The Comptroller of the Currency's guidelines for selling nondeposit products have significantly increased management responsibility for the sale of mutual funds and other uninsured products.
The primary focus of the guidelines is on disclosure, but other instructions venture into such uncharted waters as suitability, compensation, and setting and circumstances of retail investment sales.
In view of the resulting uncertainty of what will constitute adequate compliance, bank managements have substantial basis for concern.
In a recent speech to the American Bankers Association, the comptroller complained of the some banks' lack of compliance with the guidelines, which were issued in July. A spot survey by the American Banker (Nov. 29, 1993, p. 1) also uncovered what seems to be a general lack of compliance.
Confusing Requirements
The principal goal of the guidelines is to make certain that a customer buying an investment product knows it is not insured by the Federal Deposit Insurance Corp. or guaranteed by the bank and that it is subject to market risk, including reduction or loss of principal.
The guidelines assume there is a likelihood that the customer will think investment products are insured when he buys them on the bank's premises.
Accordingly, the guidelines cover third parties operating in the bank as well as employees of the bank. Disclosure - prominent and clear disclosure informing the customer about the nature of investment products - is the primary tool for preventing confusion.
The disclosures required are fairly straightforward. There is general agreement that disclosure is required in order to protect the bank from lawsuits as well as to maintain the health of the customer's portfolio.
Banks and their co-venturers should not have too much trouble complying with the disclosure mandates. But other requirements in the guidelines are confusing and impractical.
Questions Abound
For example, banks are advised that they "must ensure that compensation programs do not operate as an incentive for salespeople to sell retail nondeposit investments over a more suitable one."
Bank employees traditionally are paid salaries, while commissions generally constitute the bulk of the compensation of securities industry salespeople.
Does the Comptroller intend that all national bank staff engaged in marketing deposit instruments be paid sales incentives if other staff receive incentives for selling mutual funds? If an employee is permitted both to accept retail deposits and to sell mutual funds (a practice that the comptroller discourages but does not prohibit), is the bank required to pay the employee a commission on the sale of a certificate of deposit?
Also, on what side of the line does the platform officer fall? The private banker? Further, what types of compensation programs e.g., yearend bonuses) are incentive programs and which are not? These are but a few of the questions that bank management must grapple with in attempting to apply the Comptroller's guidelines.
Determining |Suitability'
Another source of concern in the guidelines is the requirement under a section called "suitability" that any specific fund recommended to the customer must be appropriate to the customer's financial circumstances. There is a plethora of administrative cases and judicial adjudications in the securities area concerning "suitability."
The suitability cases, however, generally do not involve mutual funds, except perhaps for a few recommendations concerning high-yield bond funds, and therefore do not offer much guidance.
But whatever the case law, a suitability recommendation requires the collection of information about the customer's financial situation, tax status, and investment objectives.
Done correctly, it can be time consuming. Ask any trust officer. Outside the trust department, bank personnel have little expertise in determining suitability.
Extra Layer of Supervision
The guidelines, by citing the National Association of Securities Dealers' rules of fair practice, require that this training result in a level of expertise that is the equivalent of that required in licensed broker-dealers.
If guidance and training is not provided, regulatory enforcement actions and lawsuits by aggrieved investors an be expected.
"Know your customer" and "suitability" are not new concepts in the securities industry and should be familiar to any registered salesperson.
Compliance with these sales practices is monitored generally by self-regulatory organizations of which the broker-dealer is a member.
The comptroller's guidelines, however, impose a new layer of supervision - bank management - whenever a sale or account relationship originates in a national bank.
The comptroller has stated that his examination authority covers all bank-related sales operations, including sales by other entities.
Impractical Mandates
The Comptroller also advises that "The bank should make it clear to other entities that bank management and the OCC will be verifying such compliance."
If they mean what they say, these mandates to national banks are costly, duplicative, and impractical of execution.
Is a bank auditor supposed to second guess the "suitability" decisions of trained and supervised salespeople of an independent broker-dealer? Are the telephone conversations of these people to be monitored by bank management? Is bank management supposed to try to integrate the compensation structure of the broker-dealer with that of its own? And what is to be the role of OCC examiners? Are they going to make their own determinations of "suitability"?
Narrowing Guidelines
As can be seen, the overlapping and duplicative supervisory structure that the guidelines set forth is fertile ground for misunderstandings between banks and their supervisors.
The additional responsibility of bank management to monitor and supervise the sales practices of what are in many cases independent third parties can cause even greater confusion, misunderstanding, and risk.
One can hope that the additional guidelines that have been promised will be narrowed to give due recognition to the long established supervisory and enforcement procedures of the securities industry's primary regulatory structure will be substantially narrowed, if not eliminated.
Two Goals
If this happens, banks will have to contend with the new requirements mainly as they apply to in-house sales by bank personnel. For those banks there will be a great many new procedures, record-keeping requirements, and training costs.
In any case, faced with the additional costs and requirements of the guidelines, it is time for all banks to undertake a comprehensive audit of their current activities with two goals.
First, they must decide what must be done to comply and, second, they must decide on how best to proceed.
