number of hearings over the years on the effect of changes in the financial markets and the perceived dangers to the consumer that occur when the lines between banking and securities begin to blur a bit.

The transaction that we are beginning to examine today is not a small one. It has been valued at $1.85 billion. It is my understanding that after the merger is completed, should it be allowed to go through, Mellon Bank will be the largest bank mutual fund adviser in the country, with over 4 percent of all mutual fund assets.

The proposed merger is one of the most significant financial transactions in recent years, and while it would certainly not be the first merger of a bank and a mutual fund company, its sheer size could lead to a rush of similar mergers. The big question we need to be asking ourselves is, are there sufficient consumer safeguards under current law to safely permit a merger of this type and scope? If not, what further protections are needed to prevent customer confusion and minimize the possibility of catastrophic losses to unsophisticated investors?

As the chairman pointed out, the S&L problems, the scandal and what it has cost us to bail out through the RTC is unbelievable, and I think that none of us want to get into that situation again. I look forward to the testimony presented in the next 2 days, and I certainly thank the chairman for holding these hearings. Mr. DINGELL. The Chair wants to thank my good friend. [The prepared statement of Hon. Carlos J. Moorhead follows:]

STATEMENT OF HON. CARLOS J. MOORHEAD

Thank you, Mr. Chairman. The subcommittee during the next 2 days will be examining the proposed merger of Mellon Bank Corporation and the Dreyfus Corporation. This is indeed a huge transaction-valued at $1.85 billion-which, should it occur, would propel Mellon Bank into the forefront of the mutual fund business in this country.

Whether this is a good thing or a bad thing depends to a large extent on how well informed the customers of the new entity are. Will they know when they are buying mutual funds from their bank that such funds, while offering a higher rate of return than an FDIC insured bank deposit, are also riskier? I understand that Mellon and Dreyfus have taken steps to attempt to alleviate this possible confusion, and I look forward to hearing more about those efforts.

These hearings promise to add to this committee's record of closely monitoring the changes taking place in our Nation's capital markets, and I look forward to the testimony we will hear in this regard. Thank you, Mr. Chairman.

Mr. DINGELL. The Chair now wants to welcome you, Mr. Levitt, to the subcommittee.

As you know, we have been friends a long time. I have had the opportunity to know you and to respect you, and to observe your dedication to the public interest. As you know, I welcomed your selection for the Chairmanship of the SEC, and I am delighted to have you before the subcommittee. I hope you feel welcome here. Mr. LEVITT. Thank you very much.

Mr. DINGELL. And you, Mr. Barbash. Thank you for being with us. We appreciate your courtesy to us today.

Gentleman, it is the rule of the subcommittee that all witnesses be sworn and testify under oath. Do either of you object to testifying under oath? It is the right, gentlemen, of all witnesses who appear before the subcommittee to be advised by counsel since they

do testify under oath. Do either of you desire to be advised by counsel during your appearance?

Mr. LEVITT. No.

Mr. BARBASH. No.

Mr. DINGELL. Gentlemen, the Chair advises then that copies of the rules of the subcommittee, and of the House of Representatives are there before you in the red and the blue books for your information as you appear and testify before us.

Gentlemen, if you will then please rise and raise your right hands.

[Witnesses sworn.]

Mr. DINGELL. Gentlemen, you may each consider yourselves under oath. The Chair now recognizes you for such statement as you choose to give.

TESTIMONY OF HON. ARTHUR LEVITT, JR., CHAIRMAN, SECURITIES AND EXCHANGE COMMISSION, ACCOMPANIED BY BARRY P. BARBASH, DIRECTOR, DIVISION OF INVESTMENT MANAGEMENT

Mr. LEVITT. Chairman Dingell and members of the subcommittee, I appreciate this opportunity to appear before you on behalf of the Securities and Exchange Commission. Accompanying me this morning is Barry Barbash, the Director of the Division of Investment Management. We are here today to discuss the concerns that Mellon Bank's acquisition of the Dreyfus Corporation raises regarding the current regulatory structure governing the securities activities of banks.

