Full text of Federal Reserve Bank of New York Circulars : Retail Sales of Nondeposit Investment Products: Examination Procedures

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FEDERAL RESERVE BANK
OF NEW YORK

o n H

June 15, 1994

RETAIL SALES OF NONDEPOSIT INVESTMENT PRODUCTS:
EXAMINATION PROCEDURES

To the Chief Executive Officers of all State Member Banks,
State Licensed U.S. Branches and Agencies of Foreign Banks,
and Bank Holding Companies in the Second Federal Reserve District:

In recent years, banking organizations have become increasingly active in selling uninsured
nondeposit investment products, such as mutual funds, to retail customers on bank premises. In
response to this development, the four Federal financial institution regulators issued an Interagency
Statement on Retail Sales of Nondeposit Investment Products (Interagency Statement) on February 15,
1994, which was distributed to your organization shortly thereafter.
Printed on the following pages are the examination procedures developed by the Federal
Reserve for use when examining retail sales of nondeposit investment products conducted on bank
premises. The examination procedures are intended for use when examining State member banks and
State licensed U.S. branches and agencies of foreign banks. They may also be used during inspections
of bank holding companies and their nonbank subsidiaries that sell nondeposit investment products on
the bank premises.
Should you or your staff have any questions regarding these examination procedures or the
related Interagency Statement, please contact Elizabeth Irwin-McCaughey, Manager, Compliance
Examinations Department (Tel. No. 212-720-6820).

C h e st e r B. F e ld be r g

Executive Vice President

f t t

/o 7 * y

Board of Governors of the Federal Reserve System
EXAMINATION PROCEDURES FOR
RETAIL SALES OF
NONDEPOSIT INVESTMENT PRODUCTS
May 31, 1994
TABLE OF CONTENTS
I. In tro d u ctio n .......................................................................................................................... 3
Program M anag em ent......................................................................................... #. . 5
Types of Products Sold ..................................................................................5
Use of Identical or Similar Names ........................................................... 5
Permissible Use of Customer In fo rm a tio n ................................................. 6
Arrangements with Third Parties .................................................................. 6
Contingency Planning .................................................................................... 7
Disclosures and Advertising.......................................................................................... 8*
Content, Form and Timing of Disclosure........................................... '. . 8
Advertising ........................................................................................................9
Additional D isclo su res..............'.................................................................. 9
Setting and Circumstances ......................................................
10
Physical Separation from Deposit A ctivities.................*......................10
Hybrid Instruments and Accounts . . . ..................
11
Designation, Training and Supervision of Sales Personnel and Personnel
Making R e fe rra ls ....................................................................................................
Hiring and Training for Sales Personnel.................................................
Training of Bank Personnel Who Make Referrals ..............................
Supervision of Personnel .............................................

11
11
12
13

Suitability and Sales P ra c tic e s ...................................................................... . . 13
Suitability of Recommendations........................... *,............................
13
Sales P ra c tic e s ................................................................................................14
. Customer Complaints ...................................................
14

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C om pensation...............................................................................'.........................

C om pliance...................................................................................................................
A u d i t ..........................................................................................................................

II. Examination O b je c tiv e s ......................... #.................................................................... 17
III. Examination Procedures ................................................................................................18
Scope ...........................................................................................................................18
Program Management and Organization ............................................................ 19
Disclosures and A dvertising.................................................................................... 21
Third Party Agreements ..........................................................................................22
Setting and Circumstances .................................................................................... 23
Qualifications and Training .................................................................................... 24
Suitability and Sales P ra c tic e s ............................................................................... 25
C om pensation...........................................................................
26
26
Compliance and Audit ........................

Comments regarding these procedures may be addressed to the attention of the
Securities Regulation Section, Division of Banking Supervision and Regulation,
Board of Governors of the Federal Reserve System, Washington D.C. 2 0 551 .

I. INTRODUCTION
In recent years, depository institutions have become increasingly involved in
selling uninsured nondeposit investment products, such as mutual funds or
annuities, to retail customers on their premises. In response to this development,
four federal financial institution regulators issued an Interagency Statement on
Retail Sales of Nondeposit Investment Products (Interagency Statement) on
February 15, 1 9 9 4 1 in an effort to enhance customer protection and lessen
possible customer confusion that such products are insured deposits. The
Interagency Statement applies to all insured banks and thrifts, including state
member banks and the U.S. branches and agencies of foreign banks.
The guidelines contained in the Interagency Statement2 apply to retail
recommendations or sales of nondeposit investment products made by:
•

Employees of a banking organization;

•

Employees of an affiliated or unaffiliated third party occurring on the
premises of the banking organization (including telephone sales,
investment recommendations by employees, and sales or
recommendations initiated by mail from its premises); and

•

Sales resulting from a referral of retail customers by the institution to
a third party when the depository institution receives a benefit for the
referral.

The following examination procedures are intended to determine if the
bank's policies and procedures provide for an operating environment th at is
designed to ensure customer protections in all facets of the sales program.
Furthermore, examiners are expected to assess the bank's ability to conduct such
sales activities in a safe and sound manner.
These procedures apply when reviewing the nondeposit investment product
retail sales activities conducted by state member banks or the state licensed U.S.

T h e Interagency Statement was issued to Federal Reserve Banks under cover of a
supervisory letter, SR 94-11, dated February 17, 1994. This SR letter superseded SR 93-35 dated
June 17, 1993, which addressed the retail sale of mutual funds on state member bank premises.
2 These examination procedures and the Interagency Statement will be included in the
Commercial Bank Examination Manual and the Bank Holding Company Supervision Manual.

