merging of the financial services markets that has
already occurred.
This development has been beneficial not only in
affording consumers more convenient access to a wide
variety of investment products at competitive prices,
but to the banks themselves in the form of service
income. Mutual fund services, along with other new
products and services, have become an important source
2
"Asset Management Account Might Fill Your Banking
Needs," Washington Post . H3, Feb. 27, 1994.
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of replacement revenue for the decreasing bank revenue*
from lending activities. Banks earn service income not
only by providing investment advice, brokerage, and
shareholder services to their retail mutual fund
customers, but by providing services to mutual funds
directly, including managing the fund's portfolio and
providing administrative, custodial, or transfer agent
services .
CONCERNS ABO UT CUSTOMER CONFUSION
The rapid growth of the mutual fund industry and
the increased availability of mutual funds to retail
consumers has given rise to serious concerns about
customer confusion. Several recent surveys show a
disturbing lack of education and awareness in the
general population as to the risks and uninsured nature
of mutual funds sold not only through banks but nonbank
mutual fund providers as well. The surveys also
indicate a high degree of confusion about the nature of
SIPC insurance. Interestingly, one survey also shows a
surprising lack of awareness as to the availability of
FDIC insurance for deposit products.
The surveys suggest that much of the confusion
about mutual funds relates to money market mutual funds.
These funds invest primarily in highly liquid short-term
investments such as U.S. government securities and do
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have a consistent record of safety and stability
comparable to insured deposits. Since they were
introduced more than twenty years ago, no investor in
such a fund has ever lost money. It is quite possible
that the surveys may have confused these funds with
money market deposit accounts (so-called "MMDAs") that
are offered by banks which are FDIC insured.
With respect to equity stock funds, customers
appear to generally understand that these funds can
fluctuate in value and carry a significant risk of loss
of principal. With respect to bond funds, however,
there is less understanding of the relationship between
the value of the fund's shares and the movement of
interest rates. More education clearly is needed from
all fund providers to help consumers better understand
the risks involved in these funds.
Two recent surveys have been used to support
arguments that customers who buy mutual funds at their
banks are not adequately informed that these investments
do not carry FDIC insurance. A closer examination of
these surveys shows that they do not provide sufficient
evidence to reach this conclusion.
SEC Chairman Arthur Levitt released an SEC-
sponsored survey of 1,000 households and told the Senate
Banking Committee last November, and repeated to the
House Energy and Commerce Committee March 2, that a key
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finding is that 66 percent of bank mutual fund holders
agreed with the statement "Money market mutual funds
â– old through banks are federally insured."
A closer examination of this survey, and a
separate survey commissioned jointly by the American
Association of Retired Persons ("AARP") and the North
American Securities Administrators Association
("NASAA"), could lead to different conclusions.
Of the sample of 1,000 demographically
representative households in the SEC survey, three-
quarters said they were the principal financial
decision-maker (PFD) . Of those, 378 said they were not
mutual fund holders and 370 said they owned mutual
funds. Of those owning funds, only 70 said they own
mutual funds sold through banks or S&Ls.
Thus, only 70 households, or seven percent, said
they had brought mutual funds through a bank. A less
emphasized finding was that 84 percent of the bank
mutual fund customers agreed with the statement, "You
can lose money in a money market mutual fund,"
suggesting that customers are aware of market risks
associated with mutual funds.
If you read the actual numerical results of the
survey, some other surprising facts emerge. First, the
respondents were better informed about the lack of
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federal insurance of mutual funds sold in bank branches
than they were about mutual funds sold by brokers
elsewhere. A full 34% of brokers' customers believed
that mutual funds are federally insured while only 25%
of those surveyed believed that mutual funds sold in
bank offices are federally insured.
The numbers for money market funds may reflect a
confusing question in the SEC's survey as much as
anything else. Forty-five percent of persons surveyed
thought that money market funds sold in banks are
federally- insured, yet only 25% of those same persons
thought that mutual funds sold in banks are federally
insured, and only 15% of those same persons believed
that they could not lose money on money market mutual
funds. What we may have here is confusion created by
the form of the question, with some consumers thinking
the survey question had to do with bank money market
deposit accounts which are in fact insured by the FDIC.
A second survey was commissioned jointly by AARP
and NASAA, and covered 1,000 financial decision makers
who presently have a relationship with a commercial
bank. Out of these 1,000 decision makers, only six
percent said they had personally purchased mutual funds
at their banks.
