Spot checks in the New York City area by the American Banker suggest that many banks are failing to adequately warn customers about the risks of mutual fund investments.

In fact, only two of 10 surveyed branches volunteered that mutual funds, unlike bank deposits, are not federally insured. Such warnings are a centerpiece of new disclosure requirements.

While reluctant to discuss the risk of principal loss, salespeople were not shy about emphasizing the potential for stellar returns, in some cases projecting double-digit gains -- another taboo.

And few bothered to mention the fees involved, while some made inappropriate investment recommendations.

Finally, some attempts at disclosure were carried out haphazardly, to say the least. At a branch of National Westminster Bank on Long Island, for example, a sign warning of the lack of deposit insurance sat atop an investment salesman's desk -- but was facing the salesman.

With banks piling into the mutual funds arena, disclosure has become a controversial issue.

Eugene A. Ludwig, the U.S. Comptroller of the Currency, has said he is unhappy with disclosure efforts to date, and some members of Congress have introduced bills to force improvement.

Bankers, in turn, have defended their compliance record.

Against this backdrop, the American Banker sent three reporters to 10 branches to survey sales practices firsthand. While the survey was not scientific, its results indicate that the industry has a way to go before meeting the disclosure guidelines.

The guidelines, issued this year by the four federal bank and thrift regulatory agencies, urge sales representatives to emphasize the difference between mutual funds and traditional bank products.

Chris Rieck, a spokesman for the American Bankers Association, said that if the results of the spot check are representative, they provide evidence of the need for more education for sales forces.

The association, he said, is working hard to educate banks about disclosure, training, and suitability of fund recommendations.

Part of the problem may be that bank sales staff are still adjusting to the new rules, said David P. Apgar, senior policy adviser to the comptroller.

"There may continue to be a lag time between senior management action on mutual fund sales practices and actual implementation at the level of employees at banks and independent broker-dealers," Apgar said.

Many of the sales representatives the American Banker visited were actually employed by outside marketing companies that are responsible for disclosure training, even though banks remain liable for any failure to comply with the rules.

Some observers played down the survey's significance.

"I don't think talking to 10 people in banks is indicative of anything," said James Shelton, executive director of the Bank Securities Association.

The real issue, Shelton said, is whether disclosures are made by the time the sale is done. Still, the association's training program does teach brokers to make up-front disclosures, he said.

One consultant who secretly evaluates bank mutual fund programs said he has seen improvement in compliance. "We're finding much better disclosure than we did six months ago," said Barry Leeds, chairman of Barry Leeds & Associates in New York.

In the American Banker survey, each reporter spoke of having about $5,000 to invest for four to five years, with the goal of making a down payment on a home.

Of 20 branches visited, half had a problem different from lack of disclosure: lack of sales personnel. Investment product representatives were not available, and platform staff had trouble finding the brokers' phone numbers and rounding up marketing material.

In the remaining 10 visits, the reporters tested the level of disclosure by inviting sales staff to make presentations about the most appropriate investments for the stated goal.

By and large, the salespeople failed to mention safety issues in their routine pitches and, when pushed with questions, gave murky replies.

At a branch of Dime Savings Bank of New York, a representative said an equity-income stock fund is like a certificate of deposit because it has a yield. He then pointed to the fund's total return for the last few years, noting that this exceeded what can be expected from bank deposit products.

J. Edward Diamond, president of Dime Securities, the bank's investment product unit, said the representative violated Dime's policy by comparing mutual funds to CDs. "I will not tolerate that," he said.

Dime is in the midst of its own spot check, Diamond said. "If we discover that kind of behavior, you can be sure very serious actions will be taken."

Brushing aside questions about risk, a Chemical Bank representative said the mutual fund he was recommending "is not at all like a CD."

But, instead of adding that the fund is not insured, he said "the risk with CDs is you'll get only two, three percent. This fund is up 16% so far this year."

Colleen Kelly, a Chemical spokeswoman, declined to comment on the incident but said, "In general, our consultants are trained to ensure that customers understand, prior to purchase, the type of investment they're getting."