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branches or agencies of foreign banks. They also apply to such activities
conducted by a bank holding company nonbank subsidiary on the premises of a
bank.
The Rules of Fair Practice of the National Association of Securities Dealers
(NASD) govern sales of securities by its member broker dealers. In addition, the
federal securities laws prohibit materially misleading or inaccurate representations
in connection with the offer or sale of securities3 and require that sales of
registered securities be accompanied by a prospectus that complies with SEC
disclosure requirements.
In view of the existence of these securities rules and laws which are
applicable to broker dealers subject to supervision by the SEC and the NASD,
examiners should note that the examination procedures contained herein 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. To the extent that no such NASD examinations or reviews have
been completed within the last tw o years, Reserve Banks should consult with
Board staff to determine an appropriate examination scope before proceeding
further. • Notwithstanding our use of NASD results of sales practice reviews,
examiners should still complete the balance of these examination procedures,
particularly those pertaining to the separation of sales of nondeposit investment
products from the deposit taking activities of the bank.
Examiners should determine whether the institution has adequate policies
and procedures to govern the. conduct of the sales activities on bank premises and,
in particular, whether sales of nondeposit investment products are distinguished
from the deposit taking activities of the bank through disclosure and physical
means that are designed to prevent customer confusion.
Although the Interagency Statement does not apply to sales of nondeposit
investment products to nonretail customers, such as fiduciary customers,
examiners should apply these examination procedures when retail customers are
directed to the institution's trust department where they may purchase nondeposit
investment products by simply completing a customer agreement.
For additional information on the subject of retail sales of nondeposit
investment products, examiners and other interest parties may find it helpful to
refer to "Retail Investment Sales - Guidelines for Banks”, February 1 9 9 4 (Industry
Guidelines), published collectively by six bank trade associations and available from

3
See, for example, Section 10(b) of the Securities Exchange Act (15 U.S.C. 78j(b)) and
Rule 10b-5 (17 C.RR. 240.1 Ob-5) thereunder.

/tt / 0 7 r f

the American Bankers Association, 11 20 Connecticut Avenue, N .W ., Washington
D.C. 2 0 0 3 6 .

PROGRAM MANAGEMENT
Banking organizations must adopt policies and procedures governing
nondeposit investment product retail sales programs. Such policies and procedures
should be in place prior to the commencement of the retail sale of nondeposit
investment products on bank premises.
The board of directors of a banking organization is responsible for ensuring
that retail sales of nondeposit investment products comply with the Interagency
Statement and all applicable state and federal laws and regulations. Therefore, the
board, or a designated committee of the board, should adopt written policies that
address the risks and management of such sales programs. Policies and
procedures should reflect the size, complexity, and volume of the institution's
activities or, when applicable, address the institution's arrangements with any third
parties selling such products on bank premises. The banking organization's policies
and procedures should be reviewed periodically by the board of directors, or its
designated committee, tp ensure that they are consistent with the institution's
current practices, applicable laws, regulations and guidelines.
As discussed in more detail below, an institution's policies and procedures
for nondeposit investment products should, at a minimum, address disclosure and
advertising, physical separation of investment sales from deposit taking activities,
compliance and audit, suitability, and other sales practices and related risks
associated with such activities. In addition, policies and procedures should
address:
Types of Products Sold
W hen evaluating nondeposit investment products, management should
consider w hat products best m eet the needs of customers. Policies should outline
the criteria and procedures that will be used to select and periodically review
nondeposit investment products that are recommended or sold on a depository
institution's premises. Institutions should periodically review products offered to
ensure they meet their customers' needs. '
Use of Identical or Similar Names
Because of the possibility of customer confusion, a nondeposit investment
product must not have a name that is identical to the narrie of the bank or its
affiliates. However, a bank may sell a nondeposit investment product with a name

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similar to the bank as long as the sales program addresses the even greater risk
th a t customers may regard the product as an insured deposit or other obligation of
tiie bank. 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.
The Federal Reserve applies a stricter rule, under Regulation Y (12 C.F.R.
2 2 5 .1 2 5 ), when a bank holding company (as opposed to a bank) or nonbank
subsidiary acts as an investment advisor to a mutual fund. In such a case, the
fund may not have a name that is identical to, similar to, or a variation of, the
name of the bank holding company or a subsidiary bank.
Permissible Use of Customer Information
Banking institutions should adopt policies and procedures regarding the use
of confidential customer information for any purpose in connection with the sale of
nondeposit investment products. The Industry Guidelines permit institutions to
share with third parties only limited customer information, such as name, address,
telephone number, and types of products owned. It does not permit the sharing of
more confidential information, such as specific or aggregate dollar amounts of
investments, net worth, etc., without the customer's prior acknowledgement and
written consent.
Arrangements with Third Parties
A majority of all nondeposit investment products sold on bank premises are
sold by representatives of third parties. Under such arrangements, the third party
has access to the institution's customers, while the bank is able to make
nondeposit investment products available to interested customers without having
to commit the resources and personnel necessary to sell such products directly.
Third parties include wholly-owned subsidiaries of a bank, bank affiliated broker
dealers (i.e.. Section 20 companies or discount brokerage firms), unaffiliated broker
dealers, insurance companies, or other companies in the business of distributing
nondeposit investment products on a retail basis.
A banking institution should conduct a comprehensive review of an
unaffiliated third party before entering into any arrangement. Such review should
include an assessment of the third party's financial status, management
experience, reputation, and ability to fulfill its contractual obligations to the bank,
including compliance with the Interagency Statement.
The Interagency Statem ent calls for banking institutions to enter into
written agreements with any affiliated and unaffiliated third parties that sell
nondeposit investment products on bank premises. Such agreements should be.

