CUNA Regulatory Comment Call
June 23, 2005
Sales of Nondeposit Investments
- The NCUA Board has issued a proposed Interpretative Ruling and Policy Statement (IRPS) regarding the sales of nondeposit investments. The term nondeposit investments covers stocks, bonds, mutual funds, and variable annuities. In order to offer certain investments to their members, credit unions may enter into a third party arrangement with a registered and licensed brokerage firm to conduct transactions without having to register with the Securities and Exchange Commission (SEC). The IRPS provides guidance regarding the establishment and operation of these third party brokerage arrangements with credit unions. The IRPS would replace the existing guidance outlined in NCUAs Letter to Credit Unions No. 150, released in 1993. Letter No. 150 is available here.
- NCUA decided to address these issues in a proposed IRPS, rather than in a letter to credit unions, for several reasons. First, an IRPS is more accessible to credit unions and other interested parties than a Letter to Credit Unions. Second, an IRPS is an appropriate format for disseminating both guidance and requirements. Finally, this format allows credit unions and other interested parties the opportunity to comment, which is not the case with Letters to Credit Unions.
- Specifically, the IRPS covers the following issues with regard to these types of investments:
- The relationship between the credit union and the brokerage firm that is used to conduct these types of transactions and the responsibilities of each.
- The required separation of the activities of nondeposit sales from the taking of deposits and shares.
- Contacts with members concerning securities sales.
- Compensation and referral fees.
- Use of dual employees (employees who work for both the credit union and broker).
- Sales to nonmembers.
- Comments are due to NCUA by July 25, 2005. Please send your comments to CUNA by July 18, 2005. Please feel free to fax your responses to CUNA at 202-638-7052; e-mail them to Associate General Counsel Mary Dunn at firstname.lastname@example.org or to Senior Regulatory Counsel Catherine Orr at email@example.com; or mail them to Mary or Catherine in c/o CUNA's Regulatory Advocacy Department, 601 Pennsylvania Avenue, NW, 6th Floor - South Building, Washington, DC 20004. You may also contact us at 800-356-9655, ext. 6743, a copy of the proposed IRPS, is here.
- Credit unions cannot register as securities brokers. The requirements the SEC places on brokers, including capital and reserve requirements, are inconsistent with those that NCUA and state supervisory authorities place on credit unions. Therefore, if credit unions wish to bring the option of nondeposit investments to their members, they must structure their involvement so that the SEC will not require them to register as brokers. The most common method credit unions employ is the third party brokerage arrangement. In third party brokerage arrangements, a credit union can facilitate a brokerage firm that is properly registered and licensed with the SEC in selling securities. The SEC permits certain facilitating entities, including credit unions, to receive transaction-related compensation from the brokerage firm without subjecting them to broker registration requirements. Basically, the credit union brings the brokerage firm to its members, the members buy the securities from the broker, and the broker provides transaction-related remuneration to the credit union.
- The nondeposit investment sales activities of credit unions must be authorized under their chartering statutes. Federal credit unions do not have the authority to sell nondeposit investments directly to their members. Under the incidental powers finder activity, however, a federal credit union may bring a broker to its members to offer them a financial service, the purchase of investments. State chartered credit unions must look to their state law for authority to engage in third party brokerage activities. During the NCUA Board meeting when this proposal was approved for publication, agency staff indicated that, like the proposed IRPS, state statutes likely track in large part guidance issued by the SEC and the National Association of Securities Dealers (NASD).
- The IRPS does not cover the issue of brokerage arrangements offered by credit union service organizations. In general, the SEC has taken the position that following the adoption of NCUAs incidental powers rule, CUSOs offering such arrangements must register with the SEC. CUNAs Brokerage Activities Task Force continues to work with the SEC and NCUA on this matter to help protect CUSOs that had continued to offer such services in good faith.
- The IRPS also references the SECs proposed Regulation B that would expand and clarify a credit unions authority to participate in third party brokerage arrangements without the requirement to register as a broker. CUNA has been a strong proponent of this authority. NCUA will make any necessary changes to the IRPS if the final version of Regulation B is significantly different than the proposed version. The SEC is not expected to act on Regulation B before this fall.
