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Retail Nondeposit Investment Sales

Introduction

versations with customers to resolve problems or disputes that may arise at a later date.

"Negative consent" letters (e.g., notices informing customers that unless they object, the bank assumes the customer understands and does not object to the transactions) may be a useful element in a compliance program but should not be the sole means of verifying that customers understand nondeposit investment product transactions and the bank's role in the process.

Examiners should determine whether a bank officer has been assigned the responsibility for assuring that the bank adequately monitors the nondeposit investment accounts of customers. Examiners should also determine whether the officer has developed or is developing a system to monitor the customer account reviews of outside vendors operating bank-related sales programs.

Oversight of Third Party Vendors When a bank uses a third party vendor to sell nondeposit investment products, the bank's board of directors must adopt a written policy addressing the scope of the activities of the third party, as well as the procedures the bank intends to use for monitoring the third party's compliance with the Interagency Statement.

To select the third party vendor and monitor the ongoing acceptability of the vendor, bank management usually reviews the vendor's experience in the business and the vendor's financial statement. Bank management also usually contacts other banks with which the vendor has done business for references. Examiners should also expect that bank management checked with the vendor's regulator before it entered into an agreement with the vendor and that management has continued to review reports furnished to the vendor by its regulator(s).

Bank management should enter into a

Comptroller's Handbook for National Bank Examiners
Temporary insert - February 1994

Section 413.1

written agreement with a third party vendor that has been approved by the bank's board of directors before the vendor is permitted to offer nondeposit investment products to the bank's customers. The agreement should outline the duties and responsibilities of each party and should include a description of all of the activities the third party is permitted to engage in on the bank's premises. The agreement also should set forth terms for the use of the bank's space, personnel, and equipment as well as compensation arrangements for personnel of the bank and the third party. The agreement also should:

• Specify that the third party will com

ply with all applicable laws and regulations and will act consistently with the provisions of this temporary insert, especially the provisions relating to customer disclosures, • Authorize the bank to monitor the third party by periodically reviewing and verifying that the third party and its sales representatives are complying with its agreement with the bank, with all applicable laws and regulations, and with the provisions of this temporary insert,

• Specify the type, scope, and frequency of reports the third party is to furnish to bank management to permit bank management to fulfill its oversight responsibilities,

• Authorize the institution and the OCC to have access to appropriate records of the third party,

Require the third party to agree to indemnify the bank for any liability that resulted from third party investment product sales program actions, • Set forth the training which the bank

expects its employees and third party personnel to possess, and • Provide for written employment contracts between the bank and the third party vendor's employees.

Examiners will review the agreement to determine that it specifies that the third party vendor will comply with all applicable requirements contained in the Interagency Statement. Examiners also will review the

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Retail Nondeposit Investment Sales

Introduction

agreement to determine if it includes provisions regarding bank oversight and examiner access to appropriate records. It is expected that compliance with the agreement will be periodically monitored by the institution's senior management.

Before entering into an agreement with a third party vendor, bank management also should be satisfied that the vendor uses a product selection process similar to the one outlined below. Banks relying on a third party vendor to select products also should understand and agree with the vendor's method of analysis and document its concurrence with that method. Examiners should determine whether management has understood and concurred. Bank management should periodically investigate the vendor's product selection process to ensure that it continues to be appropriate to the bank's customer mix. Examiners also should determine whether bank management understands and agrees with contingency plans developed by the third party vendor and the product issuer to respond to customer orders during unusual surges in redemptions.

To fulfill its oversight responsibilities, it is
expected that bank management will re-
ceive various reports from the third party
vendor and have access to the vendor's
appropriate records. The reports received
will vary with the scope of the sales pro-
gram and should be tailored to the needs of
the institution. The reports should always
include a list of all customer complaints
and their resolution. Other reports that
may facilitate bank management's over-
sight role, could include:

A periodic listing of all new account
openings and descriptions of the
initial trades;

A list of significant or unusual (for
the customer) individual sales during
a reporting period;

Sales reports by product, salesper-
son, and location during a reporting
period; and

Reports of internal compliance re-
views of customer accounts originat-
ed at the bank and reports furnished

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Temporary Insert - February 1994

Section 413.1

to the third party vendor by its regulator(s) on at least an annual basis.