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approved by an institution's board of directors, or its designated committee. '
Agreements should outline the duties and responsibilities of each party, describe
third party activities permitted on institution premises, address the sharing or use
of confidential customer information for investment sales activities, and define the
terms for use of the institution's office space, equipment, and personnel. If an
arrangement includes dual employees, the agreement must provide for written
employment contracts that specify the duties of such employees and compensation
arrangements.
In addition, a third party agreement should specify that the third party will
comply with all applicable laws and regulations and will conduct its activities in a
manner consistent with the Interagency Statement. The agreement should
authorize the institution to monitor the third party's compliance with its agreement,
and authorize the institution and Federal Reserve examination staff to have access
to third party records considered necessary to evaluate such compliance. These
records should include examination results, sales practice reviews and related
correspondence provided to the third party by securities regulatory authorities.
Finally, an agreement should provide for indemnification of the institution by an
unaffiliated third party for the conduct of its employees in connection with such
sales activities.
Notwithstanding the provisions of a third party agreement, a banking
institution should monitor the conduct of nondeposit investment product sales
programs to ensure that sales of nondeposit investment products are distinct from
other bank activities and are not conducted in a manner that could confuse
customers regarding the lack of insurance coverage for such investments.
Contingency Planning
Nondeposit investment products are. subject to price fluctuations caused by
changes in interest rates, stock market valuations, etc. In the event of a sudden,
sharp drop in the market value of nohdeposit investment products, institutions may
experience a heavy volume of customer inquiries, complaints, and redemptions.
Therefore, management should develop contingency plans to address these
situations. A major element of any contingency plan should be the provision of *
customer access to information pertaining to their investments. Other factors to
consider in contingency planning include public relations and the ability of
operations staff to handle increased volumes of transactions.

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DISCLOSURES AND ADVERTISING
Content, Form and Timing of Disclosure
Nondeposit investment product sales programs should be conducted in
a manner th at ensures that customers are clearly and fully informed of the nature
and risks associated with these products.. In addition, nondeposit investment
products must be clearly differentiated from insured deposits. The Interagency
Statement identifies the following minimum disclosures that must be made to
customers when providing investment advice, making investment
recommendations, or effecting nondeposit investment product transactions:
•

They are not insured by the FDIC;

•

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

•

They are subject to investment risks, including the possible loss of the
principal invested.

Disclosure is the most important way of ensuring that the differences between
nondeposit investment products and insured deposits are understood by retail
customers. Accordingly, it is critical that the minimum disclosures be presented in a
clear and concise manner in both oral and written communications. In this regard, the
minimum disclosures should be provided:
•

Orally during any sales presentations (including telemarketing contacts)
or when investment advice is given;

•

Orally and in writing prior to or at the time an investment account to
purchase these products is opened; and

•

In all advertisements and other promotional materials (discussed further
below).

The minimum disclosures may be made on a customer account agreement or
on a separate disclosure form. The disclosures must be conspicuous (i.e., highlighted
through bolding, boxes, and/or larger typeface). Disclosures contained directly on a
customer account agreement should be located on the front of the agreement or
adjacent to the customer signature block.
Banking organizations are to obtain a written acknowledgement - on the
customer account agreement or on a separate form - from a customer confirming that
the customer has received and understands the minimum disclosures. For nondeposit

/<?///

Investment product accounts established prior to the Interagency Statement, banking
organizations should obtain a disclosure acknowledgement from the customer at the
time of the customer’s next purchase transaction. If an institution solicits customers
by telephone or mail, it should ensure that the customers receive the written
disclosures and an acknowledgement to be signed and returned to the institution.
Customer account statements, including combined statements for linked
accounts, and trade confirmations for that are provided by the bank or an affiliate,
should contain the minimum disclosures if they display the name or logo of the bank
or its affiliate. Statements which provide account information about insured deposits
and nondeposit investment products should clearly segregate the information about
nondeposit investment products from the information about deposits to avoid
customer confusion.
Advertising
The Interagency Statement provides that advertisements in all media forms that
identify specific investment products must conspicuously include the minimum
disclosures and must not suggest or convey any inaccurate or misleading impressions
about the nature of a nondeposit investment product Promotional material that
contains information about both FDIC-insured products and nondeposit investment
products should clearly segregate the information about the two product types. When
displaying promotional sales materials related to nondeposit investment products in
the bank’s retail areas, they should be grouped separately from material related to
insured bank products.
Telemarketing scripts should be reviewed to determine whether bank personnel
are making inquiries about customer investment objectives, offering investment advice,
or identifying particular investment products or types of products. In such cases, the
scripts must contain the minimum disclosures and bank personnel relying on such
scripts must be formally authorized to sell nondeposit investment products by their
employers. Further, these personnel must have training that is the substantive
equivalent of that required for personnel qualified to sell securities as registered
representatives (see Training below).
Additional Disclosures
A depository institution should apprise customers of certain material
relationships. For example, a customer should be informed by sales personnel orally
and in writing ,prior to the sale about any advisory relationship existing between the
bank (or an affiliate) and a mutual fund whose shares are being sold by the institution.
Similarly, fees, penalties, or surrender charges associated with a nondeposit
investment product should be disclosed by sales personnel orally and in writing prior

to or at the time the customer purchases the product The SEC requires written *
disclosure of this information in the investment products prospectus.
If sales activities include any written or oral representations concerning
Insurance coverage by any entity other than FDIC (e.g.; S1PC insurance of broker
dealer accounts, a state insurance fund, or a private insurance company), then clear
and accurate explanations of the coverage also must be provided to customers at that
time in order to minimize possible confusion with FDIC insurance. Such disclosures
should not suggest that other forms of insurance are the substantive equivalent to
FDIC deposit insurance..