DESCRIPTION OF THE PROPOSED IRPS
I. SEC (and NASD) Requirements
- The broker must perform brokerage services in an area that is clearly marked and, to the extent practicable, physically separate from the routine deposit-taking activities of the credit union.
- The broker's sales representative must make complete and accurate disclosures to avoid
the possibility that a member might confuse an uninsured investment product with an insured share
account. Therefore, when selling, advertising, or otherwise marketing uninsured investment
products to members, the broker must provide clear and conspicuous disclosures to members
indicating that the products:
The broker's sales representative must obtain a separately signed statement acknowledging the
disclosures from members at the time a nondeposit investment account is opened. These
disclosures must also be featured conspicuously in all written or oral sales presentations,
advertising and promotional materials, prospectuses, and periodic statements that include information
on both deposit and nondeposit products.
- Are not federally insured;
- Are not obligations of the credit union;
- Are not guaranteed by the credit union or any affiliated entity;
- Involve investment risks, including the possible loss of principal; and
- If applicable, are being offered by a dual employee who serves both functions of accepting members' deposits and the selling of nondeposit investment products.
- When discussing nondeposit investments with a member face-to-face, the sales representative should also display a sign, readily visible to the member, that states: Investments sold here are NOT offered by the credit union, NOT guaranteed by the credit union, and DO NOT have any federal insurance. These investments may lose value.
- To avoid confusion, brokerage firms should not offer investment products with a product name similar to the credit union's name.
- Credit union employees who are not dual employees of the broker and the credit union may perform only clerical or ministerial functions in connection with brokerage transactions. Clerical and ministerial functions include: scheduling appointments with the broker's sales representative; forwarding customer funds or securities; and describing in general terms the types of investments available from the credit union and the broker under the arrangement.
- Only employees of the brokerage firm, or dual employees of the brokerage firm and the credit union, may receive incentive compensation for brokerage transactions. Other credit union employees may receive compensation for referral of members to the brokerage sales representative if the compensation is a nominal (meaning the payment may not exceed the greater of twenty-five dollars or the wages the employee is paid for one hour of work) one-time cash fee of a fixed dollar amount and the payment of the fee is not contingent on whether the referral results in a transaction.
- The credit union must have a written contract with any broker that offers brokerage services on the credit union's premises.
- The credit union should also have a written contract with any brokerage firm that offers brokerage services through credit union mailings, e-mails or telephone calls made or sent by the credit union, or through the credit union's Web site.
II. Additional NCUA Requirements, Direction and Guidance
- Before entering into a third party brokerage arrangement, a credit union must perform due diligence in selecting an appropriate brokerage firm. Due diligence should include, among other activities: a review of the firm's financial statements and capital adequacy; a determination as to whether the firm can adequately supervise its sales representatives at the credit union's location; a verification of the list of references provided by the firm; and background and NASD checks on the firm's principals and the sales representatives that will be working at the credit union.
Credit Union Policies, Procedures and Contracts
- The credit union must adopt written policies and procedures, which should cover the following
aspects of the brokerage arrangement:
(The items in bold represent a legal requirement)
- The types of products that a broker may offer through the third party brokerage arrangement. For all products, the credit union should identify specific laws, regulations, and any other limitations or requirements, including qualitative considerations, that will expressly govern the selection and marketing of products a broker may offer.
- Assignment to the brokerage firm of primarily responsible for ensuring that the nondeposit sales function is conducted in compliance with all applicable laws, regulations, and policies. The contract should, however, recognize that the credit union has the right to check for compliance and may access member accounts for verification and oversight.
- Indemnification by the brokerage firm for any monetary damages arising from nondeposit sales activities, including but not limited to improper sales practices.
- The roles of credit union employees in nondeposit investment sales and the limits on their activities. The limits and compensation for referrals must be consistent with SEC requirements.
- The location where nondeposit sales may take place and how those sales will be separated from deposit-taking activities.
