part of the Banking Act of 1933, section 5144 of the Revised Statutes was amended by adding several new paragraphs applying exclusively to bank holding companies (called holding company affiliates in the amendment) and placing limitations and restrictions upon the right of such companies to vote the stock of member banks which they owned. Prior to 1933, this section merely defined the rights of stockholders of national banks to vote their stock in such banks.

As amended, and as it now stands, this section provides that a holding company before it may vote its stock of a member bank, must first obtain a permit to do so from the Federal Reserve Board. The Board, in turn, is authorized in its discretion to grant or deny such a permit. As a condition to granting of the permit the holding company is required, on behalf of itself and its controlled banks, to agree to submit to examinations, to establish certain reserves, to agree to dispose of all interest in securities companies

The CHAIRMAN. What does that clause mean, "to dispose of all interest in security companies"?

Mr. ECCLES. There were a lot of banks that were engaged in the securities business. They had securities departments or security affiliates.

The CHAIRMAN. So they formed holding companies.

Mr. ECCLES. The National City Co. and the Chase Co.

The CHAIRMAN. They formed their own holding companies to handle securities.

Mr. ECCLES. They were required to divorce the securities business from commercial banking.

The CHAIRMAN. So they formed a subsidiary, a holding company, an associate to handle the securities, then, did they not?

Mr. ECCLES. No, they were supposed to be completely divorced, and not permitted to engage in such business even as a holding company. The holding company was required to dispose of all interests in security companies, as well as the bank.

The CHAIRMAN. Well, assuming there was a Benjamin Green National Bank, and the Benjamin Green National Bank, coming under the purview of this law, had to divorce itself from the securities business and formed the Benjamin Green Holding Co. or the Benjamin Green Corp., which took over the securities business of the bank from then on.

Mr. ECCLES. They are not supposed under the law to have any connection. For instance, you remember the J. P. Morgan & Co. had to determine whether or not it was going to be a bank or a securities house. Harriman is another case. Any number of institutions were required to determine whether they were going to stay in the banking business or be in the securities business. They could not be in both, and they were divorced.

This section here applies to the holding companies where they had security affiliates, and the holding companies were required to divest themselves of any interest in these security affiliates.

That was one of the requirements. That was in the Banking Act of 1933. [Continues reading:]

and its officers, directors and agents are subject to the same penalties for falsification of records as those applicable in the case of national banks.

Congress presumably felt that these amendments would be adequate to insure effective regulation. The Board's experience in administering those provisions, however, has demonstrated clearly the need for additional legislation if regulation is to be effective in correcting and preventing practices which are contrary to public policy and interest.

No one would suggest that in amending section 5144 in 1933 Congress intended to bring some bank holding companies under regulation and to leave others, even though meeting the same definitions, free from regulation. Yet that is what the

law now permits because it is based solely upon the voting permit. A holding company becomes subject to the law only if a voting permit is issued. But there is no mandatory requirement in the law that a holding company obtain such a permit. Undoubtedly it is believed that all would do so. All have not done so, however, because as a practical matter holding companies in many instances control the operations of banks without the need for voting their shares in such bank.

The CHAIRMAN. You mean they are sort of holding a sword of Damocles over them?

Mr. ECCLES. I suppose so. [Continuing:]

In one instance disclosed by the Board's files a holding company owns a controlling stock interest in 24 member banks yet has obtained voting permits covering only two of these banks.

Whenever the Board receives an application for a voting permit, it makes a thorough examination of the holding company and its affiliates to determine what corrections, if any, are necessary to meet basic standards. If such corrections appear necessary, they are made a condition to the granting of the voting permit. In one important case, however, when advised of the need for such corrections, the applying company simply abandoned its application for a voting permit. It was able to control its banks without voting the shares which it owns in these banks, and thus able to escape such regulations as existing law provided. Clearly the law should apply to all bank holding companies alike. This cannot be accomplished by a law which permits a holding company to elect not to subject itself to regulation. The law must be mandatory to be effective. The proposed bill provides that all bank holding companies meeting the prescribed definition shall register with the Board and, having registered, shall be automatically subject to all of the regulatory provisions of the statute.

The present definition of a holding company is inadequate. Not only does the present law fail to reach those companies which elect not to apply for a voting permit but it also fails to reach others because of inadequacies in the definition of a holding company affiliate. The present definition embraces only those holding companies which control member banks. This excludes from any regulation those companies which operate in all respects as bank holding companies, but it also fails to reach others because of inadequacies in the definition of a holding company affiliate. The present definition embraces only those holding companies which control member banks. This excludes from any regulation those companies which operate in all respects as bank holding companies but which control only nonmember banks, even though, as is frequently the case, the latter include insured banks. There are a number of companies in this category which operate numerous banking offices having substantial amounts of deposits.

