability and soundness. Finally, the ostensible ultimate target of a deregulatory effort, benefits for consumers, is commonly seen through the dual prism of quantitative (lower prices) and qualitative (convenience, new products ... ) advantages. 211 In the specifie context of financial conglomerates, other criteria of great importance may be added to the list. Moral hazard and ethical standards constitute crucial issues when dealing with banking practice. The central position he Id by banks in an economy and their responsibility for public confidence is well-known. Besides, the special nature of financial conglomerates, due to the quasi-unlimited range of financial activities they can offer and the immense amount of information they enjoy, strengthen these moral concerns. The topic of ethical conduct plays a particularly significant role with regard to the U.S. financial modernization of 1999, which deeply modified powers granted to financial institutions while redesigning the internaI organizational structure of such entities. AIso, recent U.S. scandaIs have involved sorne of the leading and most prestigious American and foreign large banks. This has led to various criticisms toward
211 See developments above at 4.3.2.1 and 4.3.2.2.
62 the universal banking model, notably with respect to the issue of conflicts of interest, thus undermining to a certain extent the option of financial conglomeration.
The assessment of the outcomes of the 1999 reform, and thus the study of potential downsides of financial conglomerates, can be undertaken through a wide spectrum of standards. However, due to the limited length of this paper, the author does not propose here to provide an exhaustive review of aIl potential pitfaIls which may derive from the existence of financial conglomerates in the United States. Rather, this study seeks to discuss a subset of concems triggered by cross-industry consolidation in the United States. These concems have been chosen with regard to their relevance in the recent context. Moreover, these negative aspects are here classified depending on the basis of the basic frame they may directly influence: financial institutions and their consumers, or the economy as a whole. Emphasis is put on the latter frame, while potential adverse consequences of financial consolidation toward big banks themselves or their consumers are briefly examined in a preliminary section. First, potential failure for large diversified banks to become more profitable or efficient and the resulting effects on consumers are succinctly analyzed below. Then, this study will provide a discussion of two serious concems that may primarily affect the general scope of the economic and financial sphere. Financial conglomerates may present a significant threat for the economy, as a result of their size and their structure, by aggravating systemic risk in financial markets. This is examined in a second section. The issue of conflicts of interests in the particular case of univers al banks is a buming topic these days. It is discussed, with evidence of the most recent corporate govemance scandaIs which have occurred in the United States, in a third section.
63 5.1 Preliminary Section: Competition, Efficiency, Profitability and Consumers
Advocates of financial conglomerates have long been promoting the economic validity of the univers al banking model, as an efficient and profitable business option. Such a claim was based on the potential for economies of scale and economies of scope, which have been addressed above. In tum, economies realized by large banks were said to ultimately benefit U.S. consumers, through lowered priees for instance. This series of benefits is actually related to the global aim of competition, which was one of the main
64 goals pursued by Gramm-Leach-Bliley Act. In effect, enhanced competition and efficiency were two alleged benefits of financial modemization. Sorne authors have been deducing from the experience of these past years that financial conglomerates have failed to achieve such objectives. As noted by Arthur Wilmarth, Jr. during summer 2002, Big diversified financial providers have produced a largely disappointing record over the past two decades ( ... ) Similarly, mergers among big banks, or between banks and other financial institutions, have generally failed to generate substantial improvements in efficiency, profitability, shareholder value or customer service ( ... ) five big global banks-J.P. Morgan Chase, Citigroup, Credit Suisse, Deutsche Bank and UBS-continue to pursue a universal banking strategy. However, all five banks have absorbed significant losses from capital markets activities at various times since the mid-1990's.212
According to this author and various other experts, such poor outcomes can be explained by different factors. 213 Particularly, two main justifications may explain the disappointing results of most mergers involving large financial institutions. First and foremost, it has been said that big banks failed to produce the expected economies of scale and scope that its advocates had predicted. As regards economies of scale, several economic studies have asserted that U.S. banks stop producing increasing retums to scale as they grow beyond the $10-$25 billion size range, and studies of foreign banks have led to similar negative conclusions. 214 Moreover, the fact that the largest U.S. banks are engaged in too many lines of business has been seen as a cause of diseconomies of scope. Studies have found global diseconomies of scope in banks that are larger than $25 billion or which mix lending activities with nontraditional, fee-based activities such as securities underwriting. 215 Claimed positive synergies do not appear, then, as being as systematic and as obvious as had been foreseen before the enactment of the 1999 bill. Purely economic forces are not the only grounds for the poor results shown by many large bank mergers. Psychological factors such as managerial self-interest and "hubris" have also been said to play a significant role in explaining these results. Various economic and behavioural studies have concluded that senior executives have strong
212 Controlling, supra note 2 at 5 and 10-11. 213 For a genera1 overview of the se questions, see Transformation, supra note 4 at 279-335. 214 Transformation, supra note 4 at 274 and 275. 215 Transformation, supra note 4 at note 278.
65 motives to exp and their firms despite potential risks which may result from their new activities.216 Studies have shown that executives strongly seek expansion, as it diminishes the potential threat to their jobs from insolvency or hostile takeovers, while leading to higher compensation and increased prestige. 217 "Hubris" and excessive optimism have also caused executives to overestimate potential gains and underestimate the associated risks of acquisitions. 218 Both empirical and behavioural studies have concluded that "hubris" frequently leads merging-firm executives to take over companies by paying excessive merger premiums, and thus ultimately bring about inefficient results for shareholders.219 These impalpable patterns are found in many speeches and declarations of big-bank CEOs whose extreme confidence have sometimes led to overambitious statements. For instance, in announcing the creation of Citigroup in 1998, co-chairman Sanford Weill proclaimed "our company will be so diversified and in so many different are as that we will be able to withstand
[market] storms". 220 The years 2001 and 2002 have been sorne of the worst in history for the financial industry, as a result of the combined forces of geopolitical uncertainty, a series of corporate scandaIs, resulting loss of investor confidence and weakness of the financial markets. 221 However, despite converging conclusions drawn by experts about performance of big banks and equally converging depressing events, the most recent financial results of sorne of the world's leading American banks do not seem to reflect such pessimistic features. 222
216 Supra note 4 at note 288. 217 Transformation, supra note 4 at note 304. 218 Transformation, supra note 4 at 289. 219 Supra note 4 at 307. 220 Cited in Michael Siconolfi, "Big UmbreIla: Travelers and Citicorp Agree to Join Forces in $ 83 Billion Merger" Wall Street Journal (7 April 1998), at A8. See also declarations like "Bigger is indeed better. We're not in any business we don't understand" (declared when NationsBank's merged with Bank of America in 1998, by Hugh McColl, the resulting bank's CEO) or the famous statement by ABN Amro chairman Jan Kalffs: "Big will be beautiful in banking". 221 See for example Sandy Weill, who stated that "2002 was probably the most difficult year in recent memory for the financial services industry". "2002 Citigroup annual report", online: Citigroup
66 For example, lP. Morgan Chase's net income for the first six months of 2003 was 78% higher than for 2002, notably due to strong capital markets results in its investment bank division,z23 Credit Suisse Group doubled net profit in the second quarter 2003 to CHF 1.3 billion and reported net profit of CHF 2.0 billion for the first half of 2003. Both business units (Credit Suisse First Boston for Investment banking and Credit Suisse Financial Services for other financial activities) reported significantly improved results on this period.224 Merrill Lynch realized in 2002 a 20.2% pre-tax profit margin on $20 billion in net revenues in an extremely tough environment. Full-year 2002 net eamings were $2.5 billion, which constitutes the third best operating performance in the firm' s history.225 Finally, the world's largest financial institution, "giant of giants" Citigroup, achieved outstanding results in the past years. 226 As noted, "Citigroup goes from strength to strength and is by far the largest bank in the world in terms of capital and with pre-tax profits of $22.8 billion in 2002, it is also one of the most profitable, producing a retum on average capital of 38.8 %.,,227 Having passed through the numerous difficulties of 2001 by increasing both its eamings and profitability, Citigroup managed in 2002 to be one of the only financial services giants "whose eamings in 2002 were higher than in 2001.,,228 In 2002, Citigroup generated record eamings of $15.3 billion. On July 14th 2003, Citigroup announced new exceptional results for the second quarter, with 12% income growth driven by an 8% increase in its total revenues.229 Its stock priee, of approximately not only showed what could be done in a tough, low interest rate environment, but also showed their strength in the global arena, especially in relation to poor performers such as the Japanese and German banks ... US bank performance contrasts sharply with the continuing heavy losses at Japan's banks and the weakness of Germany's banks" and then even asking: The key question is: how can more of the world's banks achieve the profitability that the US banks have managed?"). 223 See "J.P. Morgan Chase Second-quarter 2003 earning release", online: J.P Morgan Chase
,67 $28 in July 2002, is reaching $44 a year after. It has doubled in the past five years and has been multiplied by more than six in the past ten years. 230 These results shall not lead to the categorical conclusion that deregulation in the U.S. financial services industry and the emergence of univers al banks is an economically profitable option. From a strict shareholder's perspective, it is true that sorne universal banks, like the two large st banks in America, J.P. Morgan Chase and Citigroup for instance, have obtained sorne encouraging results. However, these good performances do not apply to all financial players, and sorne of them have decided for example to refocus on more specialized market segments due to poor results as universal banks. Furthermore, these results are perhaps promising for sorne large banks, but it is worth noting that several small, niche providers have managed to do well too, if not better than their huge rivaIs. Here above mentioned hopeful performances are the results of cost savmgs for industry members, who can cross-sell their products and benefit from various types of economies. As predicted before the 1999 Act was passed, these cost savings were consequently expected to benefit to consumers. Have consumers effectively benefited from the aforementioned advantages of Gramm-Leach-Bliley so far? A recent study analyzes actions taken by large banks under the new financial and banking framework. 231 Examined financial giants include State Farm, Allstate, Merrill Lynch, Citigroup, or J.P. Morgan Chase. - With respect to lower costs for consumers, this study concludes that "deregulation and cross-industry expansion has not typically led diversified firms to offer cost savings for consumers.'.232 This in-depth investigation reports that almost no cost savings exist in the securities market and that they are very limited in the life insurance market. Finally, in
0d 0d 230 Citigroup stock price was $7.04 on September 2 1993 and $21.35 on September 2 1998. 231 DiLorenzo, supra note 189 (stating that "this study intends to assess potentia110wer costs for consumers through a wide panel of sample product lines from the banking, securities, and insurance industries. Banking products are interest rates on home mortgage loans, interest rates on bank deposits, and interest rates and fees on credit cards. For the life insurance market, rates for term life insurance are assessed. For the securities market, prices were examined for stock brokerage services and fees charged by mutual fund companies"). 232 Ibid. at 371.
68 the banking market, the absence of lowered costs for consumers is very significant, for most big banks and for most examined products. 233 - With regard to the increased convenience predicted to result from the existence of financial supermarkets, two observations can be made. First, it has been contended that consumers did not realIy take advantage of the "one-stop shopping" possibilities offered by diversified financial firms. 234 This assertion is essentialIy supported by the idea that consumers pre fer specialized providers and are drawn to the advantages of the Internet for banking products.235 These findings do not however seem to match the reality, given the evidence of the most pertinent financial results announced by several large banks which have adopted the one-stop shopping model. Moreover, potential benefits for consumers deriving from one-stop-shopping have been acknowledged recently as an option which does bring more convenience to consumers.236 - FinalIy, regarding possible emergence of new products for consumers, a question remains: is cross-industry consolidation a relevant factor in product innovation in the banking sector? This question prevents us from dec1aring with confidence whether or not deregulation in the financial sector has encouraged innovation per se. In effect, deregulation may have fostered competition in the United States, by alIowing new entrants into the insurance, securities or commercial banking market. AlI the key innovations of these past years nevertheless seem to have been made possible owing
exc1usively to the Internet. 237 We believe that innovation in the financial sector does not rest on only one ofthese explanations. Rather, technology may have triggered and created the possibility for these changes, but competition certainly has intensified the incentives for such improvements. We consider that if these innovations are primarily direct consequences of technological change, they may nonetheless have been spurred by competitive stimulation between large banks.
233 Ibid. 234 Transformation. supra note 4, at note 284. 235 Ibid. at note 285. 236 See DiLorenzo, supra note 189 at 372 [stating however that "the one-stop financial supermarket may offer convenience to consumers, but it also, in many cases, offers access to fewer products in a product line."] 237 For example, online operations with card account or online person-to-person funds transfers.
69 Increased competition and increased efficiency were expected to profit financial players, and ultimately consumers through lower prices and other benefits. However, as has been noted, "while consumer benefits were assumed to exist and to be significant, in reality, benefits have been mode st or even nonexistent.,,238 Competition does not only consist in pursuit or achievement of industry members' interests. Competition objectives cannot be considered to have been' met if they do not achieve involve consumers' benefits. Explanations for these rather disappointing results are various. A first one lies in the fact that overemphasizing potential consumers' benefits may serve short-term electoral interests for political leaders. From this perspective, claimed advantages to consumers wou Id have been mere dissimulation, aimed only at giving the illusion of an initiatives based on public interest. A second explanation may reside in the importance for private interests and industry lobbying groups ofhaving their interests satisfied. Particular groups may thus have a great interest in overstating sorne facts which in truth are uncertain. A third justification is linked with the tremendous complexity of the economy and the multiplicity of dynamic financial and economic factors. Predictions may be elaborated within a particular frame, or by reference to an expected future situation, but the economy is so complex and it changes so fast that external events may mitigate expectations or even prevent them. A fourth explanation relies on the notion of time. Deregulation of financial services industry occurred in 1999, and it is possible to conceive that that too little time has passed in order to permit one to assess objectively the possible consequences of such a reform. FinaIly, a last explanation lies in a more pragrnatic idea. Deregulation in the financial sector may lead to consumers' benefits, but only as long as economic players make the unambiguous decision to reflect their cost savings through lowered costs for consumers. Firms may adopt different business models, different strategies, in order to increase their competitiveness and their profitability.239 Although aIl of these policies aim at a single objective, ways to achieve it may differ. Not aIl strategies are based on a cost leadership
238 DiLorenzo, supra note 189 at 323. 239 Charles W.L. Hill & Gareth R. Jones, Strategie Management: An Integrated Approaeh, 5th ed. (Boston: Houghton Mifflin Company, 2001) at 205.
70 choice, which encourages firms to compete on a constantly lower price for consumers. It may, at any rate, not have been the option chosen by financial conglomerates.
5.2 Global Risks
"The combination of sound management by bankers and appropriate supervision by regulators will help ensure an atmosphere of safety, integrity, and service that will allow all segments of the industry to serve their important role in the nation's economy.,,240
5.2.1 Systemic Risk
5.2 .1.1 Definitions
Financial conglomeration has been regarded as a phenomenon which could potentially intensify, or lead to different types of risks that may impinge on the financial system and the economy as a whole.241 One ofthem is financial risk. Financial risk can be defined as a type of risk that encompasses the difficulties of financial institutions individually as well as a systemic financial crisis.242 The following discussion does not deal specifically with risks affecting financial players individually. Rather, a special emphasis is put on the concept of systemic risk and its main implications for financial conglomerates. Systemic risk, also called systemic financial risk, corresponds to the risk that the failure of a major large diversified bank will trigger serious disruptive effects on the
240 Govemor Mark W. OIson, "A look at the banking industry in 2002" (speech at the 107th Annual Convention of the Maryland Bankers Association, Palm Beach, Florida, 21 May 2002) online: Federal Reserve Board,
71 financial system and will in tum critically affect the general economy.243 Shocks which may create hazards for financial systems are threefold: shocks emanating from the "real" sector (everything but financial-market based sector), shocks from financial markets, and shocks emanating from the financial industry. The potential failure of a major financial institution is thus included in the third category.244 It is worth noting that in financial systems which do not present a very high level of concentration, a systemic event - the event that starts the propagation of the risk - cannot be one resulting from the lone failure of a financial institution. In such a system, systemic risk will rather be based on the combined forces of a triggering event associated to negative extemalities such as spreading los ses of value or of confidence over the whole system. In a highly concentrated system, to contrast, the collapse of a sole firm or market 245 may be qualified as a systemic event. In a competitive landscape dominated by a restricted number of huge diversified banks, failure of one major financial player may cause unacceptable systemic consequences for the whole economy. The collapsing giant will be bailed-out by taxpayers, as it has happened with relatively smaller financial institutions in Norway, Sweden, the United States or Switzerland in the past two decades.246 Banking crises caused by systemic risk which have occurred in the most advanced economies have had considerable economic consequences in the past. Costs associated with the resolution of banking crises and the rescues of collapsing financial institutions are often colossal. The price paid by GIO and other countries' govemments, and thus tax payers ultimately, has been said to range from about 4% of GDP in developed countries to about 9% in developing countries.247 In response to the banking collapse which took
243 See generally, "Systemic Risk: Fannie Mae, Freddie Mac and the Role of OFHEO" , Office of Federal Housing Enterprise Oversight (February 2003) online: OFHEO
72 place in the 1990s in Japan for instance, the Japanese government reportedly spent more than $ 1 trillion to spur the economy and budgeted more than $ 500 billion to rescue its banking system.248 The GDP of the United States as of July 2003 is around $ 10.8 trillion annually.
