Two "secret shopper" surveys of bank and thrift sales of mutual funds have been issued since we released our report. One was done by a private research organization called Prophet Market Research & Consulting and was completed in April 1996. The other was done for FDIC by another research organization, Market Trends, Inc., and was completed May 5, 1996. Both surveys indicated that many banks and thrifts still were not fully disclosing to their customers the risks associated with mutual fund investing. The results of the FDIC-sponsored survey, which was the most comprehensive, indicated that, in about 28 percent of the 3,886 in-person visits, bank and thrift representatives did not disclose to the shoppers that nondeposit investment products, including mutual funds, are not insured by FDIC. The results were worse for the 3,915 telephone contacts--with no disclosure in about 55 percent of the contacts. Similarly, in about 30 percent of the in -person visits, bank and thrift representatives did not inform shoppers that nondeposit investment products were not deposits or other obligations of, or guaranteed by, the institution (about 60 percent nondisclosure for telephone contacts). Finally, in about 9 percent of the in-person visits, bank and thrift representatives did not tell shoppers that their investment was subject to loss, including loss of principal (about 39 percent nondisclosure for telephone contacts). The survey's findings on the physical location of the mutual fund sales area were nearly the same as ours, with about 37 percent of the institutions not clearly having separated the mutual fund sales area from the deposit-taking area. The survey's findings reaffirm our earlier findings and indicate that a significant number of banks and thrifts continue to inadequately disclose four basic risks associated with mutual fund investing. Neither the FDIC-sponsored survey nor ours followed the sales process through to the point at which a mutual fund was purchased and an account was opened. However, the interagency guidelines emphasize that bank customers should clearly and fully understand the risks of investing in mutual funds, and that these risks should be orally disclosed to the customer during any sales presentation. Written disclosures or other documentation are to be available to customers during the sales process that may eventually fully inform them of the risks involved. Nevertheless, making these disclosures orally during initial sales presentations is particularly important because written disclosures may not always be read or understood until after the investors' funds are committed, if at all. In responding to our report, the Federal Reserve and OCC indicated that bank practices generally complied with the interagency guidelines by mid-1995. However, FDIC's survey results indicated that many banks and thrifts still need to improve their compliance with the guidelines so that their customers are adequately informed of the risks associated with mutual fund investing. According to banking and securities regulators, additional actions are being planned or taken to improve disclosures to bank customers. Some of these actions affect only those banks or thrifts under one regulator's jurisdiction--such as FDIC's efforts to improve its data systems to provide its examiners up-to-date information for more targeted examinations, or each regulator's efforts to improve its examination guidelines. Other efforts are also being undertaken by all four bank and thrift regulators. These interagency efforts include efforts to adopt requirements that bank personnel engaged in the sale of nondeposit investment products take the securities industry's standard qualifying examinations, better training for bank personnel selling uninsured investment products, reexamination of the interagency policy statement on mutual fund sales. business, and pass relevant qualifications examinations administered for the industry by NASD. The Securities Exchange Act of 1934 excludes banks from its broker-dealer registration requirements. As a result, banks have been able to choose whether to have their own employees sell mutual funds without the need to be associated with a Securities and Exchange Commission (SEC)-registered broker-dealer or subject to NASD oversight. If bank employees are to take NASD's qualifying examination as the banking regulators propose, they are not to be registered with NASD because they would not be associated with a broker-dealer. However, under the proposal, they will have met the same initial qualifications as NASD-registered representatives. In addition, to maintain their qualifications, they would be subject to the same continuing education requirements imposed on NASD-registered representatives. FDIC officials told us that, in addition to the NASD testing and education requirements, the banking regulators plan to do further training to improve bank and thrift employees' awareness of the importance of complying with the interagency guidelines. They said that although they found better compliance by NASD-registered representatives, the difference between these representatives and other employees was small, indicating that additional training might help further improve compliance. Banking regulators told us that efforts to reexamine the interagency policy statement are focused on clarifying (1) what situations do or do not constitute a sales presentation and (2) what the institution's obligation is in assuring that an investment recommendation meets the customer's needs. An FDIC official told us that the banking regulators want to make the interagency statement less vague so that banks and thrifts can better understand what is expected of them and their employees. restrictions on brokers' use of confidential financial information from bank or thrift customer files were stricter than the interagency guidance and NASD's proposed prohibition on the payment of referral fees by broker-dealers to employees of the bank differed from the interagency guidance, which allows payment of these fees. After analyzing nearly 300 comment letters, NASD made changes to its proposed rules. The revised proposal defines confidential financial information and allows its use, but only with the prior written approval of the customer; the prohibition on referral fees remains. NASD forwarded its revised proposal to SEC for approval. SEC published the proposal for public comment and received 86 comment letters by the end of the comment period in May 1996. Most of the letters were from banking organizations or bank-affiliated broker-dealers. SEC is currently analyzing the comment letters before deciding