S E T T IN G A N D C IR C U M S T A N C E S

Physical Separation from Deposit Activities
Selling or recommending nondeposit investment products on the premises of a
banking institution may give the impression that the products are FDIC-insured or are
obligations of the bank. To minimize customer confusion with deposit products,
nondeposit investment product sales activities should be conducted in a location that
is physically distinct from the areas where retail deposits are taken. Bank employees
located at teller windows may not provide investment advice, make investment
recommendations about investment products, or accept orders (even unsolicited
orders) for nondeposit investment products.
Forming an opinion whether nondeposit investment product sales activities are
sufficiently separate from deposit activities requires an evaluation of the particular
circumstances of each bank. FDIC insurance signs and insured deposit related
promotional material should be removed from the investment product sales area and
replaced with appropriate signs indicating that the area is utilized for the sale of
investment products. Signs referring to specific investments should prominently
contain the minimum disclosures. In the limited situation where physical constraints
prevent nondeposit investment product sales activities from being conducted in a
distinct and separate area, the institution has a heightened responsibility to ensure that
appropriate measures are taken to minimize customer confusion.
In the case of banks that are affiliated with Section 20 companies that sell retail
Investment products directly to bank customers, the requirement for separation of
deposit taking facilities from the Section 20’s securities operations is absolute under
the relevant firewall conditions imposed on Section 20 companies by the Board.
Accordingly, retail sales activities conducted by a Section 20 company must be in a
separate office which, at a minimum, is set off from deposit taking activities by

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partitions and identified by signs with the name of the Section 20 company. Further,
Section 20 company employees may not be dual employees of the bank.
Business cards for designated sales personnel should clearly indicate that they
sell nondeposit investment products or, if applicable, are employed by a broker dealer.
The Interagency Statement was intended generally to cover sales made to retail
customers in the bank lobby. However, some institutions may have an arrangement
whereby retail customers purchase nondeposit investment products at a location of
the institution generally confined to institutional services (e.g., corporate money desk).
In such cases, the banking institutions should still ensure that retail customers receive
the minimum disclosures in order to minimize any possible confusion with nondeposit
investment products and insured deposits by such customers.

Hybrid Instruments and Accounts
In those cases in which an institution offers accounts that link traditional bank
deposits with nondeposit investment products, such as a cash management account,4 *
the accounts should be opened at the investment sales area by trained personnel. In
light of the hybrid characteristics of these products, the opportunity for customer
confusion is amplified, and special care must be taken by the institution in the account
opening process to ensure that a customer is accurately informed that:
•

Funds deposited into a sweep account will only be FD1C insured until
they are swept into a nondeposit investment product account; and

•

Customer account statements may disclose balances for both insured
and nondeposit product accounts.

D E S IG N A T IO N . T R A IN IN G A N D S U P E R V IS IO N O F S A L E S P E R S O N N E L A N D
P E R S O N N E L M A K IN G R E F E R R A L S

Hiring and Training of Sales Personnel
Banking organization's hiring sales personnel for nondeposit investment product
programs should investigate the backgrounds of prospective employees, In cases in
which candidates for employment have previous investment industry experience, the

4 A hybrid account may incorporate deposit and brokerage services, credit/debit card
features, and automated sweep arrangements.

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bank should check whether the individual has been the subject of any disciplinary
actions by securities, state or other regulators.
Unregistered bank sales personnel should receive training that is the
substantive equivalent of that provided to personnel qualified to sell securities as
registered representatives. Training should cover the areas of product knowledge,
trading practices, regulatory requirements and restrictions, and customer protection
Issues. In addition, training programs should cover the institution’s policies and
procedures regarding sales of nondeposit investment products, and should be
conducted on a continuing basis to assure that-staff continues to be familiar with new
products and compliance issues.
For those bank employees whose sales activities are limited to mutual funds or
variable annuities, the equivalent training is that ordinarily needed to pass NASD’s
Series 6 limited representative examination, which typically involves approximately 30
to 60 hours of preparation, including about 20 hours of classroom training. Bank
employees who are authorized to sell additional investment products and securities
should receive training that is appropriate to pass the NYSE’s Series 7 general
securities representative examination, which typically involves 160 to 250 hours of
study, including at least 40 hours of classroom training.
The training of third party or dual employees is the responsibility of the third
party. When entering into an agreement with a third party, a banking organization
should be satisfied that the third party is able to train third party and dual employees
with respect to compliance with the minimum disclosures and other requirements.of
the Interagency Statement Copies of third party training and compliance materials
should be obtained and reviewed by the bank in order to monitor the third party’s
performance regarding its training obligations.

Training of Bank Personnel W ho M ake Referrals
Bank employees, such as tellers and platform personnel, who are not
authorized to provide investment advice, make investment recommendations or sell
nondeposit investment products, but who may refer customers to authorized
nondeposit investment products sales personnel, should receive training regarding the
strict limitations on their activities. In general, bank personnel who are not authorized
to sell nondeposit investment products are not permitted to discuss general or specific
investment products, pre-qualify prospective customers as to financial status and
investment history and objectives, open new accounts, or take orders on a solicited or
unsolicited basis. Such personnel may contact customers for the purposes of:
•

Determining whether the customer wishes to receive investment
information;
12

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•

Inquiring whether the customer wishes to discuss investments with an
authorized sales representative; and

•

Arranging appointments to meet with authorized bank sales personnel or
third party broker dealer registered sales personnel.

The minimum disclosure guidelines do not apply to referrals made by personnel not
authorized to sell nondeposit investment products if the referral does not include the
provision of investment advice, the identification of specific investment products or the
making of investment recommendations.

Supervision of Personnel
Banking institution policies and procedures should designate, by title or name,
the individuals responsible for supervising nondeposit investment product sales
activities, as well as referral activities by bank employees not authorized to sell these
products. Personnel assigned responsibility for management of sales programs for
these products should have supervisory experience and training equivalent to that
required of a general securities principal as required by the NASD for broker dealers.
Supervisory personnel should be responsible for the institution’s compliance with
policies and procedures on nondeposit investment products, applicable laws and
regulations, and the interagency Statement When sales of these products are
conducted by a third party, supervisory personnel should be responsible for
monitoring compliance with the agreement between the bank and the third party, as
well as compliance with the Interagency Statement, particularly the guideline calling for
nondeposit investment product sales to be separate and distinct from the deposit
activities of the bank.