5.2.1.2 Systemic Risk and Universal Banks
Although systemic risk is not a purely American phenomenon, it is nonetheless a major source of concern for many observers oftoday's American economy. Sorne experts have notably argued that the existence of financial conglomerates strengthens the potentiality for systemic risk on financial marketplaces. 249
Universal banks and Diversification: Increased Complexity due to Cross-Industry Inroads Evidence of the last two decades shows that large banks, insurance companies and securities firms have adopted a vigorous consolidation strategy within the United States' financial sector. This evolution has created entities which are based on extremely complex structures and internaI features. While their businesses were expanding and their organization became more and more elaborate, large banks reportedly increased their involvement in high-risk activities associated with financial markets. 250 Analogous patterns illustrating a connection between diversification strategies and risk intensification have been found in the economies of most developed countries. It does not constitute an American specificity.251 In effect, a recent international study finds that between 1988 and 1998, large banks from more than twenty of the world's leading
Saporta "Costs ofBanking System Instabi1ity: Sorne Empirica1 Evidence" (May 2002) Journal of Banking and Finance, Vol. 26, No. 5 at 825-855 (quoting that "Another study of24 major banking and currency crises in the 1ast two decades estimated that cumulative los ses-the direct costs of reso1ving inso1vent institutions and the cost of 10st economic output-averaged rough1y 15-20 percent of annua1 GDP .19"). 248 Contro/ling, supra note 2 at 18. See also Akihiro Kanaya & David Woo, "The Japanese Banking Crisis of the 1990s: Sources and Lessons" International Monetary Fund Working Paper No. 00/7 (January 2000) online: IMF
73 economies have been taking increasing riskS. 252 Risky activities undertaken by big banks in the past years include for example underwriting "junk" (high-risk) bonds, leveraged syndicated lending, derivatives, securitization and venture capital related investments.253 By combining traditional lending-related activities to more sophisticated investment vehicles which have close links with financial markets, banks have become much more vulnerable to the unpredictability of market behaviour. It is possible to assert that any banking activity is based, quintessentially, on risk assessment, in order to anticipate an adequate retum on the investments that are made. Observing that traditional lending activities also contain risks, and that such activities can be much more risky than market related operations or insurance is not totally erroneous. For instance, financial giant Citigroup has absorbed spectacular losses as a result of loans granted to bankrupted Emon or within the context of the Argentinean crisis. One should remember that U.S. banks had already made a similar shift toward higher risk activities in the 1970s and the 1980s. It was one of the main reasons which led to the terrible banking crisis of the 1980s. Historical evidence then appears to be a significant element to deter banks from engaging once again in potentially disrupting activities. This banking crisis was not only the consequence of high-risk business strategies adopted by large U.S. banks. It also resulted from disastrous lending policies which allowed several categories of risky borrowers to benefit from huge 10ans,z54 Consequently, by 1990, U.S. banks he Id almost $ 600 billion ofhigh-risk 10ans. 255 It is also because of potentially deleterious effects of banks' diversification through merchant banking investments that the failure and subsequent bail-out of the French bank
252 See Gianni DeNicolo, "Size, Charter Value and Risk in Banking: An International Perspective", Working Paper Board of Governors of the Federal Reserve System (April 2001) online: IDEAS
74 Credit Lyonnais occurred.256 Indeed, what was then the largest French state-owned bank suffered huge losses after its merchant banking division, Altus Finance, used deposits to invest in foolish and high-risk non-banking ventures in several ailing European and U.S. enterprises such as Club Méditerranée or MGM studios. This infamous example of the potentially-disastrous consequences resulting from risky equity investments remains Europe's biggest-ever bank bail-out. Credit Lyonnais received successive bail-outs from the French government, for a total bill estimated at $ 27 billion. In the end, French tax payers had to bear the gigantic burden of the imprudent and silly diversification strategy of Credit Lyonnais into high-risk activities. Reference to these calamitous events sheds light on the fact that still, despite a long lasting banking crisis in the United States and resounding scandaIs in other countries, business options of sorne of the nation's largest banks significantly threaten the safety of the U.S. economy.
Universal Banks and Size: Concentrating Power within Rands of a Small Number of Entities Secondly, it is worth noting that risks inherent in potentially harmful diversification strategies are in essence not spread through a multiplicity of small or mid-size financial players. As mentioned above, consolidation of these past decades has led to the situation where an extremely small number of large diversified banks control a very substantial part ofthe U.S. financial industry.257 The troubling concentration of risky activities related to securities or derivatives within a few banks offers little support to the daims that larger banks would be safer and would not affect the stability of the financial system. Indeed, as it has been noted, "large banks failed at a higher rate than small banks during 1971-91, and excessive risk-taking by large
256 Transformation, supra note 4 at 284 and 322; Noelle T. Heintz & Robert M. Travisano, "What is past is Prologue: Why Congress Should Reject Current Financial Reform Bills and Breathe New Life into Glass Steagall" (1998) 13 St. John's J.L. Comm. 373 at 392 [hereinafter Prologue]. See "Slipping on Banana Skins" The Economist (4 April 1992); "A capital question" The Economist (5 February 1994); "Debit Lyonnais's encore" The Economist (25 March 1995); "Mal à la tête" The Economist {1 October 1994); "Aux portefeuilles, citoyens!" The Economist (28 September 1996); "The bitter end" The Economist (23 May 1998); See also Barry Jones "France Told to Recover Aid to Bank", International Herald Tribune (23 July 1998); Rachel V. Laffer "A Bank Bailout and Its Consequences" Wall Street Journal (10 July 1998). 257 Controlling, supra note 2 at 5.
75 banks posed the greatest threat to the stability of the U.S. banking system during the banking crisis of 1980-92.,,258 The fact that in ten years most of the U.S. financial sector will be controlled by a few huge univers al banks and that the number of financial services entities is predicted to shrink by 75% over the same period triggers serious concems about the soundness of the American economy.259 Such an intense concentration increases the possibility that the failure of one of the few players in the market will have disastrous 'domino' effects over the financial system, and ultimately, over the whole economy. This is systemic risk.
5.2.1.3 Supervisory Policies over Financial Conglomerates
Too Big Too Fail The emergence of larger and more complex financial institutions in the United States has led the Federal Reserve Board to define a new type of financial company called large, complex banking organizations, or LCBOs. 26o The main characteristics of such entities \ are the following: they bear substantial on- and off-balance sheet exposures, offer a wide array of services and products at both domestic and intemationallevels, and fall under the jurisdiction of several supervisors in the United States and abroad.261 In relation with the problem of systemic risk in financial markets, U.S. bank supervisory agencies have in the past three decades constantly applied an explicit policy to protect uninsured depositors and payment system creditors of major banks which had failed or were about to fail. This specific protection is commonly know as the "too big to fail" doctrine.262 The troubling interconnections between the "too big to fail" doctrine and the risks presented by LCBOs are twofold. They are briefly stated here.
258 Transformation, supra note 4 at 444. 259 Alan Levinsohn, "The Coming of a Financia1 Services Bazaar" Strategie Finance (April 2000) (citing a study re1eased in 2000 by PriceWaterhouseCoopers), supra note 5. 260 ,f' Group OJ Ten, supra note 242 at 133. 261 Ibid. 262 Congress codified the "too big to fai1" po1icy when it enacted FDICIA in 1991. See Federal Deposit Insurance Corporation Aet of 1991, Pub. 1. No. 102-242, 141(a) (1) (C), 105 Stat. 2275. Specifically, section 141 ofFDICIA authorizes the FDIC to protect uninsured depositors and other creditors in a large failing bank if such action is needed to prevent "serious adverse effects on economic conditions or financia1 stability. "
76 - First, several observers have noted that the "too big to fail" policy acts as an implicit perverse incentive for LCBOs to pursue their expansion.263 In effect, constant support offered by successive governments to protect entities from financial distress constitutes an outright encouragement for large banks to assume ever greater risks. Rence, various recent studies have shown that the "too big too fail" policy actually is in reality an indirect subsidy to large American financial institutions. Indeed, it allows them, first, to pay below-average rates to depositors and other creditors. Moreover, it offers them to remain market realities even when their capitalization is insufficient compared to the risks they take. 264 - Second, it is in fact quite disturbing to note that if U.S. regulators' CUITent policy encourages major banks to assume greater risks, it thus inevitably increases the probability that their failure will have even harsher consequences. Within this particularly scheme, U.S. federal supervisory agencies are bound to stick to their policy and thus have no option but to keep offering their crucial assistance to LCBOs. In a 2001 report on consolidation in the financial sector, the "Group of Ten" has recognized that the conjunction of complexity and unprecedented size of new financial giants does indeed increase the probability of systemic risk. 265 Another important issue in the context of LCBOs' effects on systemic risk is that LCBOs are in reality "highly integrated enterprises, despite the corporate veils between their various subsidiaries.,,266 In order to obtain expected synergies from cross-selling products and services, most financial conglomerates keep in reality a very centralized management and decisional structure. The objective of such an organization is to combine product offerings of their non-bank subsidiaries with the services of their bank (offering securities underwriting with syndicated lending or corporate-finance advice for the same corporate clients, for instance).
263 See e.g. Ron J. Feldman & Arthur J. Rolnick, "Fixing FDICIA: A Plan to Address the Too-Big-to-Fail Problem" (March 1998) 12 Region No. 1 (Federal Reserve Bank of Minneapolis) at 2 and 3-9; Edward J. Kane, "Incentives for Banking Megamergers: What Motives Might Regulators Infer from Event-Study Evidence?" (2000) 32 Journal of Money, Credit & Banking 672 at 673-74 and 691-94; Transformation, supra note 4 at 300-308,372-73 and 444-45. 264 Controlling, supra note 2 at note 20. 265 Group ofTen, supra note 242 at 125-146. 266 Controlling, supra note 2 at 15.
77 As a matter of fact, the highly developed integration of large financial institutions has obliged regulators to protect non-bank subsidiaries of LCBOs. 267 In effect, Federal authorities are greatly expected to widen the scope of "safety net" protections to the whole financial institution, and not only to its bank components, in order to avoid potentially disastrous consequences. AIso, in order to maintain stability of the economy and prevent reputational risk of the global entity, financial markets highly expect bank affiliates of LCBOs to give financial support to their non-bank parents in case of distress.268 The power of huge U.S. universal banks seems unlimited. The ability of financial giants to pursue ever-riskier activities does not give the impression that it may be held back or restricted by any mIe or authority. National as weIl as international regulators have nonetheless recently implemented a series of measures concerning large diversified banks. These mIes are aimed at ensuring the safety and soundness of financial systems, or at least seek to limit potential financial risks presented by LCBOs.
Current Risk-control Supervisory Measures
- American Regulatary Appraach ta Financial Risk under Gramm-Leach-Bliley Within the redesigned frame resulting from the enactment of Gramm-Leach-Bliley, American federal regulators rely on a fourfold pro gram to control risks presented by large diversified bankS. 269 First of aU, financial holding companies created by the 1999 Act are able to carry out securities, insurance and merchant banking activities only within separate corporate entities.270 The fact that activities which are commonly seen as more risky have to be undertaken within distinct affiliates is an idea which potentiaUy presents various benefits.
267 See e.g. Lisa M. Deferrari & David E. Palmer, "Supervision of Large Complex Banking Organizations" (2001) 87 Federal Reserve Bulletin at 51-53; Anthony Santomero & David L. Eckles, "The Determinants of Success in the New Financial Services Environment" (October 2000) 6 Economic Policy Review No. 4 (Federal Reserve Bank ofN.Y.) at 15 and 18-19 [hereinafter Determinants]. 268 Transformation, supra note 4 at 302-304 and 446-450. 269 The fourth part of the supervisory agencies' pro gram is related to the promotion of market discipline for LCBOs. It is not discussed hereafter. Rather, sorne of the potential obstacles which may arise in such an area for regulators are partially examined in the forthcoming section, within the particular context of conflicts of interest. 270 Supra note 9.
78 This may prevent fraudulent use and exchange of information or help to ensure financial health of the different affiliates of a financial holding company. However, in order to ensure the full efficiency of this measure, financial institutions have to show a strong will to respect such a provision. As seen before, huge financial institutions do not tend to comply with this type of restriction. Rather, they operate under a highly integrated model which tends to resist, and often totally disobeys, the presupposed corporate-separation requirement. Management and decisions are indeed typically made equally for non-bank affiliates and for banking subsidiaries. Secondly, banks within a financial holding company must be "well-capitalized".271 Capital requirements are not a mere creation of the 1999 bill. They constitute one of the cornerstones of banking regulation worldwide. Minimum-risk adjusted capital requirements were first contained in the 1988 Basel International Agreement. The FDIC Improvement Act of 1991 characterized various types of situations which may require "prompt corrective action". These measures may offer a significant reliability in terms of risk-monitoring for big banks, by allowing a progressive detection and thus resolution of possible financial difficulties. They led to a prevention of financial distress at earlier stages than would be allowed under usual a posteriori corrective systems. Nevertheless, capital reportedly constitutes "a lagging indicator of bank problems because dec1ines in capital are frequently not recognized or reported until banks have already become seriously troubled.,,272 Finally, banks within a Financial Holding Company must be "well managed". 273 F ederal bank supervisors assess banks' operations management standard through five characteristics.274 These criteria are capital adequacy, asset quality, management and administrative ability, earnings level, and quality and liquidity level. They are commonly summarized by the acronym CAMEL. U.S. Supervisors' role is therefore to rate banks from 1 (the strongest) to 5 (the weakest), for each ofthese criteria,
27\ See developments above at 3.1.4. 272 Arthur Wilmarth, Jr., "Restructuring the Federal Safety Net after Grarnm-Leach-Bliley", supra note 241 at 109. 273 Summmy, supra note 9 at 104-105, 108 and 112. See also Governor Laurence H. Meyer, "The challenges of global financial institution supervision" (remarks at the Federal Financial Institutions Examination Council, International Banking Conference, Arlington, Virginia, 31 May 2000) online: Federal Reserve Board
79 knowing that a bank which is rated 1 or 2 is considered as "well-managed".275 Two c1osely-linked reasons cause several observers to believe that management monitoring for LCBOs cannot be achieved with satisfactory results. First, such organizations have become increasingly complex?76 Second, large banks appear to be much more "opaque" than they used to with respect to the ratings undertaken by credit rating agencies.277 - The New Basel Agreement The CUITent U.S. risk-based capital requirements and supervisory initiatives are based on an international framework for capital measurement that was developed by the Basel Committee on Banking Supervision and approved by the Group of Ten Governors in 1988: the 1988 Capital Accord, or Basel1.278 This is the most fundamental e1ement with respect to capital adequacy standards for large, internationally active banks. It constitutes the basis for the risk-based capital adequacy standards now in place for aIl US banks and bank holding companies. In January 2001, the Basel Committee on Banking Supervision issued a new proposaI for a New Basel Capital Accord that will replace the CUITent 1988 Accord. 279 This proposaI, sometimes refeITed to as Basel II, pro vides a new regulatory framework based on "three pillars" (capital adequacy, supervisory review, and public disc10sure associated with market discipline) in order to "allow banks and supervisors to evaluate properly the various risks that banks face".28o In reality, however, Basel II capital
275 Ibid. 276 Controlling, supra note 2 at 35. 277 See Donald P. Morgan, "Rating Banks: Risk and Uncertainty in an Opaque Industry", Federal Reserve Bank ofN.Y., Staff Reports No. 105 (May 2000) online: Federal Reserve Board of New York
80 adequacy proposaI features two "new" approaches that have already been implemented by U.S. bank regulators: applying capital requirements on a consolidated basis to the entire structure of a financial holding company (inc1uding non-bank subsidiaries), and requiring capital standards for each Large Complex Banking Organization on the basis of internaI risk ratings which are developed by the financial institution's managers and reviewed by regulators. 281 After having extended the timetable for the adoption of Basel II because of numerous criticisms related to the initial project, the Basel Committee made several revisions, notably by means of public comment. On April 29, 2003, the Basel Committee on Banking Supervision issued a third consultative paper on the New Basel Capital Accord. 282 It accepted industry comments on the New Accord submitted through July 31, 2003. The Basel Committee now expects that the New Accord will be effectively implemented on December 31, 2006.
5.2.2 Conflicts of Interest
"No man can serve two masters, for either he will hate the one, and love the other; or el se he will hold to the one, and despise the other". 283
The notion of conflict of interest embraces an immense variety of situations. Conflicts of interest may occur anywhere. Where there is a dut y, wh ether explicitly stated, by law or on a deontological basis, or implied by morality for example, there may be such conflicts. Where there is an interest, or rather diverging interests, there may be such a conflict. In politics, in any type of business, in potentially any function, in professions relying traditionally on a high degree of ethical conduct, such as the legal professions for instance, conflicts of interest can be observed. They transcend disciplines and can bear
281 Controlling. supra note 2 at 2I. 282 See supra note 279. 283 Matthew 6:24.
81 different meanings depending on time and on geography.284 Like any notion directly linked with the even broader concept of morality, conflicts of interest are greatly variable. The following reflections do not purport to pro vide a comprehensive statement of all potential conflicts and measures which may be implemented in order to avoid or limit them. Rather, they seek to highlight sorne recurrent situations of conflict of interest which have emerged in the context of financial services, and more precisely within the particular framework ofU.S. financial conglomerates.