whether to approve the proposed rules. Ensuring that salespersons provide bank customers with appropriate risk disclosures during all mutual fund sales presentations presents a difficult challenge to regulators and to banks and thrifts. Over time, this task may become easier as distinctions among financial service providers continue to fade and customers become more aware of the differences between insured and uninsured products. The bank and securities regulators' proposed actions for additional training of investment representatives, requiring testing of employees, and reexamining the interagency guidelines should help improve bank and thrift compliance with disclosures required by these guidelines. However, additional steps, which may have the potential to help improve compliance with the risk disclosure guidelines, could also be taken. Such actions, for example, could include regulators (1) continuing to monitor bank and thrift disclosure practices through periodic secret shopper surveys, (2) encouraging banks and thrifts to adopt this kind of testing procedure as part of their own internal compliance audits, if legal concerns can be overcome and it is cost effective; and (3) segmenting and publicizing the results of regulatory reviews of compliance with the interagency guidelines, including the results of secret shopper surveys, when appropriate. sales presentations between customers and bank employees, and they would have difficulty doing so without affecting the customer's privacy or the performance of the employee. FDIC reported that it plans to evaluate the need for another secret shoppers survey on the basis of the results of bank examinations over the next 2 years. Because of the difficulty in monitoring oral sales presentations through examinations, it seems to us that decisions concerning the need for secret shopper surveys should not be based solely on examination results. Instead, using such surveys to supplement examination results could give banks and thrifts an additional incentive to better ensure that their personnel are providing proper disclosures. Bank regulators told us that some banks are using secret shopper surveys to monitor their own employees. A Federal Reserve official said that banks could make them part of their internal compliance audits. The need for federal regulators to do such surveys may decrease if more banks and thrifts do their own and if disclosure of mutual fund risks improves. Federal regulators could encourage banks and thrifts to adopt these surveys as part of their internal compliance audits if legal concerns can be overcome and it is cost effective. For example, some self-assessment activities, like self-testing, pose a dilemma for lending institutions in that under current law the results of self-testing programs may not be privileged or protected from disclosure to federal regulatory agencies or private litigants. Hence, despite the obvious preventative benefits to be gained from having lenders adopt continuous self-testing programs, many institutions are reluctant to undertake such programs out of fear that the findings could be used as evidence against them, especially by third-party litigants. One way to help resolve this issue would be to remove or diminish the disincentives associated with self-testing by alleviating the legal risks of self-testing when conducted by banks who, in good faith, are seeking to improve their mutual fund risk disclosures. Banking regulators suggested to us that they might also encourage depository institutions to consider methods other than secret shopper surveys to test compliance with disclosure requirements, such as calling their customers to determine if the sales person made the proper disclosures. investors than they are the safety and soundness of a depository institution. Therefore, bank and thrift regulators may want to consider the feasibility of segmenting the results of their reviews of compliance with disclosures required by the interagency guidelines, including the results of any secret shopper surveys, from other examination results and of making those results available to the public. Such segmentation and disclosure is already required in connection with regulators' assessments of bank and thrift compliance with the Community Reinvestment Act. In summary, the results of our survey and the more recent surveys, indicate that there may be a persistent problem with many banks and thrifts failing to make the basic risk disclosures required under the interagency guidelines. These disclosures are important because they can help investors fully understand the risks of investing in bank mutual funds. Banking regulators and some banks and thrifts are taking steps to better ensure that the required disclosures are made. While these actions are positive, other steps, which may have the potential to help increase compliance with these guidelines and better ensure that investors are adequately informed of the risks of their investment decisions, could also be taken. The first copy of each GAO report and testimony is free. Additional copies are $2 each. Orders should be sent to the following address, accompanied by a check or money order made out to the Superintendent of Documents, when necessary. 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Summary:
GAO discussed the Federal Deposit Insurance Corporation's (FDIC) survey concerning the risks associated with mutual fund investing. GAO noted that: (1) sales of mutual funds through banks and thrifts have increased dramatically; (2) the value of assets managed by these institutions doubled from $219 billion in December 1993, to $420 billion in March 1996; (3) 2,800 banks sold over $40 billion in both proprietary and nonproprietary mutual fund shares during 1995; (4) in February 1994, FDIC, the Office of the Comptroller of the Currency, the Federal Reserve, and the Office of Thrift Supervision jointly issued guidelines on the policies and procedures for selling nondeposit investment products; (5) these interagency guidelines require that bank and thrift customers be fully informed of the risks of investing in mutual funds; (6) the guidelines also require that banks' mutual fund sales activities be physically separated from bank deposit activities; (7) the results of the FDIC survey indicate that many banks and thrifts are not disclosing the risks associated with mutual fund investing; and (8) all four bank and thrift regulators are making an effort to ensure that bank personnel pass qualifying examinations and receive better training in selling uninsured investment products, and reexamine the current interagency policy on mutual fund sales.