The CHAIRMAN. Is that all taken care of in this bill?
Mr. ECCLES. Yes, that would be. [Continuing:]

Another and more important defect is in that portion of the present definition which defines a bank holding company as any company which owns or controls, directly or indirectly, either a majority of the shares of capital stock of a member bank or more than 50 percent of the number of shares voted for the election of directors of any one bank at the preceding election, * * *

The purpose underlying this definition is to reach those companies which control the management and policies of banks, and with this basic premise the Board is in entire agreement. However, it has long been recognized by Congress and by the courts that effective control of one company by another does not depend upon the ownership or control of a majority of the voting shares. Control can be, and often is, exercised through the ownership of a much smaller proportion of the total shares outstanding. Sometimes it is maintained without the ownership of any shares.

Similarly, the number of shares owned or controlled, as compared with the number of shares voted for the election of directors at the preceding election is an unsatisfactory basis for determining whether a holding company relationship exists. Such a restricted test puts it within the power of the holding company to establish an absence of control when in fact, it is at the same time exercising most effective control. The case in which regulation is most necessary is usually the case in which the attempt is made to take advantage of the existing definition to escape regulation.

The definition of a bank holding company in S 829 conforms more nearly to the practical realities of intercorporate relationships. It is derived in large part from the definition of a holding company adopted by Congress when it enacted the Public Utility Holding Company Act in 1935. The first part of the definition extends automatic converage to all companies which owns 15 percent or more of the voting shares of two or more banks. However, even though a company may own more than 15 percent but less than a majority of such shares, if it can demonstrate that it does not exercise a controlling influence over the management and policies of its banks, it would not be subjected to regulation under the Act. The second part of the definition permits the Board to declare a company to be a bank holding company, even though it owns less than 15 percent, or possibly none, of the shares of two or more banks, provided the Board finds after hearing, that the company does in fact control such banks.

Senator BUCK. May I interrupt, Governor Eccles? How could you control banks if you do not own any shares in the holding company? Mr. ECCLES. We have several cases where they control the management of the banks. We have management companies that do not own any shares at all, and they completely control the credit policies and the investment policies and the personnel of banks.

Senator BUCK. I still do not understand how they do it.

Is there any stock included in the control of those companies? Mr. ECCLES. Well, in the case that I have in mind, individuals own the banks and these individuals have seen fit to organize a management company which owns no stock in the bank at all, and this management company manages the banks. The management company does not own any of the stock of the bank, and they did this for the very purpose of avoiding the Bank Holding Company Act. Senator BUCK. Would this prohibit that?

Mr. ECCLES. It would cover it if it could be shown after a hearing that this company does control the policy of the banks. What we are getting at here is control without reference to the question of stock ownership, as I point out in this next paragraph. [Reading:]

The Board believes that this definition is practical and just. All companies owning the specified number of shares are affected alike. Each has a ready procedure at hand for escaping regulation by demonstrating that it does not control the management and policies of two or more banks.

The CHAIRMAN. Is there any provision that requires a notification or advice of the Federal Reserve Board under this bill, listing or setting forth the existence and enumerating of these management companies, so that you know they exist?

Mr. ECCLES. No, not where there is an absence of the 15 percent which is required-that being prima facie evidence of control. If they have less than 15 percent, then it is the responsibility of the Board to establish the fact of control, and we have the authority to make the investigations. [Continuing:]

In the clear cases (such, for example, as insurance companies which own bank shares purely for investment purposes) absence of control may be easily demonstrated without hardship. In the close cases, the burden of proof would be on the company to show that it is not in fact exerting the kind of influences upon banks which require that it be subjected to regulation.

Regulatory aspects: Turning now to the regulatory aspects of the problem, under the present law the only provision which implies a degree of administrative supervision relates to such examinations as shall be necessary to disclose fully the relations between the holding company and its controlled banks, and the further provision that for violation of the statute or of its agreement with the Board, the holding_company's voting permit may be revoked. In that event, certain penalties affecting the banks in the holding-company system may be applied.

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These provisions, particularly when considered in the light of the voluntary aspects of the existing law, fall far short of providing effective regulation. In the first place, the Board's right to examine a holding company and its controlled banks is not coupled with the specific power to require corrections. Furthermore, the penalties for violations of the statute or of a holding company's agreement with the Board are directed primarily at the banks in the holding-company group and not at the holding company itself.

The existing law contains no declaration of congressional policy upon matters which vitally affect the entire problem. The Board feels that bank holding company legislation should include as many specific declarations of congressional purpose as possible, and that, where the exercise of administrative discretion must of necessity be called into play, the legislative standards for the exercise of such discretion should be clearly stated. The provisions of S. 829 are designed to give effect to these principles.