5.2.2.1 Historical Perspective
Conflicts of interests in the U.S. financial industry are not a new phenomenon. They are almost "as old as Wall Street.,,285 Louis D. Brandeis, for example, expressed deep concems about potential conflicts of interest in the banking sphere, as part of his fight against the "money trust" and more generally in the context of his lifelong struggle with the "curse of bigness". Notably, Brandeis was concemed about potentially deleterious effects resulting from the interlocking of directors between banks and non-bank companies. He asserted that "the practice of interlocking of directorates is the root of many evils. It offends laws human and divine .. .it tends to disloyalty and to violation of the fundamentallaw that no man can serve two masters.,,286 In his famous book "Other People's Money and How the Bankers Use 11" written in 1914, he stated "The banker should be detached from the business for which he performs the banking service ... this detachment is desirable, in the first place, to avoid conflicts of interest.,,287 In the context of the widely-spread anti-Wall Street sentiment, bankers in general, and Wall Street bankers more specifically were said to be the cause of the depression.288 They concentrated the resentment of an unprecedented consensus of opponents, which ranged
h 284 But see, for a definition of conflicts of interest, Black's Law Dictionary, i ed., s.v. "conflict of interest" (defining a conflict of interest as "a real of seerning incompatibility between one' s private interests and one's public or fiduciary dut y"). 285 See Karen Contoudis, "Analyst conflicts ofInterests: are the NASD and NYSE rules enough?" (2003) 8 Fordham J. Corp. & Fin. L. 123 at note 41 [hereinafter Enough?]. 286 See infra note 287 at 51. 287 See Louis D. Brandeis, Other People's Money and How the Bankers Use It (Fairfield, NJ: Augustus M. Kelley Publishers, 1914) at 196. 288 See e.g. Vincent Carosso, The Morgans - Private International Bankers J854- J9 J3 (Cambridge: Harvard University Press, 1987). See also Ferdinand Pecora, Wall Street under Oath - The story ofour Modern Changers (New York: August M. Kelley Publishers, 1968 [1939]).
82 from small banks and small businesses to the large majority of individual investors and populists such as Father Coughlin and Ruey Long. President Roosevelt, as weIl as William O. Douglas, Chairman of the SEC and one of the major actors of the 1930s financiallegislation, were also engaged intensively in this blind and extreme fight against bankers. AIso, the perhaps most touted motive for the passage of Glass-Steagall legislation corresponds to alleged abusive practices by commercial banks, which had progressively been undertaking investment banking activities, up until 1929.289 In the wake of the 1929 crash which devastated the U.S. economy, potential conflicts of interest of bankers were extensively criticized by contemporary political leaders. Senator Bulkley, for example, one of the most adamant congressmen with respect to the issue of fraudulent behaviour of bankers, reportedly stated: "If we are to relieve the banker of the temptation to put pressure on his commercial borrower to put out a security issue on which the banker will make either an originating or an underwriting profit we must keep the banks out ofthe security business.,,290
5.2.2.2 Potential Conflict Situations in "Traditional" Banking Institutions
Conflict situations which may arise within a banking institution have been increasingly significant in the past decades. 291 Rowever, if conflicts of interest have gained prevalence due to recent substantial evolutions of prerogatives and structure of U.S. banks, they have always been risks inherent in the most 'traditional' banking activity. Moral hazard and ethical standards constitute crucial issues when dealing with banking practice, in great part because of the crucial position he Id by banks in economies and of their resulting responsibility for public confidence. Most conflict situations involving banks may be triggered by the flow of material non public information and its propagation topeople who should not have such information. As has been noted, although these informational conflicts "are often referred to as
289 See developments above about the history of the Glass-Steagall Act. 290 Origins, supra note 48 at 47. 291 Peter e. Buck and Krista R. Bowen, "Intrabank Conflicts ofInterest" (1999) 3 N.e. Banking Inst. 31 at 31 [hereinafter Intrabank].
83 'conflicts of interest' between banks and their customers, they are more appropriately characterized ... as conflicts between bank customers.,,292 Two types of potentially conflicting situations that may occur within a banking institution can be enounced. These hypotheses can be sorted depending on the frame in which material nonpublic information will flow. Sorne conflicts may arise within a single department of a bank, whereas other conflict situations may be characterized by informational dispersion from one department of a bank to another.293 - In the first case, conflicts can arise when a bank, which possesses confidential information within one of its departments (such as its commercial loan department for instance) as a result of a particular business relation with a customer, enters into a relation with another customer which has a particularly sensitive position with respect to the previous client. This type of situation can be found for example in the case of a bank which would lend money to more than one bidder in the context of an auction of a corporation.294 Moral hazard may also result for instance from the situation in which a bank that has formerly been (or that is still) providing loans to the target of a takeover starts offering lending services to the potential acquirer of that target company. Because of the relationship previously held with the target, the bank, or rather its commercialloan department may have material nonpublic information which of course should not be disclosed in any way to the company that is going to purchase the former borrower from the bank.295 In such a situation, there seems to be a subtle division line between the freedom enjoyed by bank to engage in business relationships with various entities, and the necessary protection of confidential information held by the bank about its customer. Where does bank's freedom to serve its customers stop? How is customer's confidentiality (through material nonpublic information) protected? On what legal basis would a bank which discloses nonpublic information to another borrower be held liable? Judges have adopted a quite balanced position on this important point. In effect, while banks are not denied the freedom and the right to serve all of their customers ev en where
292 Ibid. at 32. 293 Ibid. 294 Ibid. 295 Intrabank, supra note 291 at 33.
84 there are singular links between them, the courts have limited banks' capacity to use and disclose nonpublic material information with a series of restrictions. 296 The first time that the issue of conflicting situations between two borrowers of a bank in a takeover context was addressed was in 1977 in American Medicorp, Inc. v. Continental Illinois National Bank & Trust Co. of Chicago. 297 In this case, American Medicorp, Inc. wanted to pro scribe its bank from making a loan to Humana, Inc. Both of these companies were customers of the same bank and since the latter had planned to take over the former, American Medicorp, Inc. feared that the bank would make use of sorne material nonpublic information. American Medicorp, Inc. 's claim was basically based on two different grounds. First, the plaintiff asserted that offering lending facilities to Humana would constitute, per se, a breach of a fiduciary obligation of the bank. Moreover, American Medicorp, Inc. argued that the bank had used sorne of the confidential information obtained in the course of their lending relation in order to decide whether or not to pro vide financing services to Humana. The judges refused to prohibit per se a bank from lending money to a company which has announced its intention to take over one of its customers for which confidentiai information was heid. However, the judges did consider whether the bank had used sorne of the nonpublic information previously released by its target-customer in making the decision to lend sorne money to the purchasing company. Although this initiative seemed conceivable, the judges did factually end this point by stating that the bank had not used any information received from American Medicorp, Inc. in its decision to make a Ioan to Humana, Inc. They finally concluded that American Medicorp, Inc. couid not do anything about the decision of the bank to Iend money to its potentiai acquirer. 298 Two years later, in Washington Steel Corp. v. TW Corp., U.S. appeai judges of the Third Circuit were asked once again to define the position of the law with respect to a Ioan to be granted to the potentiai purchaser of a company that was aiso a client of the bank. 299
296 Ibid. 297 See American Medicorp, Inc. v. Continental Illinois National Bank & Trust Co. of Chicago, 475 F. Supp. 5 (N.D. Ill. 1977). 298 Ibid. at 10. 299 See Washington Steel Corp. v. TW Corp., 602 F.2d 594 (3rd Circuit 1979) [hereinafter Washington Steel].
85 As in the previous case, the target of a takeover, Washington Steel Corp., sought to enjoin a loan that was about to be made to its potential purchaser, arguing that the bank, Chemical Bank, had violated its fiduciary duty. Once again, the plaintiff alleged that the bank had misused nonpublic material infonnation obtained during their relationship in de ci ding whether to finance the purchaser's tender offer itself.30o Just as in the American Medicorp decision, judges of the Third Circuit concluded that there was no legal basis to impose a per se fiduciary dut y on the bank based on its receipt of confidential infonnation.301 This time though, the judges' justification for this rejection was public policy. In effect, they stated that imposing a per se fiduciary dut y on the bank in such a situation would allow companies who want to "insulate themselves from takeovers, or even from ordinary competition ... [to] simplyarrange for a series of loans from most of the major banks, supplying those banks with the requisite non-public infonnation".302 More importantly, it would preclude banks from engaging in business relations with a lot of potential customers, among which would be aIl the companies which could possibly want to purchase the borrowers. 303 On the plaintiff s claim that the bank had misused material nonpublic infonnation in order to serve its other customer' s interests, the Court asserted that even if it the bank had truly used the confidential infonnation, there was no reason to argue that "a bank violates any dut y it may owe to one of its borrowers when it uses infonnation received from that borrower in deciding wh ether or not to make a loan to another prospective borrower.,,304 One point that D.S. judges never examined in these two different cases is whether the solution would be identical in the case where a bank would propagate material nonpublic infonnation beyond the limit constituted by its commercial lending department. This point is briefly addressed below.
- Conflicts of interest can also occur III the situation where sorne confidential infonnation is dispersed between different departments of a single bank. In effect, commercial banks can experience conflict situations as a consequence of the multiplicity of its departments, and moreover, of the plurality of functions which may be undertaken
300 Ibid. at 597. 301 Ibid. at 599-60l. 302 Ibid. at 60 l. 303 Washington Steel, supra note 299 at 60l. 304 Washington Steel, supra note 299 at 602-603.
86 by the different departments of a banking organization.305 For example, nonpublic information may be disseminated from the commercial lending department, to a separate bank department like the trust department whose role is to provide its clients with recommendations on investments.306 Another problematical situation may occur when a bank obtains information about a particular company when advising a corporation which is willing to go public or which plans to merge with another entity for instance. The diffusion of confidential information acquired by bank as a result of its advisor's role, to the trust department of the bank (which may also issue recommendations on the company it advised) should be considered as improper per se, as long as the relevant information is material and non public. Indeed, the propagation of such information to the trust department may affect the objectivity and independence of the professionals who provide recommendations on stocks to investors. However, flow of information from the loan department or another department to the trust department of a bank should not always be regarded as constituting reprehensible conflict situations. When a bank issues recommendations on stocks, these recommendations have to be made exclusively on the basis of financial information available to the public, and it is fully prohibited for professionals working at a bank's trust department to review nonpublic information in order to analyze corporate stocks and make buy or sell recommendations. 307 In conclusion, it is important to note that although diffusion of material nonpublic information needs to be eradicated to prevent conflicts of interest, propagation of public information from one department of a bank to its trust department is thus not only allowed but may also be very useful.
5.2.2.3 Moral Hazard, Conflicts ofInterest and Univers al Banking
Foreword Universal banking cannot be seen as an indivisible global ground responsible for conflicts of interest in the financial services sector. In reality, increased moral hazard within the financial industry may rather result from the presence of different patterns
305 lntrabank, supra note 291 at 45. 306 Ibid. 307 See infra definition of research analyst.
87 which are usual accompanying characteristics of the creation of financial conglomerates in a country. The combined forces of abundant intra-industrial mergers, intense cross industry consolidation, the incapacity of regulators to catch up with the evolution by providing adequate supervisory measures, the unrelenting expansion of the range of activities undertaken by banks, and the consequential .complexity of resulting financÜtl institutions may thus increase the likelihood of conflicts of interest. 308 If these factors may individually contain seeds for recurrent conflict situations, their combination seems to intensify even more significantly the possibility of moral hazard in the financial sector. As indicated above, a great proportion of conflict situations are constituted by "informational conflicts". AIso, universal banks enjoy an immense amount of information, in consequence of the multiplicity of departments and functions that coexist within their corporate holding structure. This fact deeply strengthens concems about potential conflicts of interest. Recent developments undergone by the U.S. financial industry, namely an unprecedented wave of consolidation coupled with landmark deregulatory initiatives, have led to the creation ofhuge diversified banks. As a combined product of all the previously described features, univers al banks have often been predicted to be vehicles which could crystallize hazardous situations. Recent Wall street corporate scandaIs have offered very topical arguments to big banks' opponents, while undermining in sorne way the moral validity of the universal banking model. Before examining in details the most infamous events which have lately occurred within the U.S. financial sphere, the following developments provide a presentation of the most common hypotheses of conflict situations which may occur in the context of universal banks.
Conflict Situations in Universal Banking
- lnformational Conflicts and Other Conjlict Situations Various conflicts of interest may occur in the context of the notoriously wide range of activities which can be undertaken by univers al banks.309 Indeed, many of the alleged abuses are the direct consequence of the synergies that are available for a universal
308 lntrabank, supra note 291 at 45. 309 See Does it Work?, supra note Il (for a matrix representing the different hypotheses of conflicts of interest)
88 bank.310 Financial giants enjoy incredible quantities of infonnation about their many clients. Since this benefit emanates from the cross-selling ability of large banks, it is closely linked with advantages of these finns such as economies of scope. In 1994, Anthony Saunders and Ingo Walter have listed sorne of the major types of potential conflict situations which may be raised in a univers al banking environment. 311 It is worth noting that although universal banks can offer a variety of financial activities including life insurance or corporate finance advice, the issue of conflicts of interest frequently lies in situations involving the activity of underwriting securities for banks. 312 A first potential conflict situation results from the controversial concentration of securities-related and traditional banking functions within, in reality, a single overall financial player. In effect, in a universal banking milieu, salespeople and managers working at a bank have the opportunity to sell financial products of their affiliates. The objectivity of a broker when advising on the "best" financial options for their customers can therefore be undennined by the fact he has clear advantages in selling products offered under his "brand" (by its affiliate), rather than in promoting products offered by competitors. When the interest oftheir customers does not come first, brokers do not give "neutral" advice. If customers are even more disadvantaged, financially, consequently to the products that have been sold to them by the "broker-salesman", then there is a conflict of interest. This first situation has been commonly called the "Salesman 's stake". 313 A second hazardous situation may arise in the context of a large diversified bank which is able to engage in securities underwriting and which can also make investments on behalf of high-net worth individuals, for example (private banking), or make investments on its clients' accounts for its trust department. When the securities affiliate of a bank, whose function is to underwrite securities (in IPOs for instance), does not succeed in placing all of the securities in the open market, it may be try to "stufj" the discarded securities on fiduciary accounts managed by its investment affiliate and for which it enjoys a discretionary power. 314 There again, since the bank does not seek
3\0 Determinants, supra note 267 at 16. 3llSaunders & Walter, supra note 8 at 179. 312 Ibid. 313 Ibid. 313 Saunders & Walter, supra note 8 at 179.
89 primarily and above aIl to meet its clients' interests, no matter what the financial outcomes may eventually be for them, it definitely constitutes ethically reprehensible behaviour. Conflict situations also exist when a bank transfers to public investors the bankruptcy, or more generally the insolvency risk, assumed in commercial loans. Such a fraudulent operation is materialized for example when a bank, which knows that one of its clients will not b able to repay its loan due to severe difficulties, encourages the financiaIly distressed company to issue bonds or equity through its securities affiliate. Such a mechanism is very lucrative for the bank. The advantages obtained by the financial giant are twofold. First, the proceeds of the issue may be enough to pay off the totality; or least a great part, of the loan, which had seemed rather unhoped-for in such a situation. Moreover, this operation allows the securities affiliate of the bank to benefit from substantial fees, because of the underwriting realized. However, in this hypothesis, the bank hazardously transfers the bankruptcy risk of one of its customers, from itself to the public. This is highly dishonest since the commerciallending department of the bank was aware of the risk presented by its client but did not disclose this crucial fact to the investors, thus misleading an unwary public. Another type of typical informational conflict of interest can take place when one section of a financial conglomerate retains material, private information about a customer in order to allow other units to obtain higher eamings on that customer than they could have had otherwise. In effect, a commercial loan department, for instance, of a large bank, may become privy to certain material information and may try to use it for purely lucrative purposes ("in order to gain competitive advantage") in an operation handled by one of its other departments, such as its insurance affiliate or its asset management department. 315 This conflict situation cannot be intrinsically associated with univers al banks.316 However, it may occur with increased probability and intensity in financial conglomerates due to the wider range of activities which can be undertaken and to the resulting complexity and opacity ofthese organizations.
315 Determinants, supra note 267 at 16. 316 See developments above at 5.2.2.2. about potential conflict situations in "traditional" banking institutions.