Bank management must monitor compliance by third party vendors on an ongoing basis. Senior bank managers will be expected to ensure that specific individuals employed by the bank and by the third party vendor are responsible for each activity outlined in the bank's investment sales policy. The degree of bank management's involvement should be dictated by the types of products being offered, the volume of sales, the nature of customers' complaints, and the effectiveness of the third party vendor's customer protection systems.

Senior bank management also should appoint an officer responsible for ensuring that bank investment advertisements as well as advertisements prepared by another party that refer to the bank, or any advertisement used in bank-related sales, are accurate, not misleading, and include all required disclosures. In addition, any advertising or promotional material — prepared by or on behalf of a third party vendor-should clearly identify the company selling the nondeposit investment product and should not suggest that the depository institution is the seller.

Examiner access to the records of third party vendors should be governed by preliminary examination findings. When such find..ngs make it clear that bank management has discharged its oversight responsibility by reviewing and responding appropriately to third party reports, only a few customer complaints have been filed against the vendor, and the vendor's reports are timely, sufficiently detailed, and prepared by someone independent of the vendor's sales force, examiner access to third party records should generally be limited to the reports furnished to management by the vendor.

Product Selection

This section describes in general terms the methods that well-managed banks use to

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Retail Nondeposit Investment Sales Introduction

select specific nondeposit investment products and to determine that such products continue to be acceptable to the bank's customer mix. This information is provided to help examiners understand and review the process used by well-managed banks to make this determination.

Bank management should determine the specific laws, regulations, regulatory conditions or other limitations or requirements, including qualitative considerations, that will govern the sale of products to be offered. Although not required, most wellrun bank investment sales programs limit the number of products offered so that customers and salespersons will not be presented with an overwhelming number of choices. Limitations based on product quality may also make it easier for sales managers to shield certain classes of customers from inappropriate products.

As a general practice, bank investment programs offer at least one type of money market mutual fund for customers who are interested in liquidity. In addition, most banks offer a U.S. government bond fund for customers who stress safety and steady income, an equity fund for customers interested in capital growth, and a taxexempt bond fund for customers who wish to avoid taxes on investment earnings.

When deciding which funds to offer, managers should review the fund's performance over an extended period of time. Most bank managers prefer to avoid mutual funds with volatile records. Management's selection of a family of funds should not be based on the performance of one particular fund; each fund selection should stand on its own merits.

Management's selection of investment
products usually begins with an evaluation
of the stability of asset values over time
and an assessment of yields to investors.
Management also compares the perfor-
mance of other funds with similar objec-
tives over the same period(s). Specialized
ratings services (such as Morningstar or
Lipper) or rankings by analytical services

Comptroller's Handbook for National Bank Examiners
Temporary Insert - February 1994

Section 413.1

are usually regarded as necessary but secondary considerations.

Management also considers the fund's track record in terms of both risk and reward. Management analyzes the fund's net asset value versus total return, its management or operating expenses, the turnover within the fund's portfolio, and capital gains and other sources of income. Other key considerations include the composition of the portfolio and concentrations in types of holdings, sector weights, and, in the case of equity funds, the percentage of ownership represented by individual issues.

Management also evaluates important nonstatistical factors such as the continuity, tenure, and demonstrated talent of the fund's management. They also may consider factors such as the quality of a mutual fund's operational and marketing support.

The bank itself, and not another entity's marketing department, should select the funds to be offered. Independent committees and qualified analysts should make the final selections, not a sales manager whose view of the commission structure may affect this judgment.

If the bank uses outside consultants to help select a mutual fund, bank management. should determine whether the consultant receives compensation from mutual funds or mutual fund wholesalers. If the analysis is performed by another party, such as a clearing broker or third party vendor, bank management should understand and agree with the method of analysis and should document the bank's concurrence.

Regardless of who selects the mutual fund products, bank management will be expected to consider the issuer's contingency plans for handling unusual surges in redemptions at the time such products are being considered. Such contingency plans normally include emergency staffing, communications, and operational programs that are based on various market scenarios.

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Retail Nondeposit Investment Sales Introduction

Bank management should compare these contingency plans to the expected needs of bank customers during periods of stress.

Finally, once the initial selection process is complete, bank management should conduct ongoing reviews to assure that the products remain acceptable in light of the bank's objectives and customer's needs.

Selection of annuity products is conducted in the same manner. A variable-rate annuity, a hybrid form of investment that contains elements of mutual funds and insurance, could be characterized as a mutual fund operated by an insurance company. During product selection, bank management should consider the performance and composition of the portfolio that is dedicated to the annuity holders.