S U IT A B IL IT Y A N D S A L E S P R A C T IC E S

Suitability of Recommendations
Suitability refers to the matching of customer financial means and investment *
objectives with a suitable product If customers are placed into unsuitable
investments, the resulting loss of consumer confidence could have detrimental effects
on an institution’s reputation. Many first-time investors may not fully understand the
isks associated with nondeposit investment products and may assume that the
oanking institution is. responsible for the preservation of the principal of their
nvestment
Banking institutions that sell nondeposit investment products directly to
^jstomers should develop detailed policies and procedures addressing suitability o f .

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investment recommendations and related record keeping requirements. Sales
personnel that recommend nondeposit investment products to customers should have
reasonable grounds for believing that the products recommended are suitable for the
particular customer on the basis of information provided by the customer. A
reasonable effort must be made to obtain, record and update information concerning
the customer’s financial profile (e.g., tax status, other investments, income), investment
objectives and other information necessary to make recommendations.
In determining whether sales personnel are meeting their suitability
responsibilities, examiners should review the practices for conformance with the
banking institution's policies and procedures. The examiner’s review should include a
sample of customer files to determine the extent of customer information collected,
recorded and updated (for subsequent purchases), and whether investment
recommendations appear unsuitable in light of such information.
Nondeposit investment product sales programs conducted by third party broker
dealers are subject to the NASD’s suitability and other sales practice rules. To avoid
duplicating NASD examination efforts in this regard, examiners should rely on the
NASD’s most recent sales practice review of the third party when available. To the
extent that no such NASD review has been completed within the last two years,
Reserve Banks should consult with Board staff to determine an appropriate
exantination scope for suitability compliance before proceeding.further.
Sales Practices
The banking organization should have policies and procedures that address
undesirable practices by sales personnel intended to generate additional commission
income through the churning or switching of accounts from one product to another.
Custom er Complaints
The banking organization should have policies and procedures for handling
customer complaints related to nondeposit investment products. The process should
provide for the recording and tracking of all complaints and require periodic reviews of
complaints by compliance personnel. The merits and circumstances of each
complaint (including all documentation relating to the transaction) should be
considered when determining the proper form of resolution. Reasonable time frames
should be established for addressing complaints.

COMPENSATION
incentive compensation programs specifically related to the sale of nondeposit
investment products may include sales commissions, limited fees for referring

10 ^ / / /

prospective customers to an authorized sales representative, and non-monetary •
compensation (prizes, awards, and gifts). Compensation that is paid by unaffiliated
third parties (e.g., mutual fund distributors) to banking organization staff must be
approved in writing by bank management; be consistent with the bank’s written
internal code of conduct relating to the acceptance of remuneration from third parties;
and be consistent with the proscriptions of the Bank Bribery Act (18 U.S.C. 215) and
the banking agencies’ implementing guidelines to that act (see SR 87-36,- dated
October 30, 1987, or 52 Federal Register 39,277, October 21,1987). Compensation
policies should establish appropriate limits on the extent of compensation that may be
paid to banking organization staff by unaffiliated third parties.
Incentive compensation programs must not be structured in such a way as to
result in unsuitable investment recommendations or sales to customers. In addition, 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 (e.g., proprietary
mutual fund) may be inappropriate if it results in unsuitable recommendations to
customers. A compensation program that is intended to provide remuneration for a
group of bank employees (such as a branch or department) is permissible as long as
the program is based on the overall performance of the group in meeting bank
objectives regarding a broad variety of bank services and products, and is not based
principally on the volume of sales on nondeposit investment products.
Individual bank employees, such as tellers, may receive a one-time nominal fee
of a fixed dollar amount for referring customers to authorized sales personnel to .
discuss nondeposit investment products. However, the payment of the fee should not
depend on whether the referral results in a transaction. Non-monetary compensation
to bank employees for referrals should be similarly structured.
Auditors and compliance personnel should not participate in incentive
compensation programs directly related to the results of nondeposit investment
product sales programs.

C O M P L IA N C E

Institutions must develop and maintain written policies and procedures that
effectively monitor and assess compliance with the Interagency Statement and other
applicable laws and regulations and assure appropriate follow-up to correct identified
deficiencies. Compliance programs should be independent of sales activities with
respect to scheduling, compensation, and performance evaluations. Compliance
findings should periodically be reported to the institution’s board of directors or a
designated committee of the board as part of their ongoing oversight of nondeposit
investment product activities. Compliance personnel should have appropriate training

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and experience with nondeposit investment product sales programs, applicable laws
and regulations, and the Interagency Statement
Banking organizations should institute compliance programs for nondeposit
investment products that are similar to those of securities broker dealers. This
includes a review of new accounts and a periodic review of transactions in existing
accounts to identify any potential abusive practices such as unsuitable
recommendations, churning or switching practices. Compliance personnel should also
oversee the prompt resolution of customer complaints and review complaint logs for
questionable sales practices. MIS reports on early redemptions and sales patterns for
specific sales representatives and products should also be used by compliance
personnel to identify any potentially abusive practices. In addition, referral activities of
bank personnel should be reviewed to assure that they are conducted in a manner
that conforms to the guidelines in the Interagency Statement
When nondeposit investment products are sold by third parties on bank
premises, the bank’s compliance program should provide for oversight of the third
party’s compliance with its agreement with the bank, including conformance to the
disclosure and separate facilities guidelines of the Interagency Statement The results
of such oversight should be reported to the board of directors or to a designated
committee of the board. Management should obtain the third party’s commitment
promptly to correct identified problems. Proper follow-up by the bank’s compliance
personnel should verify the third party’s corrective actions.