90 - Tying Situations Tying agreements are not specific to the banking or financial world. Tying practices constitute one particular area of antitrust law. 317 Also, general competition-law provisions based on these rationales exist for various other industries such as general or specialized retail industries for example.318 In the United States for instance, anti-tying provisions of the Sherman Act have recently been involved, in highly-publicized judicial actions conceming the software market segment, against giant Microsoft. lndeed, section 1 of the Sherman Act prohibits "every contract, combination '" or conspiracy, in restraint of trade or commerce. ,,319 In our case, a tie-in or "tying" agreement can be defined as an agreement by which financial conglomerates (under the corporate structure of financial holding companies for instance) would provide commercialloans, lease or sell property, or fumish services only under the condition that the customer may ob tain some additional credit, property or service from the bank, its holding company or subsidiaries.320 However, it is worth noting that tying situations are only reprehensible when a company which offers bundled services or products has "market power". Generally speaking, tying corresponds to the situation where a bank grants or prices credit on the condition that the borrower obtains other products or services offered by another unit of the bank. Universal banks have been described as creating particularly fertile ground for tying due to the combination of different products and services on which they rely. lndeed, conflicts can occur when a financial organization packages products from different banking businesses, and moreover "ties in" the financial conditions of such transactions. As a general result of the synergies allowed by financial conglomeration, such a practice flows from the ability of a large diversified bank to use its market-power in one specific market segment, in order to push its client to purchase products of a different product line, which are offered by its affiliate. Different types of
317 See 54 Am. Jur. 2d Monopolies, Restraints ofTrade, and Unfair practices (2000) (defining a tying agreement as "an agreement by a party to sell one product but only on the condition that the buyer also purchase a different (or tied) product, or at least agree that he or she will not purchase that product from another supplier"). 318 For example, the "Loi Galland" of 1996 in France. 319 See Sherman Act, 15 D.S.C. 1. See also the important decision International Salt Co. v. United States, 332 U.S. 392 (1947) (affirming for the first time the validity of the use of the Sherman Act per se test for illegal tying). 320 Backgrounds and Implications, supra note 79 at 20.
91 tying situations may occur within a universal bank. Variations between these hypotheses may not only result from the multiplicity of financial products that can be "tied-in" by a bank, but may also arise from the way in which banks decide to tie the financial products or services together. Tying is a relatively frequent type of corporate misbehaviour today in the financial industry. Recently, a trade association study reported that 56 percent of nearly 700 large companies surveyed complained about either denied credit or changed terms of credit after the company refused to purchase other services. 32J Moreover, numerous top policy makers, such as Senate Banking Committee Chairman Richard Shelby (who expressed his "long-standing concems" about tying) , SEC Chairman William Donaldson (who confirmed in February that he would investigate alleged tying abuses), or Congressman John Dingell have reportedly expressed alarming signs about tying practices of large banks in the United States.322 Because of the specificity of the relationships enjoyed by commercial banks with their clients, and because general provisions embodied in the Sherman Act or the Clayton Act were not considered to be sufficient or, rather, appropriate to the banking context, Congress enacted antitying restrictions in the 1970 the Bank Holding Act Amendments. 323 Yet, tying of bank services became even more likely to occur in 1999 with the passage of the Gramm-Leach-Bliley Financial Services Modemization Act which took apart the longstanding walls between banking, brokerage and insurance. Hence, in 1999, Congress decided to transpose to newly created financial subsidiaries of
321 "US regulators define bank product linking mIes" Reuters (25 August 2003) online: Forbes
92 national banks the existing anti-tying provisions, namely section 106 of the Bank Holding Company Act, which seeks to prevent tying, reciprocal and exclusive dealing agreements that could be passed into between depository institutions and their affiliates. Indeed, banks enjoy a unique function in national economies; more specifically, they have a fundamental role as credit suppliers for small and large companies. In 1970, Congress perceived tie-in situations involving credit as "inherently anti competitive, operating to the detriment of banking and non-banking competitors alike; thus the anti-tying special provisions were intended to regulate conditional transactions in the extension of credit by banks more stringently than had the Supreme Court under the general antitrust statutes.,,324 When the Bank Holding Company Act was amended, banks were identified by congressionalleaders as potentially harmful economic players because their market power could allow them to coerce rather weak customers such as individuals or small (or distressed) businesses into accepting to purchase unwanted products or services as a condition of getting credit that they desperately needed.325 As a matter of fact, Congress elaborated provisions which originally intended to reach a broad panel of tying situations. However, in order to avoid the application of such measures, financial organizations have unsurprisingly gone beyond the predictable "if you purchase this, you will get a discount on that. .. " Tying situations are not any longer, if they ever were, usually contained in explicit contractual stipulations?26 Most of today's tying situations are implicit, hidden and thus harder to detect, resulting in more complex situations and in financial arrangements that have been implemented by large banks in order to circumvent existing laws. Whatever the modalities of these arrangements may be, they are nonetheless always based, in essence, on an unacceptable idea of coercion for consumers. The need for a clear and appropriate definition of tying is, today more than ever, of very significant importance.
324 National Association of Securities Dealers (NASD), Press Release, "NASD Advises Securities Firms on Tying Arrangements" (19 September 2002) online: NASD
93 An example of tying agreement is commonly referred to as th ird-pa rty loan. 327 In third-party loans, a financial conglomerate may have an incentive to offer loans at below market price conditions to customers of a securities underwriting, but on the exclusive condition that the proceeds of this financing opportunity are used to purchase products sold by other units of the same financial organization, such as life insurance products or securities that are underwritten by its affiliate, for example.328 More standard tie-in practices include tie-in sales based on "credit threat", by which a bank could use the threat of withholding or rationing credit to force one of its customers to purchase other products offered by another of its units, such as investment products.329 Other illegal situations of tying commercial bank loans to investment banking services can arise when "bridge loans" are provided with the purpose of being repaid out of the proceeds of a bond offering. 330 In the wake of recent tying practices which have been sanctioned by U.S. authorities, sorne commentators have expressed concems about the questionable compatibility of the relatively old section 106 anti-tying provision with the spirit and the letter of Gramm Leach-Bliley.331 As exposed by practitioner and academic authority Clyde Mitchell, The essential purpose of GLB is to enable banks and other financial services firms to compete head on by allowing them to offer each other's product lines. The concept raises important questions about the anti-tying provisions' applicability in this newly liberalized market. Congress should consider modifying the anti-tying provisions to reconcile them with the spirit and letter of GLB ( ... ) Clearly, the banks' coercive market power is not what it was thought to be 33 years ago, when the anti-tying provisions were drafted, at least not with respect to the corporate credit market, in which the banks must now compete with new entrants under GLB.
One of the arguments claimed by proponents of redesigned antitying provisions is that existing antitying provisions do not take into account the variety of situations in which allegedly fraudulent agreements can occur. Notably, it has been argued that identical restrictions apply to a bank lending $1 billion to a large corporation-which is seen as a
327 Saunders & Walter, supra note 8 at 179. 328 Ibid. 329 Ibid. 330 NASD Advice, supra note 324. 331 See Robert Litan, "Banks must be untied from an outdated law" Financial Times (6 May 2003). See also Mitchell, supra note 325.
94 "transaction of relative equals"-in the same way as they apply to a bank extending a credit line to the "neighborhood auto-supply store".332 Concems of this kind seem to invite reform of existing provisions or at least to caU for clarification of the somehow hazardous situation of tying agreements in the United States. In this rather troubled context, the Federal Reserve has recently decided to adopt a more aggressive attitude toward the many questions and doubts expressed these past months. It issued a few days ago new policies regarding the definition of tying situations within the U.S. financial services industry.333 What does this long hoped-for initiative truly consist of? The Federal Reserve Board's input in this tumultuous debate is threefold. It is based on a proposed interpretation of existing rules, on supervisory guidance for concemed players, and also on an exception to antitying provisions. In its proposaI, the Fed requests public comment (before the 30th of September) on its new interpretation of the anti-tying restrictions contained in section 106 of the Bank Holding Company Act Amendments of 334 1970.
The Board's aspiration lS to propose an interpretation of section 106 by offering banking organizations and their customers supervisory guidance about these provisions, 335 thereby helping banks ensure and monitor their compliance with section 106. The Board also proposes the adoption of an exception under section 106 for the financial subsidiaries of state nonmember banks.336 Despite such an outwardly strong determination to provide more clarity as to what is, and what should not be regarded as, tying agreements, the Fed's initiative does not seem to do much to attain these objectives. Numerous commentators have already expressed disappointment with respect to the Fed's proposal.337 Their arguments are notably based
332 Mitchell, ibid. 333 Federal Reserve Board of Govemors, Press Release, "Press release for Proposed interpretation and supervisory guidance with request for public comment" (25 August 2003) online: Federal Reserve Board
95 on the fact that by saying that tying is now perfectly legal in sorne cases, the Fed merely ratifies the situation in which loans are linked to investment banking deals. 338 For instance, the Fed announced in its proposaI that sorne tying of financial services is permissible, like linking discount with the condition that several insurance poli ci es are purchased. This proposaI evidently highly satisfied Wall Street commercial banks, as they have been using, for years, their ability to offer loans to their clients in order to get other lucrative business such as advising on deals or underwriting securities. However, an announcement of rather symbolic importance, but in the opposite direction, was made by the Federal Reserve Board two days after the issuance of the new proposaI by the regulator. On August 27, 2003, the Fed announced that it was fining German bank WestLB, based in Düsseldorf, and its New York Branch, $ 3 million for violations of anti-tying restrictions contained in section 106 of the Bank Holding Company Act Amendments of 1970, and related unsafe and unsound banking practices. 339 In effect, the Fed stated that in 2001, WestLB conditioned the availability or price of credit to corporate customers upon the corporate customer's appointment of WestLB as an underwriter for issuances of debt securities.340 Notwithstanding the seemingly disappointing consequences of the Fed's recent announcement, and since insufficient time and as yet-incoherent administrative policy do not allow us to see its imminent evolution, no further discussion of this initiative can legitimately be provided in this paper. Only an unyielding political will, the course of time, and the reactions to this plan will be able to define the attitude adopted by federal authorities conceming the issue oftying in the U.S. financial services industry.
regulation-and how little it has changed in the post-Emon environrnent") [hereinafter Silverman]. See also Davenport, supra note 322. 338 S'l1 verman, supra. 339 Federal Reserve Board, Press release, "Order to cease and desist and civil money penalty against WestLB AG and its New York branch" (27 August 2003) online: Federal Reserve Board
96 General Observation The discussion here provided intentionaIly focuses on the issue of moral hazard through conflicts of interests as weIl the specific case of tying in the financial services industry. However, other foreseeable risks which are also related to moral hazard in the context of universal banking have been raised in these past years, buttressed by the evidence ofresounding investment failures encountered by several huge U.S. and foreign banks. These significant risks are commonly said to arise from the combination of commercial and investment banking. Merchant banking debac1es affect customers of big diversified banks and as such, are related on a broad basis to ethical issues in the field of banking. These downsides nonetheless remain inherently associated with the issue of systemic risk. 341 For that reason, they have not been examined in this section.
5.2.2.4 Evidence of Recent ScandaIs and the New Evil of Wall Street
"1 don't think it is the right thing to do. John and Mary Smith are losing their retirement because we don't want a c1ient's CEO to be mad at US.,,342
Overview and Selected Issues On April 8, 2002, New York Attorney General Eliot Spitzer announced sc andalous findings related to analysts' conflict situations at Merrill Lynch?43 Mr. Spitzer revealed that Merrill Lynch analysts issued flawed and misleading research reports and recommendations on numerous stocks in order to generate investment banking fees for 344 the bank. According to Mr. Spitzer, even though senior officiaIs at Merrill Lynch were aware of such wrongdoings, they continued to assure public investors that the information was independent, objective, and unbiased.345 Repeatedly, Merrill Lynch (analysts) public1y recommended investors to buy stocks while expressing contrary views in private
341 See supra, note 256, about the example of the merchant banking debac1e of Credit Lyonnais through its investment unit Altus Finance. 342 Complaint of a research analyst at Merrill Lynch about giving a rnisleading "buy" rating to a poor investment. See Office of New York Attorney General Eliot Spitzer, Press Release, "Merrill Lynch Stock Rating System Found Biased by Undisc10sed Conflicts ofInterests" (8 April 2002) online: Office of New York Attorney General
97 about the same stocks, describing them as "dogs", "piece of shit", "junk", warning that the company was "falling apart" or stating there was "nothing interesting about the company except banking fees".346 As the market for Internet stocks plunged, Merrill Lynch was issuing recommendations to accumulate or buy stocks while contemptuously disparaging these companies.347 The recent corporate governance scandaIs at Emon, WorldCom and other major corporations have revealed troubling conflicts of interest in relations between large financial institutions (whether "true" financial conglomerates or huge investment banks), sorne of the largest U.S. companies, and other prominent players of the financial sphere such as accounting firms and credit ratings agencies. 348 If financial conglomerates are not directly linked to the latter two categories, wrongdoings by the former two groups have arisen within the newly created and authorized univers al banks. 349 The integrity of securities analysts and investment bankers of several big U.S banks such as Merrill Lynch but also J.P. Morgan Chase or Citigroup has been seriously undermined lateIy.350 These banks have had to pay enormous fines following the misconduct of sorne of their star analysts, but confidence in financial institutions still has not been restored. In reality, the kinds of conflicts of interest that have arisen in this troubled period were hard to avoid. Indeed, they reportedly took place in an environment that fostered, for three main reasons,
346 See Office of New York Attorney General Eliot Spitzer, "Affidavit in Support of Application for an Order Pursuant to General Business Law Section 354" at 13, Spitzer v. Merrill Lynch & Co., No. 02-401522 (N.Y. Sup. Ct. Apr. 8,2002) online: Office of New York Attorney General http://www.oag.state.ny.us/press/2002/apr/MerrillL.pdf). 347 Ibid. at 9-13. 348 See Controlling, supra note 2 at 37. 349 Ibid. 350 See "Merrill finalizes $80 million Enron-related payout" Forbes (17 March 2003). Merrill Lynch, the largest investment bank in the world, has agreed on February 20 to pay an 80-million dollars settlement to the SEC to avoid further investigations about its role in Enron scandaI. The US. regulator has approved yesterday, on March 17, a settlement in which Merrill will pay $80 million US to resolve the case. Merrill Lynch had already pioneered at the beginning of Enron scandaI, agreeing to pay 100 million dollars to New-York state in order to end Attorney General Eliot Spitzer's investigations. See also "Le PDG de Morgan Stanley défend l'indépendance de ses analystes" Le Monde (24 February 2003). Eliot Spitzer started to investigate on these issues in March 2002, and the SEC started in July 2002 to look at potential corporate misbehaviour from the largest U.S banks. In September 2002, Mr. Spitzer and the SEC began to collaborate and in December 2002, after months of negotiations, both regulator and General attorney announced that they had reached a global settlement with 10 of the largest fmancial institutions. Citigroup SSB, Credit Suisse First Boston, Morgan Stanley, Goldrnan Sachs, Merrill Lynch, Deutsche Bank, Bear Stearns, JP Morgan Chase, Lehman Brothers and UBS Warburg agreed to pay together 1.4 billion dollars, ofwhich 900 millions as a fine, 85 millions to fund an investor's education program, and 450 millions to finance independent research.
98 35 analysts' fraudulence. ! Leading analysts employed by investment banks hence had very strong incentives to recommend favorably the stocks ofbig companies.352 First, managers viewed analysts' recommendations as a decisive criterion in deciding whether to have business relationships with their investment bank. These analysts then got large bonuses when they helped their investment bankers' colleagues in securing merger deals and underwriting. Moreover, investment banks dismissed several major analysts who issued critical evaluations of sorne big banks or other corporations. 353 These conflicts of interest clearly constitute a major part of the general loss of confidence that markets and economic payers have been facing for more than two years now. th On April 28 , 2003, ten of the largest U.S. financial organizations settled enforcement actions that had been launched for alleged conflicts of interest between their research and investment banking units. 354 This global settlement constitutes the finalization of an agreement in principle that had been announced by U.S. federal regulators in December 2002, following joint investigations of U.S. securities watchdogs. The historie settlement required banks to pay penalties of $487.5 million, in addition to disgorgement of $387.5 million, other payments of $432.5 million to subsidize an independent and external research that would be offered to their clients in addition to their own research, and payments of $80 million to fund investor education, for a total of approximately $1.4 billion?55 Such an amount is substantial, but in comparison with Citigroup' s profits for the second quarter of2003, or with what other huge banks such as J.P. Morgan can make, this is surely not a "financial" issue- probably more a reputational one- for financial giants. The ten firms concerned by this important settlement are Bear, Stearns & Co., Credit Suisse First Boston, Goldman, Sachs & Co, Lehman Brothers, J.P. Morgan Securities, Merrill Lynch, Morgan Stanley, Citigroup Global Markets (formerly Salomon Smith Barney), UBS Warburg and U.S. Bancorp Piper Jaffray.356
351 Controlling, supra note 2 at 37-38. 352 Ibid. 353 Ibid. 354 See NASD, North American Securities Administration (NASAA), New-York State Attorney General, NYSE and SEC, Joint Press Release, "Ten ofNation's Top Investrnent Firms Settle Enforcement Actions Involving Conflicts ofInterest Between Research and Investment Banking" (28 April 2003) online: SEC
99 th Exactly two months later, on July 2S , 2003, lP. Morgan Chase and Citigroup, the two largest banks in the United States, agreed to pay almost $300 million in order to settle accusations regarding their roles in Enron's manipulated financial statements before the collapse of the industrial giant. 357 This specific case is not intrinsically tied to moral risks of universal banking. However, its occurrence is significantly relevant in the context of the infamous wrongdoings committed by several financial conglomerates. Infamous examples of conflict situations involving sorne of the most famous Wall Street star-analysts have been widely reported in the past months. Two of them shamefully illustrate the highly reprehensible facts that have occurred in large diversified U.S. banks. Jack Grubman, "Wall Street most celebrated telecom analyst", "Citigroup's star analyst", resigned in August 2002 from Salomon Smith Barney (Citigroup's investment banking unit), with a $32 million severance package.358 Between 1997 and 2000, Citigroup was obtaining a huge part of the investment banking deals that were made in the telecommunications sector. It thus reportedly earned almost $1 billion in fees while raising more than $190 billion for its telecom clients.359 Grubman played a crucial role in the very lucrative telecom era at Citigroup's investment banking department. As a Managing Director and research analyst at Salomon Smith Barney, in charge of the telecommunications sector, Jack Grubman was then the "linchpin for Salomon Smith Barney's investment banking efforts in the telecom sector".360 As such, his assent and favorable view were important for the bank in order to keep on making investment banking deals with telecom companies.361 Between 1999 and August 2002, when he left the firm, Jack Grubman was earning a regular compensation of $20 million per annum.