- A description of the information that may be transferred between the credit union and the brokerage firm or the brokerage firm's sales representative, including a description of how such information will be used and safeguarded and the associated privacy notices to members. The policies and contract terms must comply with NCUA's Privacy of Consumer Financial Information Rule and NCUA's Security Program Rule (Parts 716 and 748 of NCUAs Rules). The brokerage firm must agree in writing to comply with the credit union's policies on information practices.
- Contract termination. The credit union should ensure the inclusion of a provision allowing it to terminate the contract for both cause (which should include failure by the brokerage firm to adequately supervise its sales representative) and for the convenience of the credit union.
- Programs to monitor compliance of the brokerage salespeople with applicable laws and regulations. Credit union personnel performing the compliance function should be independent of any credit union personnel involved in investment product sales and management. At a minimum, the compliance function should include a system that: monitors member complaints; ensures supervisory personnel at the broker make scheduled examinations of their sales personnel; and contacts members that have purchased nondeposit investments to ensure they received and understood the required disclosures. Compliance personnel should also conduct periodic, random samplings of account activity to look for evidence of abuse.
- A dual employee should have separate, written job descriptions for the duties performed for the credit union and the nondeposit investment sales duties, which are performed for the brokerage firm. The dual employee should have no management or policy-setting responsibilities within the credit union related to nondeposit investments.
- The dual employee should not use any materials that could potentially confuse a member as to the capacity in which the dual employee is functioning. When conducting nondeposit investment business, dual employees should not reference their positions at the credit union.
- The compensation a dual employee receives for nondeposit investment activities may be paid directly by the broker to the employee. Alternatively, the broker may reimburse the credit union for the employee's nondeposit investment activities. The credit union's records and the periodic earnings statement provided to the employee should indicate how compensation is divided between nondeposit investment work and work for the credit union. A dual employee should also have written agreements with the two employers establishing the amount of each employer's compensation to the employee.
- The credit union should seek an indemnification agreement from the brokerage firm regarding liability for abusive sales practices. The credit union should also seek fidelity bond coverage or additional insurance for any credit union liability arising from employee misconduct related to the nondeposit investment function.
Sales to Nonmembers
- NCUA will allow a credit union in a third party brokerage arrangement to accept a de minimus amount of income that is not directly attributable to sales to its members. In this context, de minimusmeans that the ratio of income not directly attributable to members to the total gross income the credit union receives under the arrangement cannot exceed five percent.
- NCUA will allow a credit union in a third party brokerage arrangement to pay a de minimus amount of expenses associated with the sale of nondeposit investments to nonmembers. In this context, de minimus means that the ratio of nonmember sales expenses paid by the credit union to the total expenses paid by the credit union under the arrangement cannot exceed five percent.
QUESTIONS REGARDING THE PROPOSED IRPS
- Do you feel the explanation of the physical separation requirement provides
sufficiently clear/specific guidance?
Why or why not?
- Do you agree with all of the disclosure requirements for brokers?
Why or why not?
- Do you agree with the list of best practices for credit union policies, procedures
and contracts concerning third-party brokerage arrangements?
If not, which best practice(s) do you think should be changed or excluded and why?
- Do you have any concerns with the legal requirement for a credit union with such a
brokerage agreement to have in place a program to monitor compliance of the brokerage
salespeople with applicable laws and regulations as set forth in the proposal?
If yes, what are those concerns?
- Do you feel the guidance on the separation of duties of dual employees as well as
reimbursement is adequate?
If not, what specific aspect(s)need(s) more clarification?
- Do you think the section on sales to nonmembers is overly restrictive?
- Other comments?
Eric Richard General Counsel (202) 508-6742 firstname.lastname@example.org |
Mary Mitchell Dunn SVP & Associate General Counsel (202) 508-6736 email@example.com
Jeffrey Bloch Assistant General Counsel (202) 508-6732 firstname.lastname@example.org
Lilly Thomas Assistant General Counsel (202) 508-6733 email@example.com
Catherine Orr Senior Regulatory Counsel (202) 508-6743 firstname.lastname@example.org