AUDIT
Audit personnel should be responsible for assessing the effectiveness of the
institution’s compliance function and overall management of the nondeposit investment
product sales program. The scope and frequency of audit’s review of nondeposit
investment product activities will depend on the complexity and sales volume of a
sales program, and whether there are any indications of potential or actual problems.
Audits should cover all of the issues discussed in the Interagency Statement Internal
audit staff should be familiar with nondeposit investment products and receive ongoing
training. Findings should be reported to the board of directors, or a designated
committee of the board, and proper follow-up should be performed. Audit activities
with respect to third parties should include a review of their compliance function and
the effectiveness of the bank’s oversight of the third party’s activities.

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II. EXAMINATION OBJECTIVES
R E T A IL S A L E S O F N O N D E P O S IT IN V E S T M E N T P R O D U C T S

To determine that the banking organization has taken appropriate measures to
ensure that retail customers dearly understand the differences between insured
deposits and nondeposit investment products and receive the minimum
disclosures both orally during sales presentations (including telemarketing) and
in writing.

To assess the adequacy of the institution’s policies and procedures, sales
practices, and oversight by management and the board of directors to ensure
an operating environment that fosters customer protection in all facets of the
sales program.

To ensure that the sales program is conducted in a safe and sound manner
that is in compliance with the Interagency Statement, Federal Reserve
guidelines, regulations and applicable laws.

To assess the effectiveness of the institution’s compliance and audit programs
for nondeposit investment product operations.

To obtain commitments for corrective action when policies, procedures,
practices, or management oversight is deficient or when the institution has failed
to comply with the Interagency Statement or applicable laws and regulations.

III. EXAMINATION PROCEDURES FOR
RETAIL SALES OF NONDEPOSIT INVESTMENT PRODUCTS
SCOPE;
These procedures are based on the guidelines outlined in the Interagency
Statement The Interagency Statement applies to all banking organizations, including
state member banks and the U.S. branches and agencies of foreign banks supervised
by the Federal Reserve.
These examination procedures are intended for use when examining a state
member bank (or a state licensed U.S. branch or agency of a foreign bank) that
engages directly in the retail sale of nondeposit investment products. They should be
used in conjunction with examination procedures related to the recordkeeping and
confirmation practices applicable to banks selling securities directly to customers that
are contained in section 204.1 (questions 24-35) of the Commercial Bank Examination
Manual.
This set of examination procedures is also meant to be utilized in conjunction
with those contained in the Federal Reserve’s Bank Holding Company Supervision
Manual when examining a nonbank subsidiary that sells nondeposit investment^
products on bank premises. See the following sections for related examination
procedures:
•

Nonbank Subsidiaries Engaged in Underwriting and Dealing - Section 20
Subsidiaries, at section 2185.0; .

•

Section 4(c)(8) of the BHC Act - Investment or Financial Advisers, at section
3130.1;

•

Section 4(c)(8) of the BHC Act - Securities Brokerage, at section 3230.0;

•

Providing Administrative and Certain Other Services to Mutual Funds at section
3600.27

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P R O G R A M M A N A G E M E N T A N D O R G A N IZ A T IO N

Evaluate the institution’s structure and reporting fines (legal and functional) for
its retail nondeposit investment products operations. Determine whether retail
sales of nondeposit investment products are being made directly by employees
of the depository institution or through an affiliated or unaffiliated third party.
Identify the principals responsible for the management of the nondeposit
investment products sales program. Review their backgrounds, qualifications
and tenure with the institution.

Determine the role of the board of directors of each legal entity involved in the
sale of nondeposit investment products in authorizing and controlling
nondeposit investment products activities on bank premises. Evaluate the
adequacy of MIS reports relied upon by the board (or a designated committee)
and senior management to manage these activities.

Describe the membership and responsibilities of management or board
•
committees for nondeposit investment product retail sales programs. Review
minutes maintained by these committees for information related to the conduct
of retail nondeposit investment product sales programs.

Review and evaluate the institution’s policies and procedures, objectives, and
budget for nondeposit investment products activities. In so doing, consider the
following:
a)
b)
c)
d)

Who prepared the material;
How it fits into the institution’s overall strategic objectives;
Whether the goals and objectives are realistic;
Whether actual results routinely are compared to.plans and
budgets.

Determine how policies and procedures for nondeposit investment product
activities are developed and at what level in the institution they are formally
approved. Review the policies and procedures to see that they are consistent
with the Interagency Statement and that they address the following matters:
a)
b)
c)
d)
e)

Disclosure and advertising;
Physical separation from deposit taking activities;
Compliance programs and internal audit;
Hiring, training, supervision arid compensation practices for sales
staff and personnel making referrals;
Types of products offered, selection criteria;

f)
g)
h)
i)
j)

Restrictions on mutual fund use of names similar or identical to
that of the bank holding company or its subsidiary banks;
Suitability and sales practices;
Use of customer information;
Transactions with affiliated parties; and
Role of third parties, if applicable.

Determine how management oversees compliance with these policies and
procedures.

Review the product selection and development process to ensure that it
considers customer needs and investment objectives.

Determine if the depository institution is covered by blanket bond insurance
applicable to nondeposit investment product retail sales activities.

If the institution sells proprietary nondeposit investment products and performs
related backoffice operations, review:
a)
b)

The work flow and position responsibilities within the sales and
operations function; and
Available flow charts, job descriptions, and policies and
procedures.

After discussions with management, conduct a walk-through tracing the path of
a typical transaction. Evaluate the effectiveness and efficiency of the work flow
and the overall operation.
10.