Those six percent were then asked "Can you
remember who initially advised you to invest in the
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mutual fund account at your bank? Has it a bank teller,
a bank officer, a personal financial advisor, someone
else, or is this something you decided to invest in on
your own?" The responses were:
2 Bank teller
15 Bank officer
6 Other bank employee (volunteered)
14 Financial advisor
6 Other
41 Own decision
16 Don't know
This same six percent was later asked, "Did your
bank give you any written disclosure concerning your
mutual fund, or any material that describes the risk of
this kind of investment? 11 The responses were:
85 yes
10 no
5 don't know
Then this six percent was asked, "Did you read
the material your bank gave you?" The responses were:
86 yes
11 no
3 don't know
This survey did not report information on how
many of those six percent believed that mutual funds
were FDIC insured. It did report information on how
many of the total sample of 1,000 thought mutual funds
sold at their bank were covered by FDIC insurance, but
this information is not really relevant.
The survey also resulted in some curious facts.
The survey evidences a serious lack of education among
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those surveyed as to the availability of FDIC insurance
for bank deposit products. For example, of the 80
percent of respondents who knew that their bank offered
money market deposit accounts, nearly one-half did not
know that the account was FDIC insured, including 10%
who said that the account was not insured. Similarly,
of the 92 percent who knew that their bank offered
certificates of deposit, nearly one-third did not know
that such deposits are FDIC insured. Although all of
the respondents knew that their bank offered checking
accounts, 21 percent did not realize that the accounts
are protected by FDIC insurance.
The AARP/NASAA survey also points to a high level
of confusion regarding the availability of other
insurance programs for mutual funds and securities. In
response to the question, "As far as you know, is there
any other insurance program that protects the value of
[your account] at your bank?", 40 percent thought there
was other insurance for mutual funds, 36 percent thought
so for stocks, and 48 percent thought so for government
bonds. These results suggest that there is at least as
much confusion regarding SIPC coverage as FDIC
insurance .
Notwithstanding these results, 82 percent of the
respondents in the AARP survey said that it was easy to
understand the different fees and rates their bank
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charges for services, 75 percent responded that it was
easy to understand the financial risks involved in
making different kinds of investments through the bank
or didn't know, and 75 percent responded that the rules
and regulations that apply to different accounts and
services offered by the bank were easy to understand.
These surveys indicate an immediate need for
banks and other mutual fund providers to enhance their
training and education programs regarding mutual funds,
as well as the various other investment products
available in the financial markets generally, including
deposits.
I would like to add a note here about the
parallels that have been drawn between bank sales of
mutual funds to retail customers and Lincoln Savings and
Loan's sales of uninsured notes of its parent company to
customers. When Lincoln Savings failed, those customers
lost all of their money. In sharp contrast to the
Lincoln Savings situation, however, mutual funds hold
broadly diversified portfolios of securities of many
different issuers. The failure of any one company has
only a relatively small impact on the value of a mutual
fund. The mutual fund cannot own securities issued by
the bank that is the adviser to the mutual fund or by
any affiliate of that bank. If Lincoln Savings had sold
its customers mutual funds, those customers most likely
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would still have their money today. The failure of
Lincoln Savings would have had absolutely no effect on
the value of its customers' mutual fund shares.
BANK MUTUAL FUND SALES PROGRAMS
EMPHASIZE CU STOMER PROTECTION
The reports of customer confusion regarding
mutual funds and other investment products have sounded
a loud alarm within the banking industry. We recognize
the need for heightened attention to customer protection
and consumer education and we are responding to this
need quickly and comprehensively.
Of all the financial service providers that offer
mutual funds to retail customers, banks have adopted
among the most thorough internal policies and procedures
relating to consumer protection. Over the past year,
the industry has developed extensive policies and
procedures regarding retail sales of mutual funds.
These policies and procedures seek to minimize customer
confusion, to fully disclose the risks inherent in
mutual fund investments, to ensure that mutual fund
investments are suitable for the needs of individual
investors, to provide proper training and supervision of
sales personnel, and to ensure that compensation
programs are properly structured to protect customers.
These policies and procedures are reviewed and approved
by the bank's board of directors.
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In an unprecedented effort, the CBA and five
other banking trade associations have jointly developed
comprehensive guidelines for their respective member
institutions engaged in retail sales of investment
products. These guidelines are set forth in the booklet
attached to my testimony. As you can see, the
guidelines cover in great detail such matters as
location of sales, the setting and circumstances of
sales, disclosures, advertising and marketing,
suitability, employee qualifications and training,
employee compensation and referral fees, bank management
and board of directors oversight, arbitration, and
considerations for selecting third party providers and
investment products to be offered to customers.
The banking industry guidelines are intended to
complement the mutual fund guidelines developed by the
federal bank regulators and to assist banks in complying
with applicable regulatory requirements. The guidelines
emphasize the need to view customer interests as
paramount in all aspects of mutual fund sales programs
and demonstrate the banking industry's commitment to a
high level of customer protection. They place a strong
emphasis on oral and written disclosure and on other
ways to help customers understand the uninsured nature
of mutual funds and to make intelligent and suitable
mutual fund investments.