Now is the time for us to take action on the issue of functional regulation. This proposed merger, which will create the largest bank mutual fund operation in the United States with 4 percent of all mutual fund assets, I think provides us with the perfect opportunity to plan ahead. It provides the ideal backdrop to ensure that the American people will never see their financial regulators pointing their fingers at one another about who let what slip through the cracks of oversight.

The $1.85 billion of Mellon-Dreyfus is just one of the most striking examples of the recent growth of bank involvement in the mutual fund industry. Today, 113 banks and bank subsidiaries advise almost 1000 mutual funds with $204 billion in assets, which is more than 10 percent of total mutual fund assets.

Banks also are increasingly active in public sales of mutual fund shares, by some estimates, accounting for more than one-third of all new sales of money market funds. Under the current law, banks that act directly as broker-dealers or investment advisers are excluded from the Securities Exchange Act of 1934 and the Investment Advisers Act of 1940.

These exclusion date from a time when banks were insignificant participants in the securities business mostly because of the restrictions of the Glass-Steagall Act. Applying broker-dealer and adviser regulation to banks, therefore, seemed unnecessary at that time.

Those days have passed, and this vintage structure makes less sense in the 1990's when the interpretation of the Glass-Steagall

Act has been broadened piecemeal without the benefit of a sound statutory foundation of functional regulation.

Banks already are major participants in the securities markets, and it is likely that their role will continue to grow as their customers move from insured deposits into mutual funds and other uninsured securities products. Will the bank exclusions, a historical vestige of a simpler time, continue in effect?

Because of its size, the Mellon-Dreyfus merger dramatically highlights the SEC's concerns regarding the current regulatory structure governing the securities activities of banks. If the merger is completed as originally proposed, Dreyfus is going to become a subsidiary of Mellon Bank, not the Mellon holding company. Dreyfus will remain subject to oversight under the Federal securities laws only because it has agreed to remain a separate entity, at least for the time being.

If the bank were to choose to conduct these same activities itself directly, and not through a separate corporation, the framework of the Federal securities laws would not apply. The concern that the Federal securities laws should apply to bank securities activities, and in particular to bank mutual fund sales, arises from three policy objectives.

First, protecting investors by avoiding overreaching and confusion. Second, ensuring undivided loyalty to the customer by avoiding potential conflicts of interest between banks and their affiliated mutual funds. Third, ensuring that investor protection, rather than bank safety and soundness and depositor protection, remains the foremost concern of regulation, examination, and enforcement programs.

Although the parties to the Mellon-Dreyfus transaction have taken voluntary steps to address many of these concerns, there is no guarantee that the relationship between the mutual fund activities and banking activities will not change in the future because of either economic or competitive pressures. And no statutory safeguards apply to the growing number of banks that, like Mellon, are expanding their bank mutual fund activities.

This is just the beginning. These banks should not have the option of declining to submit to securities regulation.

Of course, a major danger fostered by the current regulatory structure is that investors may not realize that the mutual fund or other security sold to them by or through their bank is not federally insured.

The SEC has long been at the forefront of publicizing this danger. Last May, the Commission staff took this issue head on by requiring prospectus cover pages of bank-marketed mutual funds, and funds with names that are similar to banks, to prominently disclose that the shares are not insured.

We sponsored an eye-opening survey which demonstrated that 66 percent of bank mutual fund shareholders believed that their funds were insured. And we are actively working with the mutual fund industry to close the regulatory gaps through investor guides and investor bulletins and whatever other devices can be employed to change this very serious misperception.

Some policymakers ask whether cooperation between the SEC and other Federal banking regulators is the answer to these con

cerns. In fact, because of efforts that Comptroller Ludwig and I initiated, the SEC and the banking agencies have been working together on an informal basis for some time.

