Feds set forth guidelines for uninsured investments.

Growing sales of high-yield products cause concern

A debate is heating up in Washington, D.C., about how much freedom financial institutions should have to sell uninsured investment products. Such investments have been gaining tremendous popularity with bank and thrift customers in recent months, as they search for higher-yield alternatives to paltry deposit-account returns.

But financial institutions' growing role in selling investors higher-yield, uninsured investment products is causing concern among federal regulators and members of Congress. Specifically, they are concerned that investors may be misled into believing the investment products being sold by financial institutions are federally insured.

To reduce that risk, several federal regulatory agencies have lately been setting forth guidelines on acceptable securities sales practices by financial institutions. According to Chris Rick, spokesman for the Washington D.C.-based American Banking Association, the guidelines being put forth by the regulators are called "circulars." They carry with them the possibility of fines if banks do not follow the guidelines.

Sal Serrantino, president of Santa Monica-based California Research Corp., a banking industry consulting firm, stated that no formal regulations on uninsured securities sales have been established yet because the regulators needed to first set some general guidelines, which could be made effective immediately.

Banking officials actually solicited federal regulators for advice on how to safely transact investment sales, Serrantino explained.

Establishing formal regulations, on the other hand, takes a long time. They must be drawn up, commented on and reviewed.

Because sales of uninsured products have been growing so rapidly, federal regulators decided to issue guidelines because they could be put on the books quickly. Those guidelines may be converted into formal regulations at some point in the future, said Serrantino.

The most recent of these actions came on July 19, when the Office of the Comptroller of the Currency, one of four federal banking regulatory agencies, released a set of guidelines for the securities sales practices of banks under its jurisdiction.

This latest pronouncement by the OCC followed a similar set of suggested guidelines set forth by the Office of Thrift Supervision to cover securities sales practices of the savings and loan industry, and a similar set of guidelines set forth by the Federal Reserve Board for institutions under its jurisdiction.

Also, the U.S. House of Representatives Committee on Banking, Finance and Urban Affairs has asked the General Accounting Office to study the effect of mutual fund sales' growth on the banking system's safety.

As yet, no formal regulations have been set by federal regulators regarding the sale of investment products by banks and savings and loans. The set of guidelines set forth by regulators regarding the sales of such products is aimed at preventing confusion on the part of consumers who might mistakenly believe the uninsured securities are federally insured.

While the move into securities sales has been good news for banks, concern has been mounting over whether bank customers are being properly warned of the risks involved in making such investments. Federal regulators worry that bank customers are not told that such products are not insured by the Federal Deposit Insurance Corporation and that their money, including the principal, may be lost.

The guidelines set by the OCC and other federal regulators clearly state that banks must conspicuously disclose the type of risk that customers run when investing in mutual funds and annuities.

The products being sold are not to carry the bank's name because that may lead customers to believe the investments are FDIC-insured. Bank tellers may not offer investment advice.

Disclosure and advertising for investment products must indicate clearly that the products are not FDIC-insured, are not obligations of the bank, are not guaranteed by the bank and involve risk, including the possible loss of principal.

The OCC also is recommending that banks obtain signed statements from customers that acknowledge these aspects of investment products.

These measured are meant to alleviate any possible confusion on the part of bank customers that the investments are insured by the FDIC.

"When people walk into an FDIC insured institutions many will have the tendency to believe that any transaction that takes place behind those walls is insured by the government," said Serrantino.

This concern is warranted and the new guidelines are being applauded by most involved in the banking industry. Chris Rick of the ABA called them a "welcome guidance to the industry." Banks are diversifying to meet customer needs, said Rick, so the sale of such products will carry on and the guidelines will help bankers do a better job in the sale of investment products.

"I am alarmed that they (banks and thrifts) are not alarmed by the tremendous liability that they are exposing themselves to," said Serrantino.

Scores of California banks and savings and loans have jumped on the securities-sales bandwagon recently, as low interest rates cause more and more bank customers to yank their money out of deposit accounts.

Many bank customers have turned to higher-yielding securities simply because interest rates available from banks and thrifts are so low. Rather than stand by and watch as their customers flee to securities brokers, many financial institutions decided to offer the same types of securities investments through their branch offices.

Several local institutions that offer these products said they welcome the guidelines being offered by the government. Keith Pipes, chief financial officer for Chatsworth-based Great Western Investment Management, the securities brokerage division of Great Western Bank, stated that the suggestions are good for the industry overall. In its case, however, there will not be any change in practices because the thrift is "already in compliance," according to Pipes.

First Interstate Bank of California has asked for clarification on some points of the guidelines, but for the most part, "it will not impact First Interstate's program," said First Interstate Investment Products Manager Mike Johnson. First Interstate customers are clearly warned of the risk of investing in uninsured products, he said.

Some banks and savings and loans are offering their own types of mutual fund and annuity investments, while others are hiring vendors to sell and manage those investments out of the institutions' branch offices. In either case, the institutions stand to make profits from the services offered.

Even when outside vendors sell the investment products out of branch offices, the banks profit by charging fees or commissions on sales. More than one source stated that the new investment products are accounting for a large part of the record earnings that financial institutions have been posting in the last year.

More than once in interviews with bankers and spokesmen for the federal banking regulators comparisons were drawn between the present situation and the scandal in which savings and loan customers lost their life savings by investing in uninsured junk bonds through Charles Keating's Lincoln Savings & Loan. Most of Keating's investors have asserted they believed their investments were in insured certificates of deposit.

Congress, still dealing with the repercussions of that scandal, has also decided to launch an investigation into banks' securities brokering practices.

Meanwhile, the chairman of the House Banking Committee, Rep. Henry B. Gonzalez, D-Texas, expressed concern that the mutual fund industry is draining deposits from banks and savings and loans and is contributing to the lack of financing available through such institutions.

"Bank deposits can be reinvested in the community as residential, small business and consumer loans," said Gonzalez. "Mutual funds, on the other hand, invest in stocks, bonds, commercial paper of big companies and government securities. They cannot make traditional loans. Having such a dearth of loanable funds will further hamper our efforts to revive the economy."

Gonzalez has asked that the General Accounting Office conduct an investigation into whether the growth of the mutual fund market may be impairing the ability of banks and savings and loans to make traditional loans.

More people do continue to invest in mutual funds, and banks are playing a larger role in their sales than ever before. "By the end of the summer, there will be more money invested in mutual funds than in bank deposits," said Great Western's Pipes. Of all new sales, he said, more than 40 percent are being transacted by banks and savings and loans.

"The concern being expressed in Washington is real, and the big question is how the banks will respond," said Serrantino. "Selling these securities carries with it a lot more responsibility than they know."