357 See SEC, Press release, "SEC Settles Enforcement Proceedings against J.P. Morgan Chase and Citigroup" (28 July 2003) online: SEC
100 On April 2S th 2003, joint voices of the SEC, Eliott Spitzer, the NASD and the NYSE announced that Jack Grubman was censured and barred for ever from the securities industry, and fined him a total of $15 million to settle the charges against him?62 This ended a joint investigation about allegations of undue influence of investment banking interests on research analysts at large U.S. brokerage firrns such as Citigroup or Merrill Lynch. In reality, Mr. Grubman was charged with four types of shocking behaviours, different, though c1early linked together and converging into a same reprehensible prism. - First, he pub li shed fraudulent and misleading research reports on two different telecom companies, Focal Communications Corporation and Metromedia Fiber Networks, Inc. These reports predicted unrealistic future revenues for these businesses, did not disc10se material facts about these firrns, and contained material misstatements, thereby misleading investors on the huge risks associated with investing in these companies. For instance, Grubman published two notes on Focal Communications in February and April 2001 that reiterated a buy recommendation and left the target price unchanged from $30 (twice the stock price of $15.50 at this time), predicting significant growth for the company. However, these reports were saying the exact contrary views which Grubman himself and other analysts of his team privately expressed. In effect, the same day as the February Note, Jack Grubman stated that he believed Focal should be rated a 4 (underperforrn) rather than a 1 (buy), that "every single smart buysider" believed its stock price was going to zero, and that the company was a "pig".363 Mr. Grubman kept on advising investors to buy Focal Communications while he and prominent members of his staff were expressing radically different views on this company, describing the company as a "short" that needed to be downgraded.364 Contrary
362 See NASD, New-York State Attorney General, NYSE and SEC, Joint Press Release, "The Securities and Exchange Commission, New York Attorney General's Office, NASD and the New York Stock Exchange Permanently Bar Jack Grubman and Require $15 Million Payment" (28 April 2003) online: SEC
101 to these negative opinions, Jack Grubman issued on April 30th another Note on Focal that again advised investors to buy stocks ofthe company. At the end of April 2001, Grubman had reiterated on several occasions his negative views on Focal. Though the stock price had fallen to $6.48, Grubman fixed a new totally unrealistic and untrustworthy target price of$15. Focal Communications filed for bankruptcy in 2002. Similar facts occurred with Metromedia Fiber Networks, Inc. 365 Metromedia Fiber was an important investment banking client for Salomon Smith Barney, which earned approximately $49 million in investment banking fees in the firm's deals, from its IPO in 1997 to other investment banking transactions until 2001. After Metromedia Fiber's IPO, Mf. Grubman, who was in charge of company's review, held a 1 (Buy) rating and maintained it until July 25, 2001 although he regularly expressed his negative opinion on the company' s prospects. This specific case characterizes the troubling intermingled interests which coexist within universal banks. In effect, Metromedia was supposed to obtain in 2001 a credit facility from Citicorp USA, Inc. (a Salomon Smith Barney affiliate) to fund its operations. Citigroup as a global financial player had evident interest in making profitable deals for both its commercial and investment banking units. After the deadline for the financing transaction was extended twice, the facility was finally completed for less than half its full amount. However, although Mr. Grubman knew the risk for Metromedia Fiber (which faced the risk of going bankrupt after the end of 2001) of not obtaining adequate financing, and recurrently talked with colleagues about the worsening situation of the company, he nonetheless issued Notes on April 30th, June 5th and June 28th that reiterated recommendations to buy Metromedia Fiber, stating, for example: "We want to make it very clear that [Metromedia Fiber] remains one of our favorite names." He also wrongly asserted that Metromedia Fiber had obtained the loan, which would allow the company to pursue its great expansion. Metromedia Fiber sought for bankruptcy protection in 2002. - Secondly, Mr. Grubman published research reports that violated the NASD and NYSE Rules. 366 For example, in April 2001, Mr. Grubman expressed a need to downgrade six telecom companies such as XO Communications or Adelphia Business Solutions. As sorne investment bankers pressured Grubman not to downgrade these
365 Complaint, supra note 360 at 52-65. 366Joint Press Release Grubman, supra note 362.
102, compames, he consequently maintained his favorable VIeWS on these companles, continuing to advise investors to buy these stocks. 367 - Thirdly, in November 1999, Jack Grubman suddenly changed his recommendation on AT&T, going from a Neutral (3), that he held since 1995, to a Buy (1). However, the reasons for such an upgrade were rather ludicrous.368 Prior to the rating change, Sandy Weill (then co-CEO and Chairman of Citigroup and a member of the board of directors of
AT &T) had asked "his employee" to take a "fresh look" at AT &T. 369 Mr. Grubman, who was desperately trying to have his children admitted to a highly selective 92nd Street preschool in New York City, asked in exchange that Sandy Weill give him assistance in this effort. In private, Jack Grubman told friends and colleagues that he had upgraded
AT &T to have his children get into the 92nd Street preschool. 370 After Mr. Grubman finally upgraded AT&T and his children got admitted to the preschool, Sandy Weill made a $1 million donation from Citigroup to the 92nd Street preschool. 371 - Finally, it is worth noting that Mr. Grubman's upgrade of AT&T stock did not only serve his own interests but also helped Salomon Smith Barney gain investment banking business from AT &T. In 1999, largely because of Grubman's "strong support" for AT &T, Salomon Smith Barney earned $63 million in investment banking fees from AT&T's IPO of a tracking stock for its wireless unit - the largest equity offering in the United States. 372 With respect to the reported compensation obtained by Mr. Grubman and to Citigroup' s investment banking earnings, a $15 million fine, even associated with adverse reputational consequences, is not much. With respect to the resulting effects for investors, public confidence and market integrity in general, such sanctions are more or less "nothing" . Investment-banking star Franck Quattrone in 1998 joined Credit Suisse First Boston as head ofits technology sector investment banking unit. In 1999, the bank underwrote more
IPOs than did any competitor. 373 In 2000, its investment banking revenues increased more
367 Ibid. 368 Complaint, supra note 360 at 81-103. 369 Ibid. 370 Ibid. 371 Complaint, supra note 360 at 81-103. 372 Joint Press Release Grubman, supra note 362. 373 See NASD, Press Release, "Disciplinary and Other NASD Actions" (March! April 2003) online: NASD
103 than 60 percent over the previous year, to $3.68 billion. Between 1998 and 2001, Mr. Quattrone personally received compensation of over $200 million.374 On March 26,2003, he was notably charged with "spinning" and "undermining research analyst objectivity".375 At Credit Suisse First Boston, he reportedly created a "firm-within-a firm" which was directed at getting lucrative investment banking deals through highly reprehensible ways like "spinning". One of the other techniques of the so called "Tech Group" in order to obtain investment banking deals was to explain potential clients that they would get very positive research about their company if they chose Credit Suisse First Boston as their investment bank. 376 The question as to whether these pitfalls should be addressed through the intervention of the legislator or be left to self regulation remains a burning issue. Even though regulators have issued new rules to reduce these risks, the effectiveness of the new measures remains heavily criticized. For instance, it is widely recognized that most analysts continue to work in the firms where they behaved illegally. In reality, one of the largest concerns is that research analysts cannot be flawlessly isolated from the dominant "deal culture" unfortunately inherent in most investment banks. The idea of asking banks to support financially-independent research structures has been raised recently. It is a potentially very interesting solution, which most banks seem to encourage.377 Under this alternative, a third party would then be in charge of producing independent securities research, for investment banks' clients. Standards & Poor has already recently announced that it had created, to meet these goals, its own independent research department. It is important to note that investment banks' highlighted wrongdoings have a variety of causes. Not all of them are based on the tech stock bubble's "irrational exuberance" and deal-driven culture. For example, French LVMH group, world leader in the luxury goods sector, announced in February its intention to file a suit against investment bank Morgan Stanley.378 This new step in the debate about the objectivity of securities analysts constitutes the first judicial action of this kind in France, and even in the world. 379 The
374 Ibid. 375 Ibid. 376 NASD Actions, supra, note 373. 377 Controlling, supra note 2 at 67. 378 "Un débat importé en France par LVMH" Le Monde (24 February 2003). 379 Ibid.
104 French giant is asking for 100 millions euros, claiming that it has been "systematically criticized" by Morgan Stanley's luxury goods star analysts, Claire Kent. LVMH considers that these flawed comments went together with "an extreme indulgence" toward their rival Gucci, now a subsidiary of French PPR group, which hence received favorably biased coverage. L VMH asserts that the only reason for this dishonest behaviour was the fact that Morgan Stanley has been (and still is) the investment bank and mergers and acquisitions adviser of PPR in the context of the intense struggle that started in 1999 between the two French giants for the control of GucCi. 380 Morgan Stanley was an underwriter for Gucci's 1995 IPO, and has since then assisted the brand in its corporate evolution. Through this very recent illustration, it appears that the colossal financial stakes faced by investment banks can deeply challenge the integrity and impartiality of their analysts. However, these potential wrongdoings must not lead to premature or thoughtless conclusions: indeed, if Morgan Stanley ever lost this case, every company which considers that it deserves better recommendations could hence sue a bank, arguing that the comments of its analysts were not impartial. This is clearly not a desirable situation, with respect to the loss of confidence that our economies have been facing for several months now.
Who Are Analysts? What They Do and What They Should Not One type of expert is at the cross-roads of most Wall Street scandaIs of these past years: the financial analyst. Since the downfalls of the Internet bubble and of companies like Emon, W orldCom or Global Crossing came with little or no warning from these professionals, financial analysts are perceived today as Wall Street's new "breed of evil genius".381 Who are securities analysts and what are the limits to their prerogatives? What are the types of conflict situations involving these experts? The following deve10pments seek to provide a brief review of the traditional role of analysts and to address sorne of the most common potential conflict situations these analysts may face.
380 Ibid. 381 Enough?, supra note 285 at 124.
105 - The Traditional Raie ofAnalysts A research analyst, also called securities analyst or financial analyst, can be defined as a "person in a brokerage house, bank trust department, or mutual fund group who studies a number of companies and makes buy or sell recommendations on the securities of particular companies and industry groups.,,382 Fundamentally, the function of analysts has been described as "to perform research and analysis on companies in order to evaluate securities and estimate their value as investments.,,383 Analysts thus review public information about public1y traded companies and recommend to buy or to sell these stockS. 384 The largest part of an analyst's function is naturally to collect and process information that may come from a wide range of sources, both inside and outside of the company. In effect, the financial information that is collected, which is both qualitative and quantitative, constitutes a significant amount of data about the company and its sector, but also such matter as governmental actions, interest rates, and social and economic trends.385 As a result of the research they have conducted, analysts issue two different types of documents: a "report" and a "recommendation.,,386 Whereas the report contains facts and opinions compiled by the analyst about the concemed company and its securities, the recommendation is an advice to investors as to buy, sell, or continue to hold the securities of the subject company.387
th 382 See Barron 's Dictionary ofFinance and Investment Terms, 5 ed., s.v. "analysts" (hereinafter Analysts). 383 See Jill E. Fisch & Hillary A. Sale, "The Securities Analyst as Agent: Rethinking the Regulation of Analysts" (2003) 88 Iowa L. Rev. 1035, at 1040 [hereinafter Fisch & Sale]. 384 See SIA (Securities Industry Association), "Analyst Integrity, Questions, Answers Conceming Role of Analysts" (2002), online: SIA
106 As a consequence of the complexity of their job, analysts generally specialize in either a few companies or one industry or sector. 388 Whereas in theory analysts have to compile and process public corporate information, such as company reports and other secondary sources (filed with the SEC or other regulators, or available at the company, Standard's and Poor or other sources), "traditionally, analyst research also has included hands-on investigation.,,389 For example, analysts directly speak with company officiaIs during personal meetings with members of the company's management team. As has become utterly common, company managers attend analysts' conferences, in order to build relationships and share information with them.390However, since the validity of analysts' work lies mostly on their independence, such information networks may, deleteriously, create friendship-based biased reports and recommendations. As noted by the Securities and Exchange Commission, They [analysts] exert considerable influence in today's marketplace. Analysts' recommendations or reports can influence the price of a company's stock especially when the recommendations are widely disseminated through television appearances or through other electronic and print media. The mere mention of a company by a popular analyst can temporarily cause its stock to rise or fall-even when nothing about the company's prospects or fundamentals has recently changed.391
The key influence of analysts in the U.S. economy with respect to the promotion of independent and trustworthy information as a vector of healthy markets has been acknowledged by the Supreme Court in 1983 in Dirks v. SEC.392 There are three types of analysts in a commonly used classification.393 Sell-side analysts constitute about 30% of the analyst industry.394 They are the ones involved in the recent scandaIs. Sell-side analysts typically work for a full service broker-dealer, on behalf of which they make recommendations on securities of the firms or sector they coyer. The problem is that "many of the more popular sell-side analysts work for
388 Ibid. at 1041. 389 Fisch & Sale, supra note 383 at note 21. 390 Ibid. at note 22. 391 See SEC, "Analyzing Analysts Recommendations" (2002) online: SEC
107 pro minent brokerage firms that also pro vide investment banking services for corporate clients - including companies whose securities the analysts cover.,,395 Buy-side analysts advise their employer, which are usually institutional money managers like mutual funds, hedge funds or investment advisers (whose activity is to buy securities, usually for their own or for managed accounts but with other people's money) to buy, sell or hold their stockS. 396 Finally, independent analysts typically are said to be so because they do not work for firms that have other business relations with the companies they review (by underwriting their stocks for example). Independent analysts normally sell their research reports and recommendations on a subscription or other basis.397 The role of analysts in today's markets and economy is so considerable that great attention must be paid, more than ever at the light of recent conflict situations, to the potential conflicts of interest in which they can easily be involved.
- Potential Conflict Situations Involving Analysts As is generally recognized, analysts face immense pressure, in their activity, which can emanate from various sources and be based on equally diverse causes. 398 From a general perspective, these potentially disturbing factors can be sorted out into four categories.399 It is important to note that though even one of these features alone may complete1y pervert the research and judgment independence of an analyst, most of the conflict situations that have arisen recently occurred in an environment where several distorting factors were linked together. - The first factor of possible untruthfulness for analysts lies on links with the investment banking business. Expertise and advice of investment bankers are required by companies every time they seek to issue new securities or have to structure a corporate deal. Investment banking (underwriting a company's securities issue and offering corporate finance advice) is a very profitable business, which has sharply increased in the past years to reach an important part of today's large diversified banks' annual
395 Analyzing, supra note 391. 396 Ibid. 397 Ibid. 398 See e.g. Analyzing, supra note 391 (stating that "many analysts work in a world with built-in conflicts of interest and competing pressures"). 399 Analyzing, supra note 391.
