Testimony of Governor Edward W. Kelley, Jr.
Supervision of bank sales practices
Before the Subcommittee on Capital Markets, Securities and Government Sponsored Enterprises of the Committee on Banking and Financial Services, U.S. House of Representatives
June 26, 1996
It is a pleasure to appear before this Subcommittee to discuss the supervision of bank sales practices on behalf of the Federal Reserve. The recent publication of various survey results has focused attention on the performance of the banking and securities industries in educating customers about the critical differences between FDIC-insured deposits and uninsured investment products sold on bank premises.
The Board has a long history of concerns about possible customer confusion between insured deposit instruments and uninsured investment products sold on bank premises. We have worked and continue to work diligently to minimize customer confusion through a number of supervisory and educational initiatives. These initiatives include coordination among the banking agencies to formulate clear and comprehensive guidelines governing the conduct of sales programs for nondeposit investment products offered on bank premises; the development of detailed examination procedures covering all aspects of sales of nondeposit products; and the development and implementation of an ambitious, multi-faceted education program for consumers and for banks. We also have developed a productive relationship with the NASD that includes the coordination of examinations of bank affiliated broker dealers and the sharing of examination information in appropriate circumstances. Finally, the banking agencies and the securities self-regulatory organizations have been working together to extend the same professional qualification standards found in the securities industry to bank sales personnel.
Before discussing these matters in more detail, I believe it would be helpful to discuss briefly the continuing growth of the banking industry's sale of mutual funds and other nondeposit investment products that has occurred since early 1994 when the Board last testified on this subject.
Mutual Fund Sales
With respect to sales volume, excluding money market funds, banks sold about $32 billion of equity and debt funds in 1995, up from $29 billion in 1994. These uninsured investment products -- whose prices are most susceptible to changes in interest rates and other market factors -- generate the most concern that customers understand they could lose the principal that they invested. Over the years, the banking agencies have consistently sought to protect and educate customers who might incorrectly believe that such investments are insured deposit instruments.
The Interagency Statement also formalized the agencies' expectation that sales of investment products would take place in an area of the lobby distinctly separate from teller windows and other locations where deposits could be made. Moreover, advertisements and account statements that contain information about both insured deposits and uninsured investment products must separate the information and provide the three disclosures I mentioned earlier. Appropriate standards for training, compensation, suitability and supervision also were discussed.
Finally, the Interagency Statement addressed the relationship between banks and third parties that sell investment products on bank premises -- by far the most typical scenario, since approximately 87 percent of all sales on bank premises occur through broker dealers.
In the two years since their implementation, our examiners have found that banks generally have procedures in place that comply with the guidelines in the Interagency Statement. In some cases, examiners have identified material deficiencies in sales programs and instructed that they be corrected. Although the Federal Reserve is prepared to initiate an enforcement action against any bank found to operate a sales program in a manner not consistent with principles of safety and soundness, in each case in which problems were discovered, the bank responded promptly. In some cases this included a temporary suspension of sale activities until deficiencies were corrected. We have also found many banks to be pro-active in their efforts to operate investment sales programs in a safe and sound manner, and our staff answers frequent inquiries concerning compliance with the requirements of the Interagency Statement.
Pursuant to the Agreement, the Federal Reserve has worked closely with the NASD on several occasions to address supervisory issues arising from the examination of a state member bank and an affiliated broker-dealer that conducts retail sales activities on the bank's premises. While the Federal Reserve has addressed the issues with the bank to seek corrective action in response to the problems, the NASD has addressed the matter with the affiliated broker-dealer thereby assuring that all parties to the business activity are responding to the supervisors' collective concerns.
Most important, we have established effective lines of communication and a cooperative working relationship with the NASD. We think that this relationship has made our supervisory programs more effective.
NASD Proposed Rulemaking
Banking Agencies' Proposed Rulemaking on Professional
Briefly, the proposed rule would require bank employees to take and pass a securities industry professional qualification examination before beginning to sell securities to retail customers. This will ensure that bank securities representatives are appropriately trained and educated as required by the Interagency Statement, and will enhance the ability of banks to serve their retail securities customers. Continuing education requirements, such as those required of broker dealers and their employees, also would be imposed to assure continued familiarity with industry practices, securities issues and regulatory requirements. Finally, bank sales personnel would be subject to a registration process under which employment and certain disciplinary and customer complaint information could be accessed by members of the public. The banking agencies are working with the NASD to arrange for the NASD's new Central Registration Depository to maintain registration information filed with the banking agencies.
In our discussions with the trade organizations and industry participants, we have encountered strong support for the proposed rule. We will encourage the banking industry to participate by commenting on the proposal as the banking agencies work closely with the securities self regulatory organizations to bring this proposal to fruition.
Market Trends Survey
The goal of the consumer seminar program is to help retail customers understand the differences between insured deposits and uninsured investments; the goal of the banker education program is to increase compliance with the Interagency Statement, which in turn will help inform and protect customers. The program has been well received and has been discussed in numerous publications. The American Bankers Association has featured the program in its newsletter and has broadcast the video on its Skylink System.
To date, 70 consumer seminars and 47 banker training programs have been held around the country, reaching over 7,500 consumers -- including a seminar in Spanish to an audience in Puerto Rico -- and nearly 1400 bankers. Materials have been distributed to another 3,150 consumers via exhibits and town meetings sponsored by the Securities and Exchange Commission. Nearly 10,000 copies of the video, over 7,000 copies of the compliance checklists, and approximately 1,500 copies of the consumer outreach package have been distributed. The materials have been shared with federal and state regulators and are available from the Board. Selected materials have been translated into Spanish.
These seminars and educational initiatives appear to work. A comparison of knowledge levels before and after a consumer seminar indicates that individuals seem to have a better understanding of the risks associated with nondeposit investment products: 91 percent know these products are not FDIC insured, compared to 65 percent prior to the seminar; 87 percent know these products carry the risk of loss of principal, compared to 72 percent prior to the seminar. Bankers who attended our training sessions report that they feel better able to comply with the Interagency Statement, especially with respect to disclosure and the physical separation of the investment sales area from deposit taking activities.
We intend to do more. We have completed a video public service announcement that will be distributed this summer to 145 stations in the top forty national television markets. Materials for the bankers training program are currently being updated and we hope to soon initiate another round of banker education programs.
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