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Never before have the banking trade associations
united in euch a proactive effort to guide the conduct
of banking activities. The CBA and its sister
associations view this effort as critical to ensuring
the protection of investors in the interests of
furthering the long-term health of both the banking
industry and the mutual fund industry.
To help the Subcommittee understand the extent of
the banking industry's consumer protection effort, we
thought it would be useful to provide a step-by-step
description of the mutual fund sales process that banks
are expected to undertake under applicable rules and
agency directives. The sale of mutual funds (both
proprietary and nonproprietary) in the retail offices of
banks typically is conducted as follows:
When a customer in a bank office expresses an
interest in mutual funds, the customer is referred to a
trained and qualified investment specialist (not a
teller) for information regarding mutual funds. The
investment specialist is trained and qualified to sell
mutual fund products and frequently is a series 6 or 7
registered representative of an NASD member. The
customer is directed to a desk identified as a place
where noninsured investments are sold, away from the
area of the bank in which tellers accept deposits. The
investment specialist orally tells the customer that
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mutual funds are not insured by the FDIC, are not
deposits or other obligations of the bank nor guaranteed
by the bank, and that mutual fund shares are subject to
investment risks, including possible loss of the
principal amount invested by the customer. These
disclosures are also included on signs at the desk
location.
If the customer is still interested in mutual
funds, the investment specialist gives the customer the
forms necessary to open a mutual fund account and seeks
information regarding the customer's financial situation
and degree of investment experience, investment goals,
risk tolerance, and other factors relating to the
suitability of the investments for the customer. The
investment specialist reviews this information with the
customer and determines what types of investments may be
suitable for that customer. Based this information, the
investment specialist may recommend a particular mutual
fund or group of funds to the customer.
The investment specialist gives copies of the
mutual fund prospectus to the customer to read. The
prospectus describes the key features of the mutual fund
and provides the information that the SEC requires to be
given to the customer. On the cover page of the
prospectus in prominent type face there should be a
statement that the shares of the fund are not deposits
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or obligations of, or guaranteed by, the bank, are not
insured by the FOIC or any other government agency, and
that share value may fluctuate.
The investment specialist offers to help the
customer to understand the key features of the mutual
fund that are described in the prospectus, including the
risks involved, the fees involved and the types of
assets that the mutual fund invests in. If the bank or
an affiliate of the bank is the fund's investment
adviser, this fact is disclosed.
Zf the customer is interested in purchasing
shares of the mutual fund, the customer places an order
with the investment specialist and gives him or her a
check for the purchase price. The investment specialist
gives the customer a disclosure form to be signed by the
customer stating that the customer understands that
shares of mutual funds are not insured by the FOIC, are
not deposits or other obligations of the bank nor
guaranteed by the bank, and are subject to investment
risks, including possible less of the principal amount
invested by the customer. The investment specialist
forwards the customer's order and check to a supervisory
office, together with the account form, suitability
questionnaire and signed disclosure form.
Trained and qualified supervisory personnel
review the suitability questionnaire to determine
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whether the particular mutual fund is appropriate for
that particular customer's situation. If so, the order
is forwarded to the mutual fund, which opens an account
for shares in the customer's name and mails a
confirmation to the customer of the purchase of the
shares. The confirmation generally includes the
â–
required disclosures, as does the periodic account
statement sent to the customer.
While this is meant to be a general description,
you can see that a number of check points are built into
the process to avoid the sale of unsuitable investments
to retail bank customers and to otherwise address the
potential for customer confusion. We believe that our
disclosures on the risks of mutual fund investments and
the required customer acknowledgment statement go well
beyond what is required in the brokerage industry,
particularly in disclosing the lack of FDIC insurance.
BANK MUTUAL FUND ACTIVITIES ARE HIGHLY
REGULATED UNDER BANK AND SECURITIES LAWS
It is important to understand that banks engage
in mutual fund activities within an extremely
comprehensive regulatory and supervisory framework. We
have often said that banking is the most highly
regulated industry in the United States, and this is
certainly true with respect to bank mutual fund
activities.
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- 23 -
The statutory bank regulatory framework
applicable to bank mutual fund activities includes the
National Bank Act, the Bank Holding Company Act, the
Federal Reserve Act, and Federal Deposit Insurance Act,
the Bank Supervision Act, and the FD1C Improvement Act
of 1991, among others. These laws include prior
approval and notice requirements, minimum capital
requirements, restrictions on affiliate transactions,
insider transactions, restrictions against
anticompetitive practices, and public benefit standards,
among many other regulatory provisions.
Bank mutual fund activities also are subject to
extensive regulation under the federal securities
statutes, including the Investment Company Act of 1940,
the Securities Act of 1933, and the Securities and
Exchange Act of 1934, among others.