108 eamings.400 This example is actually the major element that underpins the action brought by LVMH against Morgan Stanley which has been referred to above. 401 Hazardous effects of such an activity with respect to securities analysts' integrity are threefold.402 Firstly, the analyst's bank can also act as an underwriter for the company he is reviewing. In this case, the bank has a dual interest, both financial and reputational, to make sure that the issue of securities is going to be a successful operation. In the specifie context of an IPO for example, analysts often provide the investment banking team with valuable services, by "assisting with due diligence research into the company, participating in investor road shows notably".403 This premise suggests that favorable reports and recommendations are greatly appreciated by investment bankers in order to realize successful (and very lucrative) transactions. Secondly, from a broader perspective, analysts may receive pressure for favorable reports in order to allow profitable long-term investment banking relations between the companies they review and their own employer. In this case, CEOs of large and powerful companies will refuse to continue doing investment banking deals with investment banks that do not coyer favorably their stock. Thirdly, analysts can even initiate investment banking business by issuing favorable reports which will thus attract new clients for future securities underwritings. - A second element which can trigger moral hazard lies on the financial consequences that "buy" recommendations may have on investment banks eamings. In effect, brokerage firms which employ analysts may benefit from substantive brokerage commissions when one of their securities analysts issues a very positive recommendation (hence advising investors to buy the concemed stock), since this will be likely to result in increased purchases of securities.404 - A third ingredient of possible conflict situations is related to the analyst's compensation. Depending on the structure of the analyst's compensation and on whether this package includes elements linked with the investment banking division or not, the analyst may have strong financial incentives to tum his reports and opinions in a biased
400See Robert R. Glauber, Chairman and CEO of the NASD, "Written Testimony before the Senate Committee on Governmental Affairs", Hearing on Analyst Independence (27 February 2002) online: NASD
109 direction.405 Beyond social and political pressure to issue favorable recommendations, securities analysts can thus face an even more devious incentive to mislead investors: money. lndeed, compensations or bonuses of research analysts have often been tied to the results of the investment banking units.406 Such an aligninent can depend on the number of investment banking deals that are "brought" to the investment bankers and successfully carried out thanks to the analyst, for instance.407 The analyst's remuneration can also be based on the profitability of the firm's investment banking division.408 In sorne large financial organizations, the investment banking departments even actually review analysts in order to help management in the determination oftheir compensation.409 - Fourthly, analysts can have strong interests in issuing favorable reports and recommendations of companies' stocks, because of ownership interest. For instance, an analyst, other employees as well as the financial institution for which they work may have significant positions in companies reviewed by the analyst. 410 An example of this situation was shockingly made public in the context of Jack Grubman's fraudulent behaviour toward AT &T stock in relation with Sandy Weill, then CEO of Citigroup, who was on the Board of Directors of AT&T. 411 Also, analysts or other employees of large banks may also "participate in employee stock-purchase pools that invest in companies they cover.,,412 Moreover, "an analyst's firm or colleagues may acquire a stake in a start up by obtaining discounted, pre-IPO shares".413 This has become more and more frequent these past years in Wall Street notably, under the name of "venture investing". This type of remuneration nevertheless constitutes a highly immoral incentive, which induces plenteous troubling aspects such as, among others, a high potential for insider-trading situations.414 Effectively, under such compensation, the analyst, in association or not with
405 Glauber, supra note 400. 406 See Laura S. Unger, as Acting Chairrnan, U.S. Securities and Exchange Commission, "Conflicts of Interest Faced by Brokerage Finns and Their Research Analysts", Rearings on the Quality of Wall Street Research Before the Rouse Subcommittee on Capital Markets, Insurance and Govemment Sponsored Enterprises, 106th Congo (2001) [hereinafter Unger]. 407 Analyzing, supra note 391. 408 Ibid. 409 Unger, supra note 406. 410Fisch & Sale, supra note 383 at 1043-1045. 411 See developments above. 412 Analyzing, supra note 39. 413 Ibid. 414 As a result of meetings between analysts and the top management of concemed companies for example.
110 his employing finn and with other of his colleagues, will benefit from owning securities in companies that he covers.
Conclusion: New Rules, but What Does it Change?
In an effort to respond to the loss of confidence in the markets and to fight fraudulent behaviour in financial organizations, the Self Regulatory Organizations (SROs) have recently decided to react radically. The SROs are entities which were established pursuant to the federal securities laws in order to participate in the regulation of the securities sector. They have competence to promulgate rules that apply to all the industry members of these organizations.415 However, such SROs' rules have to be approved by the Securities Exchange Commission and the Federal Reserve Board. These two bodies are the two federal agencies which remain as the ultimate watchdogs for the U.S. securities and financial sector. In the first months of 2002, the SROs took the initiative and made regulatory rule proposaIs to the SEC. The National Association of Securities Dealers ("NASD")
th 415 Barron's Dictionary ofFinance and Investment Terms, 5 ed., s.v. "Selfregulatory organizations".
111 proposed a new rule (rule 2711), and the New York Stock Exchange ("NYSE") proposed amendments to its Rule 472 (which deals with Communications with the public).416 The SEC has approved very recently proposed rule changes for these two SROS.417 In reality, the approved rules as weIl as the new proposaIs are quite similar to the substance of the measures embodied in the Merrill Lynch settlement.418 The notable exception is that these changes will affect aIl members of these two SROs, instead of reaching only one isolated company. Moreover, the global settlement reached by several regulators and agencies with ten of Wall Street's most prominent firms for a total of more than $ 1.4 billion also contains significant provisions in order to fight analysts' conflict situations. AlI of these rules seek to eliminate conflicts of interest which can arise very easily between research analysts and investment bankers. The SROs, the SEC, and the New York Attorney General's office also intended to eliminate conflicts of interest linked with the allocation of IPOS. 419 This practice commonly referred to as "spinning" was moreover addressed by rules promulgated by the NASD, while the ten large firms which were part of the global settlement finalized in May 2003 were unequivocally proscribed from this type of wrongd omgs.· 420
416 See NASD and NYSE, Rulemaking, "Notice of Filing ofProposed Rule Changes by the National Association of Securities Dealers, Inc. and the New York Stock Exchange, Inc. Relating to Research Analyst Conflicts ofInterest" (8 March 2002) online: SEC
112 Generally speaking, the Merrill Lynch agreement and new SRO regulations hereupon mentioned are aimed at providing disclosure of potential investment banking conflicts while insulating analysts from the pressures which emanate from investment banking units. Measures contained in these rules are based on five series of main ideas in order to address the issues of conflicts of interest. First, these rules focus on analysts' prohibition against tying favorable ratings to investment banking services.421 Secondly, the relevant provisions seek to restore the structural limits between a firm's investment banking and research departments. For example, the rules thus prohibit investment banking departments from having supervisory relationships with research analysts or proscribe any links between an analyst's compensation and specifie investment banking transactions. 422 Thirdly, new provisions oblige the disclosure of financial ties between investment banks and their analysts and the companies who hire them, such as a managerial role in a public offering of securities, for instance, or another investment banking role with the bank's client during the previous twelve months. 423 Fourthly, the rules restrict the analyst, and members of his or her households, from investing in securities of a company that would be in the sector he is covering (before the IPO of the relevant company). Analysts must also disclose whether they have stocks of companies they are recommending, and they are banned from trading in securities of companies they coyer within a period of thirty days before and five days after they issue reports or recommendations on this issuer. 424 Finally, new provisions attempt to bring more clarity on the process of rating and recommending stocks. In effect, these rules seek to avoid situations in which an analyst provides a recommendation but expresses a radically different opinion about the stock in private company. As a matter of fact, financial organizations must now, for instance, explain in their research reports the meaning of the terms they use, and they must use terms in a manner consistent with their plain meaning. 425 On top of these rules, the Global settlement reached by Mf. Spitzer with ten major financial players features further efforts to avoid conflict situations. For example, this
421Fisch & Sale, supra note 383 at note 255. 422 Ibid. at 257. 423 Ibid. at 263. 424 Fisch & Sale, supra note 383 at 265. 425 Ibid. at 270.
113 historic settlement includes an outright prohibition on research analysts against participating in efforts to solicit investment banking business, including Wall Street roadshows or sales-pitches.426 Moreover, it requires firms' research groups to be physically separated from their investment banking departments in order to prevent the flow of information between the two groupS.427 AIso, research units now have their own legal and compliance departments that do not report to the investment banking unit. Furthermore, a very important trait ofthis agreement is that it fosters objective advice for public investors by obliging the firms to furnish independent research.428 This remarkable initiative will be funded, for the next five years, through the $ 450 million paid by the ten parties to the Global Settlement. Under this new system, each firm thus has to contract with several independent research houses that will provide independent research to the firm's clients. For each brokerage house, regulators will appoint a monitor who will be responsible for purchasing the independent research. 429 The monitor, who is the key player in this new measure, has to choose at least three independent research firms to provide reports and recommendations to brokerage houses.430 Finally, this solution appears to be a promising way to prevent overly optimistic research reports aimed at winning investment-banking deals from large companies, typically such as advice on mergers and acquisitions or underwriting IPOs. The recent infamous events which took place in Wall Street have thus triggered a record wave of measures in order to restore public confidence and integrity in the financial sector. Structural changes have significantly affected the way global firms do their business in the United States. These reforms should help moderate sorne of the most scandalous practices that have become totally common in the banking industry in the past years. However, although the overall goal of promoting analysts' independence is commendable, several issues remain. For example, the rules which prohibit analysts' compensation linked with investment banking only affect compensations that are tied to specifie investment banking transactions. These restrictions unfortunately do not apply to
426 Global Settlement, supra note 354. 427 However, it is important to note that analystscan give their opinion to investment bankers, upon request, in a process called "vetting". 428 Global Settlement, supra note 354. 429 Ibid. 430 Ibid.
114 compensations linked with general investment banking (such as global investment banking earnings for the firm). In effect, in this case, the rules only require that this existing link has to be disclosed, which palpably will not permit analysts to provide with truly objective investment advice. InternaI pressures may not be the only reasons which can undermine the analysts' independence or objectivity. Today, analysts are still under the indirect pressure of the companies they coyer. As noted above, analysts commonly undertake "hand-on investigation" about an issuer before recommending its stock. Research analysts thus have private meetings, conference calls or send written questions to the top management and staff of the company before issuing their report. This dependence on the company' s reliability critically weakens the position of analysts since "even when an issuer is not a client of the firm", "the issuer's management could retaliate against a bad report by cutting off the analyst's access to management, or not answering an analyst's questions on conference calls".431 Ultimately, because of the plurality of activities undertaken by large firms, this could have negative effects on other units of a global bank by preventing the issuing company from using the financial organization's investment banking services for future deals. For a long time, "Chinese Walls" have been perceived as being the right answer to the issue of moral hazard in banking.432 The recent rules constitute a remarkable effort to recreate such "Chinese Walls" between the investment banking departments and research analysts of large diversified banks. However, for several reasons, the validity of such an option -i.e., the efficacy of "Chinese Walls" in addressing potential conflict situations remains seriously in doubt. First, the simple existence of these walls constitutes evidence of the problem itself, which seems inherent in the very combination of such activities.433 Second, as seen above, the recent evolution of the role and functions of securities analysts
431 Enough?, supra note 285 at 148. 432 See generally C. Nakajima and E. Sheffield, Conjlicts ofInterest and Chinese Walls (London: Butterworths Compliance series, 2002) (defining "Chinese WaIls" as a "set of internaI mIes and procedures, which are designed to control and prevent the communication and misuse of confidential information between departments ofa multiple function financial intermediary"). In reality, "Chinese WaIls" most commonly refer to procedures implemented in order to prevent informational conflict situation between investrnent banking departments and research analysts. N otwithstanding their name, "Chinese W aIls" are not physical creations; rather, they consist in written procedure such as policy statements (internaI to a specifie company), which prohibit material, non-public information flows between sensitive departments. 433 See e.g. Fisch & Sale, supra note 383 at 1095.
115 suggest that "Chinese W alls" are not adequate measures in the current context. In effect, practical evidence shows that research analysts tend to be more and more dragged over existing walls, as they participate even indirectly in investment banking business. Consequently, "Chinese Walls" present a significant risk of permeability owing to the nature of relationships and functions within financial conglomerates. From such a perspective, "Chinese Walls" are totally at variance with the functional role of the units which they seek to isolate. Moreover, due notably to the complexity of large banks and to risk-taking incentives for these financial giants, the impermeability of "Chine se Walls" has been, and still is, deeply questionable. Finally, it is important to keep in mind that building and implementing such walls, or other similar limitations on information sharing within a single corporate "umbrella", may undermine the fundamental reason for combination or integration. Building walls, while at the same time seeking to benefit from different types of synergies or informational advantages, may indeed weaken both efforts.
In the light of the various wrongdoings and of the vigorous responses that have followed, the most effective, even if radical, way to prevent the many sorts of conflict situations would be to completely separate research departments from broker-dealers. Based on the idea that "no man shall serve two masters", such a solution would foster a research environment exempt from most of the potential pitfalls studied above and which are particularly recurrent when research and other services co-exist within a same entity. In such a system, analysts would be as free as possible from the ill-fated influence of customers, employees of other units or colleagues. As an intermediate remedy to this rather extreme option, the solution of independent research certainly constitutes a step in the right direction. Having research houses of large diversified banks buying independent research from independent researchers has a lot of undeniable advantages. However, this measure is only set up for a period of five years. Whether Wall Street firrns will continue to rely on such a solution after the imposed period remains uncertain. Let's hope it will prove to have the expected effects, and that it will do more than just cure on a short-terrn basis the incessant wrongdoings that undermine the integrity of the U.S. financial system.
116 Importantly enough, the various measures taken in the past months by the SEC, the Attorney General of the State of New York and different SROs serve Wall Street in trying to convince Washington that it is perfectly capable of managing its business by itself. Lawmakers in Washington do not want to feel that the recurrent (and ultimately effective) lobbying efforts of the financial services industry have resulted in nothing but moral hazard and unethical business practices. As a matter of fact, financial industry's apprehension is palpable that a legal intervention, three years after the historical repeal of the Glass-Steagall Act, would bring about a new division of their. now combined businesses. This would drastically roll back market forces and sanction financial institutions for not having able to manage the legacy conceded gradually by Congress in the past decades and, more prominently than ever, in 1999.434 Beyond the mere debate about financial conglomeration and the validity of universal banking -beyond the issue of ethical standards and integrity in the financial world- this reversaI would furthermore put into question the effectiveness and the legitimacy of legislative initiatives in the United States.
434 See The Sarbanes-Oxley Act of2002, Pub. L. No. 107-204,501, 116 Stat. 745 (2002) (constituting indeed a legal intervention in the post Grarnm-Leach-Bliley era. However, this Act does not concem specifically banking and securities. Rather, it addresses a broad range of issues dealing with corporate govemance).
117 CONCLUSION
In banking, "change is a permanent condition".435 Change lies in the very essence of banking. AlI bankers, industry leaders, observers and regulators know the importance of evolution in the banking world. Change is perhaps the most critical element, the most inherent factor in this particular industry. In this study as welI, the notion of "time" is fundamental. In effect, it is the indispensable element to correctly assess new regulatory steps in the U.S. banking sector, whether or not these initiatives lead to deregulation. Time is also crucial to determine whether or not things occur, in practice, as they have been predicted to. This thesis argues that the trade-off between claimed benefits and risks of universal banking in the United States has to be assessed in the light of historical and dynamic interaction between market forces on the one hand, and regulators and Congress on the other hand. The history of the past two centuries provides an instructive view of the evolution ofU.S. banks and their relations with the authorities that rule them and regulate their activities. From this perspective, the inexorable pressure for change seems to come predominantly from the banking industry, although other factors may have played a significant role in encouraging change in the banking sphere.436 Historical evidence shows that banks have always been driven to seek new markets, especially to stay competitive with foreign banks and to find new ways to remain profitable as traditional banking became less lucrative and financial markets were booming. As a consequence of these persistent efforts, the two long-established types of limits imposed on U.S. banks, namely product limitations and geographical restrictions, have collapsed.437 It is important to note that a remarkable factor in the recent evolution ofbanking in the United States is the globalization of our economies, and more specifically the globalization of the financial services industry. Numerous experts and congressional leaders have been arguing these past years, and notably in the context of the latest
435 Regulatory, supra note 48 at 502. 436 Regulators, for instance, as a result oftheir acquiescence toward expanding activities ofbanks. 437 The successive repeals of the McFadden Act and of the Glass-Steagall constitute the most topical illustrations for this trend.
118 significant banking deregulation exercise (Gramm-Leach-Bliley), that legislative means were a desirable way to reinforce the position of U.S. financial institutions within the global financial world. Under such arguments, a comprehensive reform (or "modemization", for proponents of such change) of the U.S. financial sector was particularly essential in order to promote U.S. banks against their Swiss or German · . 438 counterparts fior mstance. Overall, persistent market pressures seem unstoppable. They, in themselves, shape thoroughly the face of the U.S. financial services industry. This is disturbing since it challenges the fundamental princip le that each power should be limited by a countervailing power. In an address delivered in February 2002, called "Implementing the Gramm-Leach-Bliley Act: Two Years Later", and which summed up the consequences of this landmark legislative step, Govemor Mark W. OIson of the Federal Reserve Board stated the following: "Everyone who has been involved in the financial services industry during the past two decades recognizes that it is the markets--not the Congress and not the regulators--that are the force for dynamic change".439 The fact that market forces create the need for change is in itself not disturbing in any way: it even relates to the most basic and healthy conception of liberalism. Rather it is the lack of counter balance through other interests, and their vindication through public-authorities. The two meet the point where private interests collide with purely economic concems. This point represents the notion of national interest that is, ideally, intended to be reached in any deregulatory effort. From this perspective, the CUITent situation seems to show that if sorne criteria may have indeed benefited from the 1999 reform, even partially, other crucial factors may be in dangerous position in the U.S. financial sector. The emergence of powerful universal banks on the American banking scene and the evidence of recent events in the country have led to significant concem. Public policy
438 Keynote, supra note 78 at 12 (saying: "by allowing each of the American companies to offer a wider variety of products, 1 think we are going to see America's position in financial services become much stronger. This is important because sorne of our European competitors have broader rights"). It is worth noting that this has, in this specific case, rather inextricable links with sorne form of excessive1y optimistic (and questionable) patriotism. In the same speech, Senator Leach continued his address by saying: "We are the leaders in almost every area-from the arts to science to business organization. In politics, we are the great exception in terms of the quality of the individuals serving in government ... On the other hand, our political process is extraordinary. That is, the American political system is so strong that average people can do reasonably weIl within these parameters". 439 Implementing, supra note 189.
