4000 - Advisory Opinions
Guidance Concerning the Retail Sale of Mutual Funds and Other Non-Deposit Investment Products Through a Securities Brokerage Service
July 28, 1994
Ann Loikow, Counsel
This letter responds to your May 31, 1994 notice concerning the proposed agreement between XYZ Corporation ("XYZ") and ("the Bank") regarding XYZ's securities brokerage service.
On February 15, 1994, the FDIC, along with the other bank and thrift regulatory agencies, released a joint statement on retail sales of mutual funds and other nondeposit investment products by federally insured financial institutions ("Guidelines"). The Guidelines, a copy which is enclosed for your reference, supersede guidance previously issued by the FDIC. They apply to insured depository institutions offering a mutual fund or other nondeposit investment product sales program at the retail level, either directly or indirectly. The Guidelines suggest how an institution can implement such a program in a safe and sound manner and avoid customer confusion.
Although your letter mentions various measures the Bank will take to clarify to customers that the brokerage service and the bank are separate entities, it does not mention customer disclosures concerning the nature of nondeposit investment products. Customers must be informed that the products offered by XYZ are: 1) not insured by the FDIC, 2) not a deposit or other obligation of, or guaranteed by, the depository institution, and 3) subject to investment risks, including possible loss of the principal invested. The timing of these disclosures is discussed in more detail in the Guidelines. Generally, the disclosures need to be made orally during any sales presentation, in writing when opening an account, and in advertisements and other promotional materials. All written disclosures should be conspicuous and presented in a clear and concise manner. The Bank should also disclose the existence of any fees, penalties, or surrender charges, and any advisory or other material relationship between the Bank and an affiliate and an investment company whose shares are sold by the Bank.
According to your letter, XYZ will conduct its sales activities in office space separate from the Bank. This is in accordance with the Guidelines, which suggest sales be conducted in a physical location distinct from where retail deposits are taken to minimize customer confusion. You do not indicate whether the arrangement contemplates using Bank employees as a source of referrals. If this is the case, tellers or other employees in the routine deposit-taking area should not make general or specific investment recommendations regarding nondeposit investment products, qualify a person to purchase such products, or accept orders for such products, even if unsolicited.
Your letter also states that XYZ will provide compliance and procedure manuals, as well as training and supervision for its representatives. As discussed in the Guidelines, the training should impart a thorough knowledge of the products involved, applicable legal restrictions, and customer protection requirements. You also indicate that Bank employees will have an extremely limited role in XYZ's sales--accepting deposits or transfers into brokerage accounts. The Guidelines explain that any employees who have direct contact with customers should receive training to ensure a basic understanding of the Bank's sales activities and the strict limits of bank-employee involvement.
The Bank, if it has not already done so, needs to adopt a written statement that addresses the risks associated with the proposed sales program, contains a summary outlining the policies and procedures of the institution's program, and addresses the concerns described in the Guidelines. The Bank's statement should also include the scope of XYZ's activities, and the procedures for monitoring XYZ's compliance.
Finally, the Bank needs to enter into a written agreement with XYZ that is approved by the Bank's board of directors. The Bank should conduct an appropriate review of XYZ prior to entering into the agreement. The Guidelines explain in greater detail what must be included in the agreement. Generally, however, the agreement should describe the duties and responsibilities of each party, ensure XYZ's compliance with all applicable laws, authorize the Bank to monitor and review Spectrum's compliance, authorize access to XYZ's records by the Bank and the FDIC as necessary or appropriate to evaluate compliance, and require XYZ to indemnify the Bank for potential liability arising from the sales program.
Your letter indicates that the Bank and XYZ have already addressed many of the issues covered in the Guidelines. We advise you to consult the Guidelines as you finalize the arrangement with XYZ. Special attention should be paid to the section on disclosures. You may also want to review the Security and Exchange Commission's November 24, 1993 letter to Chubb Securities Corporation, which contains the latest guidance regarding networking arrangements between broker/dealers and financial institutions. A copy of the letter is enclosed along with a copy of the NASD's recent notice on this issue. If you have any further questions, please write or call me at (202) 898-3796.