However, I would say that these efforts are merely a stopgap. They make the best of a difficult situation by relying largely on personal relationships and personal goodwill. Joint regulatory and inspection efforts, I think, can never really substitute for institutional relationships grounded in sound public policy and written into law after years and years of experience that will survive long after I and other current regulators have left our offices.

To replace this patchwork quilt, I would hope that Congress can ensure that the expert securities regulator designated nearly 60 years ago, the SEC, can protect investors through uniform rules consistently applied to all participants in the securities markets. Five basic points demonstrate the urgent and compelling need for functional regulation:

First, investor protection must be the priority when banks engage in securities activities. Bank safety and soundness and protection of the bank's depositors are certainly appropriate priorities when regulating banking activities that concern taxpayer insured funds. But there are other priorities when it comes to regulating bank activities in the securities marketplace.

The banks' customers in its securities activities have different interest from the banks' depositors and the FDIC and other regulators. I think one of the great SEC Chairman in history, William Cary, put it better than anything I could think of when he said in 1963: "The great objectives of banking regulation are controls over the flow of credit in the monetary system, the maintenance of an effective banking structure, and the protection of depositors. [But] these objectives neither utilize the same tools nor achieve the same results as [SEC standards of] investor protection."

Second, investors deserve a single consistent standard of protection, whether they purchase securities from a bank or a registered broker-dealer. Currently, investors who purchase securities directly from banks are not protected by the securities regulatory scheme that exists for broker-dealer, and a comparable scheme simply does not exist under banking law.

For example, bank securities sales personnel are not subject to a uniform qualification, examination, and disciplinary program that focuses on the potential for abuse that exists in connection with securities activities.

Third, customer confusion about bank sold securities simply has to be eradicated. Sales of mutual funds conducted in a bank's lobby next to the very windows which take bank deposits, or sales conducted by bank employees, may mislead customers into believingand indeed they have misled customers into believing-that these mutual funds may be federally insured.

Common or similar names may also mislead bank customers. In spite of voluntary measures and efforts by banking regulators, recent surveys-led by an SEC-sponsored survey that was, I might add, corroborated by at least two subsequent surveys conducted by other organizations-indicate a troubling degree of investor confusion about the status of their investment in bank mutual funds.

Fourth, functional regulation would certainly be more rational than our current patchwork system. In an era of regulatory consolidation and reinventing government, a separate regulatory scheme is certainly redundant and wasteful from the taxpayer's perspective-it hardly seems appropriate for the Federal bank regulators to hire and train what becomes no more than a "mini-SEČ" staff. Finally, functional regulation would eliminate the existing regulatory gaps. Under the fragmented regulatory scheme enforced today, the Commission is unable to supervise securities activities conducted directly by banks. In an increasingly complex and interconnected financial services marketplace there is an increased danger that fraud one day might simply slip through the cracks because the SEC lacks full access to records in an examination. This, I think, is a significant and an avoidable systemic risk.

The Commission believes that these concerns have really been fully addressed by functional regulation and the bill to address that program introduced by Chairmen Dingell and Markey and Congressmen Moorhead and Fields-H.R. 3447. The Commission strongly supports this bill as a means of enhancing investor protection and eliminating the current regulatory duplication and vulcanization that inevitably result from Federal statutory exclusions for bank securities activities.

H.R. 3447 would promote consistent, functional regulation of all market participants that offer the same products and perform the same functions. It would apply proven, legally enforceable brokerdealer competency standards, supervision requirements, suitability and sales practice rules, and financial responsibility requirements to banks and bank employees involved in securities sales.

The bill would also address the conflicts of interest between banks and their affiliated investment companies. The SEC is pleased to reiterate, reinforce and restate its support for H.R. 3447, and to urge its prompt enactment.

Mr. Chairman, I welcome the opportunity to be before you today, and to address questions that you or your colleagues may have. [Testimony resumes on p. 32.]

[The prepared statement of Mr. Levitt follows:]