119 implications in banking matters can be sorted based on three main notions: systemic safety, market integrity and the customers' position. In these three areas, financial markets need public regulation based on the fact that public policy concerns associated with these risks could not be adequately handled by the market alone. The situation of U.S. banks' customers in the redesigned framework is, for now, far from being as advantageous as had been predicted by proponents of legislation allowing the creation of universal banks. Rather, benefits resulting from efficiency seem to have remained within the pockets of large banks, which have not passed them on their customers through lower prices, for instance. In effect, from a purely business perspective, universal banking in the United States seems to constitute a desirable option because it is an efficient operational structure. U.S. banks have shown good resilience from the difficulties of the past years. In the specific case of Citigroup (which is more than a symbol in this domain), and on a purely financial basis, universal banking has been a highly successful choice for the giant whose hefty profits now seem unalterable. The global performance of U.S. banks in the past year has even led the eminent journal "The Banker" to ask: "How can more of the world's banks achieve the profitability that the US banks have managed?" This apparent financial health must not occult the unacceptable latent risk for the U.S. economy which would result from the failure of one of its financial conglomerates. Adequate regulation is encouraged to intervene as soon as possible in order to address the legitimate concerns associated with the issue of systemic risk. Moreover, the repeated ethical wrongdoings which have occurred in the recent years on Wall Street have profoundly undermined the credibility of the universal banking option in the United States. These scandaIs have gone so far in magnitude and frequency that public trust has been dramatically shaken. Even though large banks may seem to obtain encouraging financial results, reputational risk, not to mention legalliability, remains an issue that they must keep in mind. AlI taken together, these concerns reflect a rather unflattering image of the univers al banking model "à l'Américaine". Would it then be a better solution to "breathe new life
120 into Glass-Steagall Act" as has been recommended?440 We conclude in the negative even if recent circumstances might seem to support a contrary view. It is our view that deplorable scandaIs of these past years are, to a very large extent, the result of the combined forces of greed, unethical behaviour and unsound investment and lending decisions. The depression-era Glass-Steagall Act had become largely inadequate in the CUITent state of U.S. banking. We consider that the United States in truth needed - just as aIl other economically-important countries have- a banking framework in harmony with the considerable changes that have occuITed in the past seventy years. Hence, we believe that it is possible to make a fresh start under the CUITent Gramm Leach-Bliley Act. Yet rapid and substantial steps must be taken in order to demonstrate, at last, the viability of the redesigned U.S. banking system. Will regulatory responses occur in time in order to preclude other, and perhaps even more harmful risks? This is much to be hoped for. We believe that the approach chosen, through the instrumentality of SROs, is a good one on the issue of moral hazard. This approach might be helpful indeed, on issues other than moral hazard, such as risk management for instance. Similar actions based on a close cooperation of large diversified banks with regulators must be taken soon. It would seem very much in their enlightened self interest to cooperate in such an approach rather than to wait for legislative restrictions to be imposed. The stakes are high. For the American economy, these are nothing less than the stability and integrity of the financial system.
440 See Prologue, supra note 156. See also Don More, "The Virtues of Glass-Steagall Act, An Argument against Legislative Repeal" (1991) Columbia. Bus. L. Rev. 433 (explaining that adopting a univers al banking system in the United States would be "an unwise policy decision", notably with respect to the safety and stability of the economy).
121 APPENDICES
Appendix 1:
Figure 1: Full Financial Ser\lices Integr8tion
CmJ1lJlt'rd,li fm'i','itJ/It!ilf 1J1.fitll't1ll Ct! Otlœr 1/(]IlMJl,~ B1II1M1t,~ Adi.'ities FiJI Il /l,'ial Ac/Mlies ;ldMtlé~s Senù'e.\
FiÇ1ure 2: Partial FinCl ncial Services Inte~J ration (UniversClI Bank - German Vmiant)
1 f1Jnluu!rchli 1 lJwestJ1u'Jlt Bmlkill,~ AClÎvifk, Bm/Mil.!! :ktiviIÏt'S 1 1 1 1
1 1 il/su ralla! Olher FiJUwcilll A('(ÎI'ith~\ Sen'Ü:t's
122 Figure 3: Fin,:mcial Services Integration vi8 Bank Ownership
Commerdttl B.w~'ij/,f( /ktfl'itit'~'
1 1 lill'estme.tit HOIlMll,g lilStl mIle j1 OfIl CI' Fi 11(111 cit1l Aclit'itù'.~ ActMtit:':i S{'fTia."
Fi~lure 4: Integr
FùumCÎ(l1 5,'t'/'I'ices Hohlillg Camp/Illy
1 1 1 1 1 (tlmmercilll Im't'sfJIIt'IIf Bmlkillj{ hUI/J'flIlCi! OtlWt Fiwwt'ill! IJ(mkin,U: !ktMtre.'j At'fÎl'iril's AftMtie.~ SI!/Ticcs
123 Appendix II:
List of f;u.'tors
Fpn:,!s di~ C û,! s,r\'ings ul!ribut'lblc b:1 T~chllü1:)!J;Y: l\.-lmb:1 incfticicn.::ies i n IH\xlllct diwr$ifi~nlion li n:lll cial innov':lIiün f Cc'Qn() mi.:s "r :.ù' pe) RC\' crotolit,n of lhe CUIn Ri"k rcduction duc 10 pmdud DCré'~lllati 0 Il Cultural c()n"tr'lil1t~ 1 cl\)s,,·lin11 ;;lIld d ivC'r:-i li l'~ li on ~. n::~:'::;~:~J;lllClll:1 Pri,nlis,llion Dn~'n"lrllcli.)n (breukin~ u[' or inMituticm" inlO more "Iyxiali:>ed unit", Bai luuls or lillllncini conditiol1$ of Ou hlOun:ing fin11"; '·lmmgcri':ll elllpir-c building und Cl imalc or "clpitnl market" Inl.:rncL retrenc Il mcn t 124 Appendix III: Chmt H.1 J\lotÎ\'u for cmuulidatiuft PIlIl;:] 1: E.:onûlllies of;,c .. l,: ~-r~~l Hl 4J 4; 7( Pllnell: Ecol1omies of ".::ope ~\w.w* Er< 'X' r~L-;;N nu '*'#'1' i~kr ~~~W1j 125 Chart 11.2 o;cüntinllcd'I Pancl J: T cdm 1) !ogY' "" de.:: tn.lnic OJ mm!:/" •....: P'E"",,~l 'IN~ t.(-) !il :0'0 t':< p';; :ü ~j J' JO m PlIllc14: Del>~,gLlllHi()1l 126 (h,ut 11.1 (continued'I Il,ulel 4: Revenu\!' >:nlmnccl1l~nl one-:;I('p "hopping 1'.l~"i'iI P'Ulo::! 5: Risk n:du..:tioll: (ll'Lxluct divcr..iIÎc"':r1ion ~'r,;;'<"",,~ "f~ l,) ""11) .):(1 ~'.J ,n'" }:'/ ,J)' " ;'";1 i'M :>., h'l',"i Prmel6: Changc in oly,,1Ilis.1tiolllll fOCLJ~ r.~I!(",,·U ,:t' .~ f.4; 127 Chart 11.1 (continllcd'i Pand 3: T cd1l1 J) logy - dcctn:m.Îc LU mm.:!'c....:: rw,~;~ P,meI4: Dcrcgulalin!1 128 ('1I'lIt .2 I:c'c'ntinucd) Panel Il: Bail out and IImlllcialllondition;; ~l) j~~ __~~~~ ____~~~ ____-L-L- ,,10;;.-". >!'?r-~j$tI 129 CharlllJ I;'orc:e, diSCOilU'lI2i1l1! conmlidntlon Panel 1: ,Lq;al and l'.:pul.1tory impedimcnb PmoIld P~~ut iiÂl \1: 00 P P;r'M! M .... bord. r, 'Nlhl1 •• gn.nt 1<:<. 'l(; 0: Moj~1"àjt rrfU\l!'1 130 BIBLIOGRAPHY LEGISLATION The Sarbanes-Oxley Act of2002, Pub. L. No. 107-204,501, 116 Stat. 745. Gramm-Leach-Bliley Financial Services Modernization Act, Pub. L. No. 106-102, 113 Stat. 1338 (1999) (codified in scattered sections of 12, 15 & 19 D.S.e.). Riegle-Neal Interstate Banldng and Branching Efficiency Act of 1994, Pub. L. No. 103- 328, §§ 101-03, 108 Stat. 2338, 2339-54. Federal Deposit Insurance Corporation Act of 1991, Pub. L. No. 102-242, 141(a) (1) (C), 105 Stat. 2275. Bank Holding Company Act Amendments of 1970, Pub. L. No. 91-607, 84 Stat. 1760, 1766-67 (codified as amended at 12 U.S.C. (1988)). Bank Holding Company Act of 1956, Pub. L. No. 84-511, 70 Stat. 133 (1956) (codified as amended at 12 U.S.C. 1841-1850). Glass-Steagall Act, sections 16,20,21, and 32 of the Banldng Act of June 16, 1933, ch. 89,48 Stat. 162 (codified as amended in scattered sections of 12 U.S.C.) (partially repealed in 1999). Sherman Anti-Trust Act, Ch. 647,26 Stat. 209 (1890) (codified as amended at 15 U.S.e. (2000)). National Banking Act, 12 Stat. 665 (1864) (codified as amended in scattered sections of 12 U.S.e. (1982)). National Currency Act, 13 Stat. 99 (1863). JURISPRUDENCE American Medicorp, Inc. v. Continental Illinois National Bank & Trust Co. of Chicago, 475 F. Supp. 5 (N.D. Ill. 1977). Bank v. Hawkins, 174 U.S. 364 (1899). Barron v. McKinnon, 196 Fed. 933 (1912). 131 California Bankv. Kennedy, 167 US. 362 (1897). Cockrill v. Abeles, 86 Fed. 505 (1898). Dirks v. SEC, 463 U.S. 646, 658 (1983). Gress v. The Village ofFort Loramie, 125 N.E. 112 (Ohio) (1919). International Salt Co. v. United States, 332 US. 392 (1947). McCulloch v. Maryland, 17 US. (4 Wheat.) 316, 331 (1819). Merchants' Nat. Bank v. Wehrmann, 202 US. 295 (1906). National Bank v. Case, 99 US. 628, 633 (1878). National Bank v. Hawkins, 174 US. 364 (1899). Spitzer v. Merrill Lynch & Co., No. 02-401522 (N. Y Sup. Ct. Apr. 8, 2002). Washington Steel Corp. v. TW Corp., 602 F.2d 594 (3rd Circuit 1979). SECONDARY MATERIALS MONOGRAPHS i. Collections of Essays Crossfield, Anne & Heemann, M., ed., Banking Law Survey: 1999/2000, (Boston Dordrecht-London: Kluwer Law International, 2001). Cup, Benton E., ed., The Future ofBanking (Westport, Connecticut - London: Quorum Books, 2003). Melnick, et al., ed., Creating Value in Financial Services, Strategies, Operations and Technologies (The Hague: Kluwer Academic Publishers, 2000). Saunders, A. & Walter, L, Universal Banking, Financial System Redesigned (Chicago London-Singapore: Irwin Professional Publishing, 1996). 132 ii. Books Brandeis, L. D., Other People 's Money and How the Bankers Use It, (Fairfield, NJ: Augustus M. Kelley Publishers, 1914). Carosso, V., The Morgans - Priva te International Bankers 1854-1913 (Cambridge: Harvard University Press, 1987). Dymski, G. A., The Bank Merger Wave, The Economic Causes and Social Consequences ofFinancial Consolidation (Armonk, New York-London, England: M.E. Sharpe, 1999). Hammond, B., Banks and Politics in America from the Revolution to the Civil War (Princeton, NJ: Princeton University Press, 1957). Hill, C. W.L. & Jones, G. R., Strategic Management: An Integrated Approach, 5th ed. (Boston: Houghton Mifflin Company, 2001). Holland, D. S., When Regulation Was Too Successful-the Sixth Decade ofDeposit Insurance (Westport, Connecticut: Praeger Publishers, 1998). Johnson, H. J., Global Positioningfor Financial Services (Singapore-New Jersey London-Hong Kong: World Scientific, 2000). Krooss, H. E. & Blyn M. R., A History ofFinancial Intermediaries (New York: Random House, 1971). Pecora, F., Wall Street Under Oath - The Story of Our Modern Changers (New York: August M. Kelley Publishers, 1968 [1939]). Pierce, J. L., The Future ofBan king (New Haven and London: Yale University Press, 1991). Redlich F., The Molding ofAmerican Banking, Vols. l and II. (New York: Johnson Reprint Corp, 1968). Saunders, A. & Walter, L, Universal Banking in the United States: What Could We Gain? What Could We Lose? (New York-Oxford, Oxford University Press, 1994). Timberlake, R., The Origins of Central Banking in the United States (Cambridge, MA: Harvard University Press, 1978). Van den Berghe, L.A.A & Verweire, K., Creating the Future with Ali Finance and Financial Conglomerates (Boston-Dordrecht-London: Kluwer Academic Publishers, 1998). Barron's Dictionary ofFinance and Investment Terms, 5th ed. 1998. 133 ARTICLES i. Journal Articles Austin AD. & Solomon, E. A, "A New Antitrust Problem: Vertical Integration in Correspondent Banking" (1973) 122 U. Pa. L. Rev. 366. Barth, J. R, Brumbaugh, R D. Jr., & Wilcox, J. A "The Repeal of Glass-Steagall and the Advent of Broad Banking" (2000) Journal of Economic Perspectives 191. Baums, T. & Gruson, M., "The German Banking System - System of the Future?" (1993) 19 Brook. J. Int'l L. 101. Buck, P. C. & Bowen, K.R, "Intrabank Conflicts oflnterest" (1999) 3 N.C. Banking Inst. 31. Chapelle, J. c., "Section 1972: Augmenting the Available Remedies for Plaintiffs Injured by Anticompetitive Bank Conduct" (1985) 60 Notre Dame L. Review 706. Conjura, C., "Independent Bankers Association v. Conover: Non-banks banks are not in the business ofbanking" (1986) 35 Am. u.L. Rev. 429. Contoudis, K., "Analyst conflicts oflnterests: are the NASD and NYSE rules enough?" (2003) 8 Fordham J. Corp. & Fin. L. 123. Deferrari L. M. & Palmer, D. E., "Supervision of Large Complex Banking Organizations" (2001) 87 Federal Reserve Bulletin. DiLorenzo, V., "Cost-benefit Analysis, Deregulated Markets, and Consumer benefits: a Study ofthe Financial Services Modernization Experience" (2002/2003) 6 N Y. U J Legis. & Pub. Pol'y 321. Felsenfeld, c., "The Bank Holding Company Act: Has it lived its life?" (1993) 38 Vill. L. Rev.2. Ferrara, P. J., "The Regulatory Separation of Banking from Securities and Commerce in the Modem Financial Marketplace" (1991) 33 Ariz. L. Rev. 583. Ferran, E., "Do Financia1 Supermarkets need Super Regulators? Examining the United Kingdom's Experience in Adopting the Single Financial Regulator Model." (2003) 28 Brooklyn J. Int'l L. 257. Fisch, J. E. & Sale, H., "The Securities Analyst as Agent: Rethinking the Regulation of Analysts" (2003) 88 Iowa L. Rev. 1035. 134 Garten, H. A., "Regulatory Growing Pains: a Perspective on Bank Regulation in a Deregulatory Age" (1989) 57 Fordham L. Rev. 501. Garten, H. A. "Universal Banking and Financial Stability" (1993) 19 Brook. J. Int'l L. 159, 163. Hanweck, G. A. & Shull B., "The bank merger movement: efficiency, stability and competitive policy concerns", (1999) 44 Antitrust Bulletin. Heintz, N. T. & Travisano, RM., "What is past is Prologue: Why Congress Should Reject CUITent Financial Reform Bills and Breathe New Life Into Glass-Steagall" (1998) 13 St. John's lL. Comm. 373. Hoggarth, G., Reis, R & Saporta. V., "Costs ofBanking System Instability: Sorne Empirical Evidence" (May 2002) Journal ofBanking and Finance, Vol. 26, No. 5. Horton, W. L. Jr., "The Perils of Univers al Banking in Central and Eastern Europe" (1995) 35 Va. J. Int'l L. 683. Jeannot, J. M., "An International perspective on Domestic Banking reform" (1999) 14 Am. U. Int'l L. Rev. 1715. Johnson, C. A., "Holding Credit Hostage for Underwriting Ransom, Rethinking Bank Antitying Rules" (2002) 64 U. Pitt. L. Rev. 157. Kane, E. J. "Incentives for Banking Megamergers: What Motives Might Regulators Infer from Event-Study Evidence?" (2000) 32 Journal of Money, Credit & Banking 672. Kane, E. J. "Implications of Superhero Metaphors for the Issue of Banking Powers" (1999) 23 J. Banking & Fin. Leach, J. A., "Keynote Address" (2001) 6 Fordham J. Corp. & Fin. L. 9. Macey, J. R., "The Business of Banking: Before and After Gramm-Leach-Bliley", 25 Iowa J. Corp. L. 691. Macey, J. R., "The Inevitability ofUniversal Banking" (1993) 19 Brook. J. Int'l L. 203. Malloy, M. P., "Banking in the Twenty-First Century" (2000) 25 J. Corp. L. More, D., "The Virtues of Glass-Steagall Act, an Argument against Legislative Repeal" (1991) Columbia. Bus. L. Rev. 433. Nance, M. E., & Singhof, B., "Banking's Influence over Non-bank Companies After Glass-Steagall: a German universal comparison (Fa1l2000) 14 Emory Int'l L. Rev. 1305. 