June 17, 1994
TO: BANK INVESTMENT MANAGEMENT MEMBERS NO. 23-94
BOARD OF GOVERNORS NO. 52-94
RE: FEDERAL RESERVE'S EXAMINATION PROCEDURES ON MUTUAL FUND
SALES
__________________________________________________________
The Federal Reserve Board recently issued the attached
examination procedures concerning the sale of mutual funds and
other nondeposit products. The procedures are more detailed than
the Interagency Statement on bank sales of nondeposit products that
the federal banking agencies recently released.
The procedures state that, in view of the existence of SEC and
NASD supervision of registered broker-dealers, the procedures "have
been tailored to avoid duplication of examination efforts by
relying on the most recent examination results or sales practice
review conducted by the NASD and provided to the third party
[broker]." (If no NASD examination has occurred within the last
two years, the procedures direct the Reserve Banks to consult with
the Board staff to determine an appropriate examination scope.)
1. Types of Products Sold
The procedures state that bank management "should consider
what products best meet the needs of customers." There should be
periodic review of these products.
2. Common Names
Banks may not offer nondeposit investment products with a name
identical to the name of the bank or its affiliate. Moreover, "the
bank should review the issuer's disclosure documents for compliance
with SEC requirements, which call for a thorough explanation of the
relationship between the bank and the mutual fund."
3. Third Party Arrangements
The bank agencies' Interagency Statement requires depository
institutions to enter into written agreements with third parties
that sell nondeposit products on bank premises. The agreement
should "authorize the institution and Federal Reserve examination
staff to have access to third party records considered necessary"
to evaluate compliance with the agreement.
4. Contingency Planning
Bank management should develop contingency plans to address "a
heavy volume of customer inquiries, complaints, and redemptions" in
the event of "a sudden, sharp drop in the market value of
nondeposit investment products."
5. Disclosure
The procedures call for disclosure similar to that required by
the Interagency Statement. But while the Interagency Statement
requires disclosure of non-FDIC status in confirmations that have
the name or logo of the bank or its affiliate, the examination
procedures require disclosure in confirmations "that are provided
by the bank or an affiliate" and that contain such a name or logo.
6. Compensation
The examination procedures state that compensation paid by
unaffiliated third parties such as mutual fund distributors to
banking organization staff must be approved in writing by bank
management. Incentive compensation programs must not be structured
in such a way as to result in unsuitable recommendations. If sales
personnel "sell both deposit and nondeposit products, similar
financial incentives should be in place for sales of both types of
products." A compensation program that offers significantly higher
remuneration for selling a specific product such as a proprietary
mutual fund "may be inappropriate if it results in unsuitable
recommendations to customers."
7. Other Requirements
The examination procedures also address other matters covered
by the Interagency Statement, including the physical location of
nondeposit sales, training of sales personnel, and suitability.
Paul Schott Stevens
General Counsel
Attachment