Selection analysis for fixed-rate annuities differs from variable-rate annuities. Since fixed-rate annuities are obligations of insurance companies, the risks associated with them relate to the issuer's ability to honor the terms of the annuity contract. Accordingly, the safety of an annuity depends upon the financial standing of the firm that issues it and the selection analysis involves an assessment of the quality and diversification of the company's assets, its holdings of junk bonds, mortgage-backed securities, and problem real estate loans, as well as the continuity of management.

Because it is difficult to independently analyze insurance companies, ratings provided by rating agencies such as A.M. Best, Standard & Poor's, Duff & Phelps, Moody's and Weiss Research play a part in annuity analysis. If bank management relies significantly on such ratings rather than on its own analysis, however, examiners should expect that the issuer selected by the bank has received top ratings from most of the ratings services.

When analyzing annuities, management also should recognize that an issuing insurcompany can, in certain circumstances, sell or simply transfer the annuity contract to another insurance company,

ance

Comptroller's Handbook for National Bank Examiners
Temporary Insert - February 1994

Section 413.1

thereby extinguishing its obligation to the purchaser of the annuity. Annuity owners are generally, but not always, asked to consent to this transfer. A bank selling annuities should consider the possibility of such a transfer in its product selection analysis. At a minimum, the bank should disclose this possibility to prospective

customers.

Interagency Statement on Retail Sales on Nondeposit Investment Products

The full text of the interagency statement begins on the next page.

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Retail Nondeposit Investment Sales

Introduction

Interagency Statement on Retail
Sales on Nondeposit Investment
Products
February 15, 1994

Introduction

Recently many insured depository institutions have expanded their activities in recommending or selling to retail customers nondeposit investment products, such as mutual funds and annuities. Many depository institutions are providing these services at the retail level, directly or through various types of arrangements with third parties.

Sales activities for nondeposit investment products should ensure that customers for these products are clearly and fully informed of the nature and risks associated with these products. In particular, where nondeposit investment products are recommended or sold to retail customers, depository institutions should ensure that customers are fully informed that the products:

Are not insured by the FDIC;

Are not deposits or other obligations of the institution and are not guaranteed by the institution; and,

• Are subject to investment risks, including possible loss of principal invested.

Moreover, sales activities involving these investment products should be designed to minimize the possibility of customer confusion and to safeguard the institution from liability under the applicable anti-fraud provisions of the federal securities laws, which, among other things, prohibit materially misleading or inaccurate representations in connection with the sale of securities.

The four federal banking agencies — the Board of Governors of the Federal Reserve System, the Federal Deposit Insurance Corporation, the Office of the Comptroller of the Currency, and the Office of Thrift Supervision - are issuing this Statement to provide uniform guidance to depository institutions engaging in these activities.

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Section 413.1

(Note: Each of the four banking agencies has in the past issued guidelines addressing various aspects of the retail sale of nondeposit investment products. OCC Banking Circular 274 (July 19, 1993); FDIC Supervisory Statement FIL-71-93 (October 8, 1993); Federal Reserve Letters SR 9335 (June 17, 1993), and SR 91-14 (June 6, 1991); OTS Thrift Bulletin 23-1 (September 7, 1993). This Statement is intended to consolidate and make uniform the guidance contained in the various existing statements of each of the agencies, all of which are superseded by this Statement. Some of the banking agencies have adopted additional guidelines covering the sale of certain specific types of instruments by depository institutions, i.e., obligations of the institution itself or of an affiliate of the institution. These guidelines remain in effect except where clearly inapplicable.)

Scope

This Statement applies when retail recommendations or sales of nondeposit investment products are made by:

Employees of the depository institution; Employees of a third party, which may or may not be affiliated with the institution (see Note, below, addressing which institutions are covered), occurring on the premises of the institution (including telephone sales or recommendations by employees or from the institution's premises and sales or recommendations initiated by mail from its premises); and • Sales resulting from a referral of retail custoiners by the institution to a third party when the depository institution receives a benefit for the referral.

(Note: This Statement does not apply to the subsidiaries of insured state nonmember banks, which are subject to separate provisions, contained in 12 CFR 337.4, relating to securities activities. For OTSregulated institutions that conduct sales of nondeposit investment products through a subsidiary, these guidelines apply to the subsidiary. 12 CFR 545.74 also applies to such sales. Branches and agencies of U.S.

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