135 Norton, J., & Olive, C. D., "Globalization of Financial Risks and International Supervision of Banks and Securities Finns: Lessons from the Barings Debacle" (1996) 30 Int'l Law. 301. O'Neal, M. K., "Summary and Analysis of the Gramm-Leach-Bliley Act" (2000) 28 Sec. Reg. L.J. RodeUi, R. N., "The New Operating Standards for Section 20 Subsidiaries: The Federal Reserve Board's Prudent March Toward Financial Services Modernization" (1998) 2 N.e. Banking Inst. 311. Santomero, A & Eckles, D. A, "The Detenninants of Success in the New Financial Services Environment" (October 2000) 6 Economic Policy Review No. 4 (Federal Reserve Bank ofN.Y.). Shaw, B. & Rowlett, J. R., "Refonning the U.S. Banking System: Lessons from Abroad" (1993) 19 N.C. J. Int'l L. & Corn. Reg. 91, 113. Santos, J. AC. "Commercial Banks in the Securities Business: A Review" (1998) 14 J. Fin. Serv. Res. 35. Sirota Gaetano, S., "An Overview ofFinancial Services Refonn" (1998) 5 Conn. Ins. L.J. 793. Sommer, J., "The Birth ofthe American Business Corporation: Of Banks, Corporate Governance, and Social Responsibility" (faU, 2001) 49 Buffalo L. Rev. 1011. Weinberg, J. A, "Tie-In Sales and Banks" (Spring 1996) 82 Fed. Res. Bank of Richmond Econ. Wilmarth, A E. Jr., "The Transfonnation of the U.S. Financial Services Industry, 1975- 2000: Competition, Consolidation and Increased Risks" (2002) University of Illinois Law Review 215. Wilmarth, A E. Jr., "The Expansion of State Bank Powers, the Federal Response, and the Case for Preserving the Dual Banking System" (1990) Fordham L. Rev. 1133. Wu, A. C., "PRC's Commercial Banking System: Is Universal Banking a Better Model?" (1999) 37 Colum. J. Transnat'l L. 623. ii. Collections of Essays: Articles Cocca, C., "The Future of Swiss Banking", in Benton E. Cup, ed., The Future ofBanking (Westport, Connecticut - London: Quorum Books, 2003). 136 Kroszner R. S., "The Evolution ofUniversal Banking and its Regulation(s) in Twentieth Century America", in A. Saunders & I. Walter, Universal Banking, Financial System Redesigned (Chicago-London-Singapore: Irwin Professional Publishing, 1996). Rogers, D., "Universal Banking, Does it Work?" in Me1nick et al., ed., Creating Value in Financial Services, Strategies, Operations and Technologies (The Hague: Kluwer Academic Publishers, 2000). Shull, B., "Financial Modemization under the Gramm-Leach-Bliley Act: Back to the Future", in Benton E. Cup, ed., The Future ofBanking (Westport, Connecticut - London: Quorum Books, 2003). Steinherr A., "Performance of Univers al Banks: Historical Review and Appraisal", in A. Saunders & I. Walter, Universal Banking, Financial System Redesigned (Chicago London-Singapore: Irwin Professional Publishing, 1996). Walter L, "Univers al banking: A Shareholder Perspective", in Edward L. Melnick et al., ed., Creating Value in Financial Services, Strategies, Operations and Technologies (Boston-Dordrecht-London: Kluwer Academic Publishers, 2000). Wilmarth, A. E. Jr., "Restructuring the Federal Safety Net after Gramm-Leach-Bliley" in Benton E. Cup, ed., The Future ofBanking (Westport, Connecticut - London: Quorum Books, 2003). iii. Other Articles Anason, D., "Advocates, Skeptics Face Off on Megadeals" American Banker (Apr. 30, 1998). Davenport, T., "Fed Defines Tying, and Gets Jump On Critics" American Banker (26 August 2003). Eichenwald, K. with Atlas, R. D., "2 Banks Settle Accusations" New-York Times (29 July 2003). Gasparino, C., "The SEC and Spitzer Might Outlaw 'Spinning' of IPOs" Wall Street Journal (5 November 2002). Jones, B., "France Told to Recover Aid to Bank", International Herald Tribune (23 July 1998). Laffer, R. V., "A Bank Bailout and Its Consequences" Wall Street Journal (10 July 1998). 137 Levinsohn, A., "The Coming of a Financial Services Bazaar", Strategie Finance (April 2000). Litan, R., "Banks must be untied from an outdated law" Finaneial Times (6 May 2003). Seiberg, l, "Fed Expected to Act Soon on Citigroup Deal Approval" Ameriean Banker (18 August 1998). Siconolfi, M., "Big Umbrella: Travelers and Citicorp Agree to Join Forces in $ 83 Billion Merger" Wall Street Journal (7 April 1998). Silverman, G., "Words Should Be the Ties That Bind" Financial Times (3 September 2003). Vickers, M., "Citigroup Boosts Financial Modemization On Wall Street" Business Week (1 May 1998). iv. No Authors "Top 1000 World Banks" The Banker (July 2003). "The Business Week Global 1000" Business Week (15 July 2002). "Bank Holding Company Non-banking Activities - Lending", Iowa Banking Review (March 1996). "Citigroup: Historie Barriers Erode" Ins. Reg. (28 September 1998). "Who's carrying the can?" The Eeonomist (16 August 2003). "Slipping op Banana Skins" The Eeonomist (4 April 1992). "A capital question" The Eeonomist (5 February 1994). "Debit Lyonnais's encore" The Eeonomist (25 March 1995). "Mal a la tête" The Eeonomist {1 October 1994). "Aux portefeuilles, citoyens!" The Eeonomist (28 September 1996). "The bitter end" The Eeonomist (23 May 1998). "US regulators define bank product linking rules" Reuters (25 August 2003). "Buying Peace" The Eeonomist, (31 July 2003). 138 "The Repentant Banker" The Economist (24 August 2002). "Le PDG de Morgan Stanley défend l'indépendance de ses analystes" Le Monde (24 February 2003) "Un débat importé en France par LVMH" Le Monde (24 February 2003). "Merrill finalizes $80 million Enron-related payout" Forbes (17 March 2003). "Federal Reserve No Longer in DeniaI on Tying", Association for Financial Professionals (AFP) (3 September 2003). OTHER MATERIALS i. Reports and Statements Amel, D., "Consolidation and Efficiency in the Financial Sector: A Review of the International Evidence", (Paper, Federal Reserve Board, Finance and Economic Discussions Series, 2002). DeNicolo, G., "Size, Charter Value and Risk in Banking: An International Perspective", (Working Paper, Board of Governors of the Federal Reserve System, April 2001). Feldman, R. J., & Rolnick, A. J., "Fixing FDICIA: A Plan to Address the Too-Big-to-Fail Problem" 12 Region No. 1 (Federal Reserve Bank of Minneapolis, March 1998). Fernandez, F., "The Roles and Responsibilities of Securities Analysts" 7 Res. Rep. 3 (2001). Kanaya, A., & Woo, D., "The Japanese Banking Crisis of the 1990s: Sources and Lessons", International Monetary Fund Working Paper No. 00/7 (January 2000). Mitchell, C., "Alter Anti-Tying Laws to Reflect GLB" White and Case LLP (2003). Morgan, D. P. "Rating Banks: Risk and Uncertainty in an Opaque Industry", Federal Reserve Bank ofN.Y., Staff Reports No. 105 (May 2000). Ruding, H. O. "The transformation of the financial services industry", occasional paper, Financial Stability Institute, Basel Committee on Banking Supervision (2001). Shull, B., "Financial Modernization Legislation in the United States, Background and implications"), UNCTAD discussion paper no 151 (October 2000). 139 Skipper, H. J., "Financial Services Integration Worldwide: Promises and Pitfalls, Insurance and Private Pensions Compendium for Emerging Economies" book 1-5 b), OECD (2000). Wilmarth, A. E. Jr., "Controlling Systemic Risk in an era of Financial Consolidation", IMF (2002). Citigroup, "2002 Citigroup annual report". Citigroup, "Citigroup Report for Second Quarter Earnings" (2003). Credit Suisse, "Credit Suisse Second quarter 2003 results". J.P. Morgan Chase, "J.P. Morgan Chase Second-quarter 2003 earning release". Merrill Lynch, "Merrill Lynch 2002 Annual Report". Basel Committee on Banking Supervision, "Overview of the New Basel Capital Accord" (April 2003). Department of the Treasury, OTS, OCC, FDIC and the Board of Governors of the Federal Reserve System, "the Implementation of New Basel Capital Accord, Advance Notice of Proposed Rulemaking" (4 August 2003). Group ofTen, "Report on Consolidation in the Financial Sector" (January 2001). IMF, "Financial Crises: Characteristics and Indicators ofVulnerability," World Economic and Financial Surveys-Financial Crises: Causes and Indicators (May 1998). Office of New York Attorney General, "Agreement between the Attorney General of the State of New York and Merrill Lynch, Pierce, Fenner & Smith, Inc.," (21May 2002). Office of Federal Housing Enterprise Oversight "Systemic Risk: Fannie Mae, Freddie Mac and the Role of OFHEO"(February 2003). The Tripartite Group of Bank, Securities and Insurance Regulators, "The Supervision of Financial Conglomerates" (July 1995). H.R. Conf. Rep. No. 106-434, at 151-52 (1999). Senate Report No. 106-44, at 4-6 (1999). Gauber, R., Chairman and CEO of the NASD, "Written Testimony before the Senate Committee on Govemmental Affairs", Hearing on Analyst Independence (27 February 2002). 140 Gramm, P. Senator, Statement, the Gramm-Leach-Bliley Act: Financial Services Modernization: Hearings before the Senate Comm. on Banking, Housing and Urban Affairs, 106th Congo 1 (1999). Komansky, David H., Chairman, Merrill Lynch, Statement, the H.R. 10 - Financial Services Modernization Act of 1999: Hearings before the House Comm. on Banking and Fin. Servs., 106th Congo 143 (1999). OIson, M. W., Testimony before the Subcommittee on Financial Institutions and Consumer Credit of the Committee on Financial Services, Financial Services Regulatory ReliefAct of 2003, U.S. House of Representatives (27 March 2003). Patterson, Michael E., Chairman, Statement, Financial Services Council the Gramm Leach-Bliley Act: Financial Services Modernization: Hearings before the Senate Comm. on Banking, Housing and Urban Affairs, 106th Congo 1 (1999). Unger, L. S., U.S. Securities and Exchange Commission, "Conflicts of Interest Faced by Brokerage Firms and Their Research Analysts", Hearings on the Quality of Wall Street Research Before the House Subcommittee on Capital Markets, Insurance and Govemment Sponsored Enterprises, 106th Congo (2001). Zuckerberg, Roy, J., Chairman, Securities Industry Association, Statement, the H.R. 10- Financial Services Modernization Act of 1999: Hearings before the House Comm. on Banking and Fin. Servs., 106th Congo 143 (1999). ii. Speeches Bies, S., "Corporate Governance and Risk Management" (Address delivered at the Annual International Symposium on Derivatives and Risk Management, Fordham University School of Law, New York, 8 October 2002) Bies, S., "Financial Markets and Corporate Governance in the United States and Other Countries" (Remarks delivered at Thunderbird, The American Graduate School of International Management, Glendale, Arizona, Il February, 2003). Bies, S., "Bank Performance and Corporate Governance" (remarks at the 1 12th Annual Meeting of the Tennessee Bankers Association, Hot Springs, Virginia, Il June 2002). Greenspan, A., "Corporate Governance"(Remarks at the 2003 Conference on Bank Structure and Competition -via satellite, Chicago, Illinois, 8 May 2003). Meyer, L. A., "The challenges of Global Financial Institution Supervision" (Remarks at the Federal Financial Institutions Examination Council, International Banking Conference, Arlington, Virginia, 31 May 2000). 141 OIson, M. W., "Implementing the Gramm-Leach-Bliley Act: Two Years Later" (Speech before the American Law Institute and American Bar Association, Washington, D.C., 8 February 2002). OIson, M. W., "A Look at the Banking Industry in 2002" (Speech at the 107th Annual Convention of the Maryland Bankers Association, Palm Beach, Florida, 21 May 2002). OIson, M. W., "The Gramm-Ieach-Bliley Act and Corporate Misbeaviour-Coincidence or Contributor?" (Remarks at the Conference on the Implementation of the Gramm-Leach Bliley Act, American Law Institute and the American Bar Association, Washington, D.C. 8 February, 2003). iii. Press Releases . Board ofGovernors of the Federal Reserve System, Proposed rule 12 CFR Part 225, Reg. Y; DocketNo. R-I078 (31 July2000). Board of Governors of the Federal Reserve System, Final rule 12 CFR Part 225, Reg. Y; Docket No. R-1078 (19 December 2000). Board of Governors of the Federal Reserve System, "Press release for Proposed interpretation and supervisory guidance with request for public comment" (25 August 2003). Board of Governors of the Federal Reserve System, "Order to cease and desist and civil moneypenalty against WestLB AG and its New York branch", (27 August 2003). Department of the Treasury, Bank Holding Companies and Change in Bank Control, Interim Rule and Proposed Rule 12 CFR Part 1500 (17 March 2000). Department of the Treasury, OTS, OCC, FDIC and the Board of Governors of the Federal Reserve System, "the Implementation of New Basel Capital Accord, Advance Notice of Proposed Rulemaking" (4 August 2003). NASD, "NASD Advises Securities Firms on Tying Arrangements" (19 September 2002). NASD, NASAA, New-York State Attorney General, NYSE and SEC, Joint Press Release, "Ten ofNation's Top Investment Firms Settle Enforcement Actions Involving Conflicts of Interest Between Research and Investment Banking" (28 April 2003). NASD, New-York State Attorney General, NYSE and SEC, Joint Press Release, "The Securities and Exchange Commission, New York Attorney General's Office, NASD and the New York Stock Exchange Permanently Bar Jack Grubman and Require $15 Million Payment" (28 April 2003). 142 NASD, "Disciplinary and Other NASD Actions" (March/April2003). NASD and NYSE, Rulemaking, "Notice of Filing ofProposed Rule Changes by the National Association of Securities Dealers, Inc. and the New York Stock Exchange, Inc. Relating to Research Analyst Conflicts of Interest" (8 March 2002). NASD and NYSE, Rulemaking, "SEC, Self-Regulatory Organizations, Order Approving Proposed Rule Changes by the New York Stock Exchange, Inc. Relating to Exchange Rules 344 ("Supervisory Analysts"), 345A ("Continuing Education for Registered Persons"), 351 ("Reporting Requirements") and 472 ("Communications with the Public") and by the National Association of Securities Dealers, Inc. Relating to Research Analyst Conflicts of Interest and Notice of Filing and Order Granting Accelerated Approval of Amendment No. 3 to the Proposed Rule Change by the New York Stock Exchange, Inc and Amendment No. 3 to the Proposed Rule Change by the National Association of Securities Dealers, Inc. Relating to Research Analyst Conflicts of Interest" (29 July 2003). NASD, "Notice to Members 03-44, SEC Approves Amendments to Rules Governing Research Analysts' Conflicts ofInterest" (29 July 2003). Office of New York Attorney General Eliot Spitzer, "Merrill Lynch Stock Rating System Found Biased by Undisc10sed Conflicts oflnterests" (8 April 2002). SEC, "SEC Settles Enforcement Proceedings against J.P. Morgan Chase and Citigroup" (28 July 2003). SEC, "Complaint: SEC v. Jack Benjamin Grubman, United States District Court Southern District of New York" (28 April 2003). 143