A new cop is walking the banking beat, and industry lawyers said bankers better take note.
The Securities and Exchange Commission is becoming as important to the banking industry on mutual fund issues as the Justice Department is on fair-lending.
"The enforcement operation at SEC is one of the most effective in the federal government," said Andrew Sandler, a partner in the Washington office of Skadden, Arps, Slate, Meagher & Flom. "Bankers are well advised to be vigilant on this issue."
"Many times bankers myopically view their regulators as either being the Federal Reserve, Office of the Comptroller of the Currency, or the Federal Deposit Insurance Corp.," said Barry H. Genkin, a partner at Blank, Rome, Comisky & McCauley in Philadelphia. "They don't realize that they have a really big brother looking over their shoulder."
William R. McLucas, the SEC's director of enforcement, said he expects banks to occupy an increasing portion of his agency's attention. Although he didn't discuss current cases - the SEC is as secretive about its investigations as the Justice Department - he did say he expects to bring enforcement actions against banks in the near future.
"As we go to more full-service operations and one-stop shopping for financial services, you will see more issues about complying with the securities laws," Mr. McLucas said in an interview.
The SEC, as opposed to the Justice Department, has primary jurisdiction over all securities matters. It either can sue in court or bring administrative proceedings against banks or bankers violating the rules. Damage awards have exceeded $10 million in past cases.
Prior to 1994, the SEC had brought only one major case against a bank selling mutual funds. A broker at a First Union Corp. subsidiary was fined for misleading consumers into transferring bank deposits into mutual funds.
But in the past two years, the SEC has begun investigating bank sales practices more aggressively. Industry lawyers said they expect the agency to file the first suits from these probes next year.
Mr. McLucas said the SEC is interested in two issues: disclosure and suitability.
Rules issued by the banking regulators and the SEC require bankers to inform consumers that mutual funds do not carry deposit insurance. Also, bankers must tell customers that they could lose all or part of their initial investment if the fund's price falls.
Bankers also must match investment opportunities with the level of risk a consumer is comfortable accepting. The concept, known as suitability, is intended to prevent bankers from selling a high-risk product to a person looking for a safe place to store excess cash.
"You have to ensure that the disclosures are accurate and the incentive to make the sale doesn't eclipse the fundamental obligation to be candid about the risk," Mr. McLucas said.
Bankers may have a tough compliance job ahead. A recent FDIC study found that nearly 30% of all banks didn't make the appropriate disclosures.
Mr. McLucas warned bankers to study the securities laws before offering mutual funds. "You have to acclimate yourself to the rules and then do it properly," he said.
Mr. Sandler said the best way to avoid the SEC's spotlight is to spend the money up front on employee training. "They must ensure that people in direct customer service positions are making the appropriate disclosures and (are) otherwise conversant on the bank's obligations under the securities laws," he said.