With the current volatility of the securities markets, financial institutions are likely to confront vastly increased enforcement and litigation risk related to the sale of securities products on bank premises and by bank-affiliated entities.
On the government enforcement front, about two years ago the Securities and Exchange Commission announced its intention to investigate and initiate enforcement actions against insured institutions that violate the federal securities laws when marketing and selling mutual funds or other securities products on bank premises.
In May 1998 the SEC announced a settlement with NationsBank related to charges that NationsSecurities had engaged in deceptive and misleading sales practices in its sales of mutual fund products during 1993 and 1994.
Over the past several years similar allegations have been made against Great Western, Amsouth, and Barnett Banks in private class-action litigation.
Additional enforcement and litigation activity is likely. An SEC representative has stated that the agency is "aware of similar complaints" against other banks. In addition, it has recently been reported to be investigating the mutual fund sales practices of other major banks. And plaintiffs' class action lawyers have stated an intention to bring additional actions.
Given these developments, banks offering investment products and services in competition with independent broker-dealers and investment advisers should carefully analyze their own sales practices.
Unless a bank carefully considers and designs its marketing efforts, government lawyers using 20-20 hindsight might deem them fraudulent or deceptive. Liability in this area could be premised on a banks' inaction, given that regulators increasingly require affirmative conduct to eliminate inferences of fraud and deception.
Historically, the bank regulatory agencies, not the SEC, have taken the lead in overseeing the sale of mutual funds by banks. In 1994 the Federal Reserve, the Federal Deposit Insurance Corp., the Office of the Comptroller of the Currency, and the Office of Thrift Supervision jointly issued an "Interagency Statement on Retail Sales of Nondeposit Investment Products." It set guidelines for bank-affiliated sellers of such products.
The interagency statement requires that institutions not place the sellers of nondeposit products in proximity to the retail deposit area. Also, tellers and other employees in that area are not to make "make general or specific investment recommendations regarding nondeposit investment products," qualify customers for purchase of such products, or make recommendations.
Institutions also must ensure that incentive plans to not "result in unsuitable recommendations or sales" to customers, the stattement says.
And they must explain specifically, in "conspicuous and easy to comprehend disclosures," the nature of the nondeposit products and their inherent risks.
Beginning in 1996, however, the SEC announced that it was investigating the securities sales practices of certain banks and expected to bring enforcement actions within the following year.
Little was heard until May 1998, when the SEC announced the NationsBank settlement. The complaint centered on whether NationsSecurities had met suitability and disclosure requirements in its marketing and sale of "term trusts"-government bond funds whose performance is strongly linked to interest rate fluctuations.
Though NationsBank had the misfortune to be an early target of SEC enforcement action on these issues, other banks are sure to receive similar scrutiny. Both the SEC and the banking agencies have stated that they believe many financial institutions are not in compliance with the Interagency Statement in their marketing and sales practices.
Under these circumstances, it is imperative that bank-affiliated entities selling securities products take affirmative steps, as outlined in the Interagency Statement, to guard against customer confusion. Failure to undertake such proactive compliance initiatives can be a costly mistake.
Financial institutions have already paid millions of dollars in fines and private settlements to resolve suitability and disclosure violations alleged against them.
A compliance review should evaluate, among other things:
The policies and procedures, marketing materials, and training programs of both the bank and its affiliated broker-dealer, as they relate to suitability and sales practices.
The contractual relationship between the bank, its affiliated broker- dealer, and/or any related third parties.
The adequacy of disclosures and representations made in advertising and promotional materials.
The incentive compensation structure relating to the sale of nondeposit investments of both the bank and its affiliated broker-dealer.
Banks also should establish a monitoring program to ensure that their policies and procedures are being implemented in compliance with the interagency statement and all applicable banking and securities laws and regulations.