Determine whether the institution has established any contingency plans for
nondeposit investment product programs for handling adverse events, such as
a sudden market downturn or period of heavy redemptions.

11.

Review the institution’s earnings and evaluate:

a)
b)

Profitability of nondeposit investment products activities, including
any investment advisory fees they may receive; and
Income and expense from the sales, investment advisory, and
proprietary fund management activities related to nondeposit
investment products, as a percentage of noninterest income and
expense.

D IS C L O S U R E S A N D A D V E R T IS IN G

he Interagency Statement identified certain minimum disclosures that must be made
>customers. They are that nondeposit investment products
•
•
•

are not insured by the Federal Deposit Insurance Corporation (FDIC);
are not deposits or other obligations of the institution and are not
guaranteed by the institution; and
are subject to investment risks, including the possible loss of the
principi invested.

Determine whether the minimum disclosures are being provided orally to
customers during sales presentations (including telemarketing contacts) or
when providing investment advice on specific investment products.

Determine if the customer account agreement (or a separate disclosure form)
presents the minimum disclosures in a clear and conspicuous manner. The
disclosures should be prominent (e.g., highlighted through bolding, boxes,
.and/or larger typeface), and should be located on the front of the customer
account agreement or adjacent to the customer signature block.

Determine whether customers sign an acknowledgement that they have *
received and understand the minimum disclosures. The acknowledgement can
be on the customer account agreement or it can be on a separate disclosure
form. Determine that customers who opened accounts prior to issuance of the
Interagency Statement receive the written minimum disclosures and
acknowledge receipt at the time of their next transaction. Review a sample of
customer accounts to determine whether customers received the minimum oral
and written disclosures.
In those cases in which sales confirmations or account statements provided by
the bank or an affiliate bear the name or logo of the bank or an affiliate,
determine that the minimum disclosures are conspicuously contained on the
front of the documents.
Review advertisements and promotional material that identify specific
nondeposit investment products to determine that they conspicuously contain
the minimum disclosures. Any materials that contain information about insured
deposits and nondeposit investment products should clearly segregate the
information about investment products from the information about deposits.
Review telemarketing material used to solicit new business. To the extent that
employees identify specific products, seek customer investment objectives,

m io ih

make investment recommendations or give investment advice, determine •
whether:
a)
b)

. c)

The minimum disclosures are included in the script;
Bank employees engaged in telemarketing activities are authorized
by the bank to recommend or sell nondeposit investment products
and whether their training is the substantive equivalent of that
required for securities registered representatives; and
The material contains any statements that may be misleading or
confusing to customers regarding the uninsured nature of
nondeposit investment products.

.1 8 .

In those cases in which nondeposit investment products are sold by employees
of an affiliated broker dealer, determine that any written or oral representations
concerning insurance coverage provided by SIPC, a state insurance fund, or a
private insurance company, are clear and accurate and do not suggest that
they are the substantive equivalent to FDIC insurance available for certain
deposit products.

19.

*!n cases in v hich the bank or its bank i.ulding company (or affiliate) acts as an
investment advisor to, or has some other material relationship with, a mutual
fund whose shares are sold by the bank, determine that:
a)
b)
c)

oral and written disclosure of the relationship is made prior to the
purchase of the shares;
bank advised mutual funds do not have names identical to the
bank;
bank advised mutual funds with names similar to the bank are
sold pursuant to a sales program designed to minimize the risk of
customer confusion; and
bank holding company advised mutual funds do not have names
identical to, similar to or a variation of the name of the holding
company or i^s subsidiary bank.

Determine that disclosure .of any sales charges, fees, penalties, or surrender
charges relating to nondeposit investment products is made orally and in writing
prior to the purchase of these products.

TH IR D PARTY AGREEMENTS
21.

In those cases in which sales of nondeposit investment products are conducted
by employees or representatives of a third party, review all contractual

MmiH

agreements between the bank and the third party to determine whether they
cover the following:
• a)
b)
c)
d)
e)
f)

Duties and responsibilities of each party; •
Third party compliance with all applicable laws and regulations,
and the Interagency Statement;
Authorization for the institution to oversee and verify compliance
by the third party;
Provision for access to relevant records to the appropriate bank
supervisory authorities;
Written employment contracts for dual employees;
* Indemnification of the institution by the third party for the conduct
of its employees in connection with nondeposit investment product
sales activities; and
Policies regarding the use of confidential customer
information for any purpose in connection with sales of nondeposit
investment products.

22.

Obtain and review the most recent NASD examination results for the third party
.. from the bank or the third party broker dealer. Also obtain and review
examination related correspondence and any disciplinary matters between the
broker dealer and the NASD or SEC. Review the institution’s progress in
addressing any investment recommendations or deficiencies noted in the
examination results or other material.

23.

Where any retail sales facilities of the institution are leased to an affiliated third
party that sells nondeposit investment products:
a)

Assess whether the lease was negotiated on an arm’s length basis
and on terms comparable to similar lease agreements in the local
market; and
Review any intercompany relationships for compliance with
Sections 23A and 23B of the Federal Reserve A ct

SETTING AND CIRCUMSTANCES
14.

Determine whether the sale of nondeposit investment products is conducted in
a physical location distinct from deposit taking activities of the bank. In so
doing:
a)

Verify that nondeposit investment products are not sold from teller
windows;

Determine that signs or other means are used to distinguish the
nondeposit investment products sales area from the retail deposit
taking area of the institution;
Determine whether space limitations preclude having a separate
investment products sales area, and, if so, whether the institution
clearty distinguishes nondeposit investment products from insured
bank products or obligations; note how this is accomplished; and
Determine if retail sales of nondeposit investment products are
being conducted by a Section 20 company; if so, determine that
such sales are conducted through a separate office (i.e., a
location physically separate from the deposit taking area of the
bank which, at a minimum, is set off by partitions and identified by
signs with the name of the Section 20 company) and that no
Section 20 company employee is a dual employee of the bank.