Nonbanking activities of bank-holding companies:

One of the most salutary requirements of S. 829 is that contained in section 5, which would require that the activities of bank-holding companies be limited solely to the business of banking or of managing and controlling subsidiary banks. To that end a holding company would be required within a stated period to divest itself of any securities except those in companies which are necessary and incidental to its banking operations, or which are eligible for investment by national banks.

Senator FULBRIGHT. Does that mean primarily bonds and mortgages?

Mr. ECCLES. That is right. The holding company could acquire what the bank could hold.

Senator CAIN. The bank holding companies in that sense, it would put them into immediate liquidation, but not in any rapid fashion. I think you have a 2 year beginning limitation.

Mr. ECCLES. And a right to extend if hardship is imposed. Certainly there should be no further acquisitions and the process would be one of becoming banking institutions, rather than investment and banking institutions.

Senator BUCK. Is there not some benefit to be derived from bank holding companies, if, as you believe, they are run properly?

Mr. ECCLES. Well, I think that the bank holding companies, many of them have done a constructive job.

Senator BUCK. And banking interests?

Mr. ECCLES. And they have adhered strictly to the banking business, and they have not undertaken to avoid or to evade anything. They have gotten the voting permit and they have in no way tried to undertake any expansion without approval.

I would say that some of them have done a very good job, particularly in the Northwest, in two bank groups there.

Senator BUCK. Are there a very few of these in the East?
Mr. ECCLES. Very few in the East.

Senator BUCK. They are in the West, the Middle West?

Mr. ECCLES. There are some in the East, one group up in New England, one or two. There is one in New York State; the Marine Midland is a big one in New York State. They are scattered throughout the country. It is not a matter that is strictly applicable to the West. They are in the majority of the States. They cover that majority of the States of the Union. There are 23.

The CHAIRMAN. You mean collectively?

Mr. ECCLES. There are 28, I mean.

The CHAIRMAN. Collectively their activities spread over the different States, but you have some companies, have you not, that cover 20 States in themselves?

Mr. ECCLES. Five or six States is all.

Senator CAIN. Holding companies which hold reasonable favor in your eyes, are those which have restricted their activities to the banking business.

Mr. ECCLES. That is right. That is correct, and not only restricted their activities to the banking business, but have not undertaken to buy out their competition and, through pressure, to become monopolistic in their operations. [Reading:]

The reasons underlying this requirement are simple. Accepted rules of law confine the business of banks to banking and prohibit them from engaging in extraneous businesses such as owning and operating industrial and manufacturing concerns. It is axiomatic that the lender and the borrower or potential borrower should not be dominated or controlled by the same management. In one exceptional situation, however, the corporate device has been used to gather under one management many different and varied enterprises wholly unrelated to the conduct of a banking business.

The CHAIRMAN. Is that in New England?

Mr. ECCLES. That is primarily in the West.
Senator FULbright. Where?

Senator CAIN. West of the Mississippi River.

Senator FLANDERS. West of the Rockies?

Mr. ECCLES. The New England company you referred to, I think, Senator, has a lot of investments in its holding company, aside from

The CHAIRMAN. I knew the answer to that question before I asked it. Mr. ECCLES. The one I am referring to here has not only investments, but has control and assumed the management for a great many concerns outside of banking. [Reading:]

When a bank holding company has expanded its operations into other and unrelated fields, it tends more and more to take on the characteristics of the type of institution to which the Investment Company Act of 1940 was addressed. Yet such a company, if it holds a voting permit from the Board, is exempted from the provisions of the Investment Company Act. It is necessary, in keeping with sound banking principles, that such a company should be required by law to adjust its affairs so as to become either bank holding company, or an investment company. It should not be permitted to remain a hybrid beyond a period reasonably necessary for it to adjust its affairs.

Section 5 would make it unlawful after 2 years, or longer if the Board deemed necessary to avoid undue hardship, for a bank holding company to own the securities of any company other than a bank or to engage in any business other than that of banking or managing and controlling banks. Exceptions are made in favor of those companies which are reasonably incidental to the business of banking, such as safety deposit companies and the like, and a bank holding company may lawfully acquire securities from its banks when requested to do so by any Federal or State examining authority.

Senator BUCK. What would be the purpose of requiring them to do that?

The CHAIRMAN. I would raise that point. It does not make sense. Mr. ECCLES. In other words, a bank may make a phoney loan in order to get control of a company, and if it makes a loan for that purpose, it would then take over the loan and thus take the security into its portfolio. It would then have legally acquired control of a company other than a bank.

We say that if in the first place a bank holding company cannot acquire the ownership of a company other than a bank, it would be unlawful under this, but you cannot prevent the holding company from taking out of the bank paper that the examiner may require it