The federal banking regulators have extensive
resources to monitor and enforce compliance with these
laws. Banks that engage in mutual fund activities are
subject to frequent periodic examination. Federal law
requires the federal banking agencies to conduct a full-
scope, on-site examination of each insured bank not less
than once during each 12 month period, or every 18
months for very small well capitalized banks. Federal
bank examiners are permanently located on-site in large
banks all day, every day, year round.
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All of the federal bank regulators have
intensified their examination focus on bank mutual fund
activities. The OCC recently added a lengthy new
section to the Handbook for National Bank Examiners
setting forth detailed guidance for examiners to follow
in reviewing bank mutual fund retail sales operations.
The high degree of banking supervision was noted
by SEC Chairman Levitt who, in comparing it to the SEC's
resources, stated that N [e]ven though the investment
company industry is two-thirds the size of bank, thrift
and credit union assets, the entire Commission had only
260 staff for its 1993 investment management program
compared to almost 21,000 staff available for the
oversight of banks, thrifts and credit unions."
Federal banking regulators have a host of
enforcement tools to ensure compliance with the laws
applicable to bank mutual fund activities. Under the
Bank Supervision Act, an agency can initiate an
administrative enforcement proceeding if the agency
believes that the institution or an institution-
affiliated party is engaging or has engaged, or the
agency has reasonable cause to believe is about to
engage, in an unsafe or unsound practice or violation of
Testimony of Arthur Levitt, Chairman, U.S. Securities
and Exchange Commission, before the Subcommittee on
Securities, Committee on Banking, Housing and Urban
Affairs, U.S. Senate, Nov. 10, 1993.
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a law, rule, or regulation, or written condition imposed
by the agency.
Depending upon the severity of the offense, the
banking agency can force the bank immediately to stop
the unsound practice or violation, impose fines of up to
$1 million per day for the violation, make the bank fire
the responsible persons, ban the responsible persons
from the industry for life, and force the bank to
correct the conditions that resulted from the violation
and adopt procedures designed to ensure that it will
never happen again. The federal banking agencies can
take Immediate action without hearing if the situation
warrants, or can go through an administrative process
within the agency to force compliance. The federal
banking agencies are not shy about using these
enforcement powers.
Under FDICIA, a banking regulator can downgrade a
well-capitalized bank and apply the applicable prompt
corrective actions authorized under FDICIA if it
determines that the bank is engaged in an unsafe or
unsound practice.
The ability of the banking regulators to enforce
compliance with the mutual fund guidelines has been
questioned since the guidelines are not rules or
regulations. As noted above, however, the enforcement
powers of the banking regulators extend to unsafe and
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unsound practices as well as violations of rules and
regulations. I doubt that the federal regulators would
hesitate to declare as an unsafe or unsound practice a
bank's sale of mutual funds without any disclosure that
the fund shares are not FDIC insured, for example.
Moreover, the federal regulators are highly skilled in
obtaining compliance with regulatory "guidelines* 1 even
though they are not technically "regulations."
There appears to be a misperception that bank
mutual fund activities are not subject to the
protections of the federal securities laws. While the
federal securities laws defer to the federal banking
agencies to provide regulation in certain areas, bank
mutual fund activities in fact are highly regulated by
both the SEC and the federal banking agencies under the
securities laws.
All mutual funds sold by banks are distributed by
broker-dealers that are regulated and examined by the
SEC and NASD. All mutual funds sold by banks are
required to be registered with the SEC under the
Investment Company Act of 1940, unless they qualify for
the limited exemptions that are generally available.
Shares of bank-sold mutual funds are required to be
registered with the SEC under the Securities Act of
1933. The 1940 Act contains a number of complex,
substantive requirements relating to the operation of
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mutual funds. As a general natter, the 1940 Act Is
designed to protect Investors by regulating the
operations of the mutual fund and the relationship
between the mutual fund and the firms that provide
services to the mutual fund. The 1933 Act is primarily
a registration and disclosure statute. The content of
prospectus disclosures, advertising, marketing materials
and other communications to potential purchasers of
mutual fund shares through banks is heavily regulated
under the 1933 Act.
While banks are exempt from broker-dealer
registration under the Securities Exchange Act of 1934,
it is important to realize that they are not exempt from
the Act's antifraud provisions. The antifraud
provisions prohibit false or misleading statements in
connection with the offer or sale of a security,
including a mutual fund. This means that all
advertising or marketing materials relating to mutual
funds may not contain untrue statements or any
statements that, while true, might tend to be
misleading. In addition, the anti-fraud provisions
impose an affirmative obligation to disclose information
that would be important to a potential investor in
making an investment decision.
The SEC has a powerful arsenal of enforcement
powers to remedy violations of the applicable securities
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laws by banks. The SEC is authorized to investigate any
person or firm (including a bank) suspected of violating
the federal securities laws or SEC rules adopted under
the laws. It can issue cease and desist orders against
any person (including a bank) whenever it believes the