Banks and the Securities Business: Limitations and Opportunities
| Publication year | 1989 |
| Pages | 2313 |
1989, December, Pg. 2313. Banks and the Securities Business: Limitations and Opportunities
In 1933, Congress enacted what has become known as the Glass-Steagall Act ("Act") in response to one of the perceived causes of the 1929 stock market crash and the high number of bank failures throughout the United States. The Act erected a legal barrier separating commercial banking from investment banking. In recent years, however, commercial and investment banks have had to compete for the same customers. The new bank products which have resulted from this cross-industry competition bear many of the attributes of securities. In addition, expansive interpretations by federal banking regulators have punched holes in the Glass-Steagall wall.
These new bank products and expansive interpretations provide numerous opportunities for banks to develop profitable securities businesses. Furthermore, banks that participate in the securities business now may be better positioned to take advantage of future regulatory interpretations and possible legislative reforms. This article discusses the limitations of the Glass-Steagall Act, efforts to expand banks' powers under the Act and "securities" activities allowed to banks under current law.
The Act is comprised of four provisions. Section 16(fn1) applies to national
The business of dealing in securities and stock by [a national or member bank] shall be limited to purchasing and selling such securities and stock without recourse, solely upon the order, and for the account of, customers, and in no case for its own account, and the [national or member bank] shall not underwrite any issue of securities or stock. . . .(fn3)
Federal banking regulators and the courts have interpreted this provision to permit banks and bank holding companies ("BHC") to buy and sell securities for customers on an agency basis.(fn4)
Despite its prohibitive language, § 16 expressly permits banks to underwrite and deal (as a principal) in securities issued by the U.S. government and its agencies, as well as general obligations of any state or municipality.(fn5) Further, § 16 authorizes national and member banks to purchase "investment securities" for their own accounts, subject to certain limitations.(fn6)
Section 20(fn7) of the Act prohibits member banks(fn8) from being affiliated with any entity that is "engaged principally" in the issuance, underwriting, public sale or distribution of securities.(fn9) Until recently, § 20 was understood to prohibit banks from being affiliated with any entity engaged in the business of underwriting and dealing in securities. However, in 1987, the Federal Reserve Board ("Board") approved the applications of several of the largest U.S. BHCs, authorizing their subsidiaries to underwrite and deal in municipal revenue bonds, mortgage-backed securities, third-party commercial paper and "consumer-related receivables." The Board added corporate debt instruments to the list in 1989.(fn10) The Board reasoned that these activities would not violate the "engaged principally" test if each subsidiary limited its income from underwriting and dealing in previously ineligible securities to 10 percent of its total gross income.(fn11) The Courts of Appeal for the Second Circuit and District of Columbia Circuit have upheld the Board's 1987 decisions.(fn12) However, the Board's February 1989 decision...
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