As for reps comparing the performance of CDs and mutual funds, "Every sales situation would call for a different explanation," Kelly said.

Sales staff at two branches were quick to discuss risks.

A Bank of New York platform employee repeatedly said mutual funds are not insured by the Federal Deposit Insurance Corp. During his presentation, he mentioned this several times and read off the disclosure statement on the back of a marketing brochure like a cop reading a suspect his Miranda rights.

A broker at a Long Island branch of European American Bank also quickly explained that mutual funds are not like CDs and are not insured by the FDIC.

But eight of the 10 banks made no oral disclosures. Apgar of the comptroller's office pointed out that such disclosures must be made during all oral presentations as well as being included in marketing materials and new mutual fund account forms.

Regulators also want investment-sales areas to be distinguishable from the rest of the bank. Practices varied widely, with investment-sales areas ranging from desks on the platform to separate rooms within the branch.

In addition to segregating sales representatives, regulators want prominently displayed posters and desktop signs warning that mutual funds are not insured. The spot check found few such disclaimers in branches.

An exception was Natwest, where posters hanging in windows advertised the availability of funds and noted in small print that mutual funds pose risks, lack insurance, and are not bank products. But a broker failed to follow up by making these disclosures verbally.

"It is our policy to discuss this verbally," said Tim Connolly, a spokesman for Natwest. "There are also acknowledgment forms that customers sign when investing in a mutual fund."

The survey also uncovered shortcomings in the mutual fund marketing materials handed out by banks. Many brochures lacked disclosure statements because they were out of date or produced by nonbank fund companies.

Bank sales reps also came up short in explaining fees charged for buying mutual funds. They rarely mentioned these fees, or "loads," unless directly asked.

For instance, a representative at Chase Manhattan Bank first said there was no sales fee, and later mentioned there was a 5% charge for withdrawing money in less than six years.

Chase spokesman Ken Mills said that the bank "just put in a back-end load feature" a few weeks ago. The load "scales down to zero," Mills said, so the sales representative "was accurate."

Sales staff weren't shy about boasting of funds' performance. A Chemical sales representative said that money invested in a balanced fund should double about every five years.

At a Chase branch, a salesman recommended Chase's Vista Growth and Income Fund, saying that it should return "over 10%" annually over the next five years.

"We try to tell customers what mutual funds have done in the past, and about their management, and not what they can do in the future," Mills said.

Claims about future performance are inappropriate, said Mary A. Malgoire, a principal in Malgoire Drucker Inc., a financial planning firm in Bethesda, Md. "It's horrible. It means that they don't have any knowledge or understanding of investments."

For example, she said, from 1968 to 1981 the average annual rate of return was 5%. "It's just not true that it can't happen."

Malgoire suggested that consumers carry tape recorders into sales meetings so that they have evidence of what sales reps have told them. "Then, if it doesn't work out, they can take the bank to court," she said. "That will force the bank to put responsible, well-trained people in those positions."

Sales representatives often made recommendations for the $5,000 investment without asking about customers' financial condition. They should be asking questions to determine needs, said Apgar of the comptroller's office.

Using the limited information about investing to amass enough for a down payment, brokers offered a grab bag of investment products, including conservative municipal bond funds, aggressive growth funds, and many offerings in between.

Two sales representatives even suggested annuities, products that can be tapped before retirement only by paying a penalty.

While a case could be made for many types of funds for the stated goal, "the annuities are off the deep end of the spectrum as far as I'm concerned," Apgar said.

But banks' insistence that they do not pressure customers into bank-sponsored funds was supported by actions' of a European American Bank sales representative.

The salesperson was flanked by a large poster of the Rembrandt Funds managed by LaSalle National Trust, a sister company, while he discussed a number of outside funds.

He never mentioned the Rembrandt funds until asked for information about them. The representative said he wasn't "comfortable" recommending the funds, as they had been launched in January and didn't yet have a track record.

Kalen Holliday, Michael O'D. Moore, and Karen Talley are reporters for the American Banker.

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