On Dec. 15, the National Association of Securities Dealers issued a wake-up call to banks involved in sales of securities such as mutual funds.
In its Notice to Members 94-94, the NASD appears to proclaim its intention to govern, as the primary regulator, the manner in which banks sell products to their customers.
The proposed rule largely incorporates provisions of the Securities and Exchange Commission's November 1993 "no action" letter to Chubb Securities Corp., which governs networking arrangements between broker-dealers and financial institutions. However, it contains elements that significantly extend the scope of the Chubb letter and that are guaranteed to cause controversy in the banking industry.
First, the NASD seeks to intrude on the relationship between a bank and its affiliated broker-dealer.
This may have an impact on the industry because of a current trend among larger institutions to move away from third-party marketers and internalize the nondeposit sales program by creating an affiliated broker-dealer.
Most banks that have undertaken such a step have managed the relationship between the bank and the broker-dealer affiliate in an informal manner.
Now, however, the NASD proposes to mandate a formal agreement between the bank and the affiliate. The NASD also proposes a new mandatory disclosure stating that investments are not protected by the Securities Investor Protection Corp. as to loss of principal."
The SEC's own 1993 survey found general consumer confusion as to the nature of such insurance, even if the investment was purchased at a traditional securities broker. Thus, banks seem to be targeted for competitive disadvantage by having to make a disclosure that is not required of other NASD regulated broker-dealers.
A provision of the proposal certain to cause comment by banks is the prohibition against payment of referral fees to unlicensed bank employees.
If this implicitly permits the bank to pay a one-time, nominal referral fee, as permitted by banking regulators, interagency statement on retail investment sales, then banks should be able to live with this change. But if the NASD's aim is to prohibit a referral fees to unlicensed bank
Another important discrepancy between the proposal and the interagency statement lies in the proposal's unconditional man date that the investment sales space be physically distinct from the insured deposits area. The proposal contains no recognition, as is found in the interagency statement, that physical considerations may prevent sales from a distinct area.
A proposal that the broker - dealer be solely responsible for setting the compensation of registered representatives - even if the sales representative is a dual employee of the bank and the broker-dealer - is a further intrusion on the discretion of the banks.
This may lead to conflicts with banking regulators who have consistently asserted authority over compensation schemes that affect bank employees.
The section of the proposal that discusses communications with the public has several problematic elements. One is a requirement that the broker-dealer must send the account statement directly to the customer. This would eliminate the ability of banks to offer statements that combine investment accounts with other account information.
The proposal also mandates that marketing materialscontain a disclosure that the financial institution is not a registered broker or dealer, ignoring the fact that commercial banks are exempt from such registration.
The proposal also prohibits mentioning the financial institution in advertising materials except to state where brokerage services are available, but requires the identity of the broker-dealer to be featured conspicuously.
Finally, the proposal forbids use of confidential bank financial information by the broker-dealer, whether or not it is affiliated with the bank, but makes no attempt to define "confidential" - raising the prospect of a conflict with the banking regulators.
