A proposed SEC rule would be a setback after 10 years of progress toward bank regulatory modernization.

Unless the SEC changes course, traditional bank trust and custody activities are in jeopardy.

For just about a decade, bankers, regulators and Congress have worked together to modernize this country's regulatory framework with three clear goals in mind: allow banks to diversify their product and service offerings; enhance bank safety and soundness; and eliminate regulation that does not serve a demonstrable purpose from either a safety and soundness or a consumer protection point of view.

By adhering to these three goals, we have built a banking system that is dramatically safer and more robust than it was in the previous quarter-century, and a system that is providing consumers with better products in ever more convenient ways.

However, the gains of the last decade will be undermined if regulators place additional regulatory burdens on the financial services sector that provide no clear, demonstrable benefit to the safety and soundness of the sector or to consumers.

One example of this kind of misguided regulation is found in a recently proposed rule from the SEC. This rule would restrict some traditional activities in which banks are presently allowed to engage directly (RIN 3232-A119, 66 Fed. Reg. 27760, May 18, 2001). This proposal would harm all banks, but it would be particularly corrosive for community banks, a sector we should try to promote as a matter of policy.

The SEC is proposing, among other things, to do the following:
Generally require banks that engage in traditional securities-related trust activities to either register as broker/dealers (which is a practical impossibility) or "push out" their securities-related activities to a separate registered broker-dealer.

Create a line between traditional trust activities and full-brokerage activities based on a "chiefly compensated" test that is flawed in three respects:

(1) It is enormously complex and expensive for the banks and the agency to administer.

(2) It is extremely disruptive, because it would require account-by-account calculations, rather than an overall "line of business" analysis.

(3) It is biased in favor of determining that activities should be conducted by an SEC-registered broker-dealer entity.

All of these things would cause bankers to throw up their hands and push these traditional activities out of the bank, rather than incur the headaches and expense of complying with the new rules.

Upset bank custody operations by restricting customary fees for order-taking.
Impose additional and disruptive restrictions on referral fees paid to bank employees.
Require banks to be registered as dealers in asset securitizations, unless they meet an unreasonably high bar in terms of whether the securitization pools are "predominantly" originated by banks.

It is hard to believe, but in fact there would be essentially no benefit to all these time-consuming and expensive new rules. The rules would merely impose added costs that will ultimately be borne by the consumer, and burdens that will diminish the time and resources available to banks to deal with real safety and soundness issues.

Trust department and other securities-related activities conducted by banks have not caused any material safety and soundness problems, nor have they resulted in significant consumer complaints. On the contrary, the record of banks in this area is remarkably strong.

The SEC proposal is an overly aggressive interpretation of the Gramm-Leach-Bliley Act, which is designed to broaden the menu of activities a bank can offer and to decrease their regulatory burden. The act eliminated the broad bank exemption from the securities laws, but at the same time, it added clear, activity-specific exemptions that are designed to ensure that banks can continue doing what they have always done in the bank under the previous broad exemption.

The SEC proposal is intended to keep banks from conducting a full-service broker-dealer business in the bank. In reality, the effect of the SEC proposal would be to undo the Gramm-Leach-Bliley exemptions for traditional bank activities by making it so costly and complicated for banks to continue these activities in the bank that they would be forced to push them out into a separate broker-dealer.

Some banks, bank trade associations, and bank regulators have spoken out against this proposal. This is not enough. All bankers should speak out strongly about this proposal.

The SEC is run by some of the most sophisticated and able public servants in government. Therefore, there is good reason to hope that once the problems with the current proposal are fully aired, the agency will develop a more workable solution.