QUALIFICATIONS AND TRAINING
25.

Determine whether employees of a depository institution are providing
investment advice, making investment recommendations or selling nondeposit
* investment products directly to retail customers. If so, determine whether:
a)
b)

26.

Background checks have been performed by the depository
institution; and
Sales personnel have received training that is the substantive
equivalent to that provided to a securities registered
representative.

Review the training program provided to employees of the depository institution
that are authorized to provide investment advice, make investment
recommendations or sell nondeposit investment products. Assess whether the
program addresses the following subject matters:

a)
b)
c)
d)
e)

General overview of U.S. financial markets;
Detailed information concerning specific product lines* being
offered for sale;
Generally accepted trading practices for the products available for
sale;
General overview of federal securities laws and regulations
(antifraud and disclosure);
Banking regulations and guidelines applicable to sales activities
(e.g., anti-tying prohibitions, Interagency Statement, supervisory
letters on sales of specific investment products, etc.);
Policies and procedures specific to the institution;
24

g)
h)

Appropriate sales practices, including suitability of investment,
recommendations and disclosure obligations; and
Appropriate use of customer lists and confidential customer
information.

Determine whether the institution has any continuing education program or
periodic seminars on new products or compliance.

Determine whether supervisors of bank sales personnel receive special training
pertaining to their supervisory responsibilities that is the substantive equivalent
of training required for supervisors (General Securities Principals) of registered
representatives.

Review training of bank employees who are not authorized to sell nondeposit
investment products but who make referrals, such as tellers, customer service
representatives, and others. In so doing, determine whether such employees
have been provided training in appropriate referral practices, including the limits
on their activities.

SUITABILITY AND SALES PRACTICES
The following procedures on suitability and sales practices are applicable when
inducting an examination of a depository institution whose employees offer
vestment advice, make investment recommendations, or sell nondeposit investment •
-oducts. Examinations involving registered broker dealers should rely on the NASD’s
view of sales practices or its examination to assess the organization’s compliance
ith suitability requirements.
1

Determine whether depository institution personnel recommend nondeposit
investment products to customers. If so, determine that sales personnel obtain,
record, and update the following information (* not necessary when money
m arket mutual funds are being recommended):
a)
b)
c) *
d)*
e) *

Age;
Tax status;
Current investments and overall financial profile, including an
estimate of net worth;
Investment objectives; and
Other personal information deemed necessary to offer reasonable
investment advice.

Review a representative sample of customer accounts that were opened at
several different branch locations. Assess whether customer suitability

information is obtained, and whether investments appear unsuitable in light of
such information.
32.

Review customer complaints involving suitability of investment
recommendations. Determine whether the bank's original recommendations
appear unsuitable in the context of the information available at the time of sale.
Note how suitability complaints are resolved.

COM PENSATION
33.

If employees of the depository institution provide investment advice, make
investment recommendations, or sell nondeposit investment products,
determine:
a)

Whether any incentive compensation plan available to nondeposit
investment product sales personnel strongly favors proprietary or
other specific products; and, if so, determine how the institution
ensures that customers are not placed into unsuitable
investments; and
Whether compliance and audit personnel are excluded from
incentive compensation programs directly related to the results of
nondeposit investment product sales.

34.

Determine that fees paid to bank employees for referrals to depository
instrtution sales personnel or third party sales staff are based on a one-time,
nominal fee of a fixed-dollar amount and are not dependent on a successful
sale.

35.

Determine that the* bank's compensation policies address remuneration of bank
employees by third parties and that these policies are incorporated in the
bank’s code of conduct, in so doing, determine that the bank’s policies were
approved by the board of directors and are consistent with the proscriptions of
the Bank Bribery Act and the interagency guidelines adopted thereunder.

C O M PLIA N C E AND AUDIT
36.

Review and assess the depository institution's compliance program for
nondeposit investment product sales activities. In so doing, consider the
following:

a)
b)

. Frequency and scope;
Workpapers;
26

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c)
d)
e)
f)

Degree of independence from the sales program;
Follow-up on material findings;
Centralization of findings from all compliance areas; and
Role of the board of directors in reviewing findings.

37.

Review the criteria used to evaluate bank sales personnel for compliance with
the institution’s policies and procedures, specifically, those policies relating to
disclosure and suitability.

38.

Determine whether compliance personnel approve or review new accounts,
periodically review transactions in accounts, and review sales and referral
activities of bank personnel.

39.

Review the customer complaint process and the associated complaint log to
determine if complaints are addressed on a timely basis.

40.

Review progress in addressing identified compliance problems.

41.

Evaluate the experience, training and qualifications of compliance personnel.

42.

. .Review the scope of audits and determine if the following areas were
adequately addressed:

a)
b)

c)
d)

e)
f) -

g)
h)
0

Disclosure and advertising;
Physical separation of nondeposit investment product sales
activities;
Compliance;
Sales practices and suitability;
Product selection and development;
Use of confidential customer information by bank and third party
sales personnel;
Third party compliance with agreement with the institution;
Personnel training and background checks; and
Operations (clearing, cash receipts and disbursements,
accounting, redemptions, etc.), if applicable;

43.

Obtain all internal and external audit reports regarding the institution’s
nondeposit investment product activities performed over the past year (including
management’s responses). Review for exceptions, recommendations, and
follow-up actions. Ascertain if significant exceptions were presented to the
institution’s audit committee or board of directors for their review.

44.

For external audits, obtain a copy of the engagement letter and comment on
the adequacy of the firm’s audit review.

Full text of Federal Reserve Bank of New York Circulars : Retail Sales of Nondeposit Investment Products: Examination Procedures

FRASER