NDIP - More Than Just Another Product

Banks are constantly looking for new product opportunities. One of the most popular new products is the sale of non-deposit investment products ("NDIP"). These products are getting heightened attention from regulators, consumers and the competition. It is an area where regulatory concepts and policies are emerging even as the products are being developed.

Up to now, regulatory guidance on the most important issues - such as the responsibilities of bank management and the requirements of a compliance program - have been contained in policy statements rather than regulations. This gives banks flexibility in the specific details of their products and programs but establishes the expectation that bank programs live up to key principles. Whether the bank regulatory agencies continue to rely on policy statements or move toward detailed regulations depends on how banks design and manage their NDIP program and products.

In this issue, we take the somewhat unusual step (for us) of providing comprehensive background and information about NDIP compliance elements. We do this to provide you with a single document that contains your basic references - to lay the groundwork, so to speak. This will therefore serve as your "starter issue" on NDIP.

We also believe that the regulatory policies on NDIP are the foundation for future compliance programs on new products and services. This issue is therefore designed to lay out the basic concepts and program elements of NDIP compliance. These concepts and program elements may form the foundation of future new product compliance programs.

This is also the primary example of the emerging roles for regulatory agencies. The FDIC, as the insurer of deposits, has developed detailed examination procedures and, with the support of banking trade groups including the American Bankers Association and America's Community Bankers, conducted one-day training seminars for the industry all across the country. This role of the regulator as an educator is a significant development. It increases the opportunities for information exchange between the regulator and the regulated. In fact, FDIC invites comments, ideas, and suggestions. Most important for the compliance manager, the seminars are an opportunity to understand the goals and priorities of the regulator. This understanding can be critical when making strategic decisions.

Where's the Risk?
Regulatory agency concerns about NDIP are driven by safety and soundness. These concerns about safety and soundness are based on the perception that Banks are exposed to new and significant liability in offering non-traditional products. FDIC's concern is based on the lurking liability for deposit account insurance and the safety and soundness of insured institutions. FDIC cannot quickly forget the payouts of the '80s and does not want to see that repeated - even on a smaller scale - by a problem that could be avoided.

FDIC believes banks are exposed to liability in two significant ways. First, lawsuits and class actions have already been brought against the first banks offering NDIP products. Banks, the FDIC believes, are perceived as the deep pockets that would be sued when a customer loses money in an investment. This kind of lawsuit can eat into or consume the bank's profits. There are already situations where bank presidents and officers have been sued even though the sale was made through a third party vendor. Defending lawsuits - to say nothing of losing them - is expensive. This risk of loss can directly affect the bank's bottom line.

Worse yet is the perception that the bank should be responsible for the competence of the broker/dealer with which it has a relationship. FDIC cautions that banks are not the only organizations for which compliance is an issue. There are performance concerns in broker/dealer firms as well.

The sums involved in liability cases can be substantial. For example, Great Western paid $23 million in actions involving trading losses. And there are other cost risks. Failure to maintain continuing education credits will lead to an NASD fine.

The second safety and soundness concern is the risk to the bank's reputation. Negative publicity for the bank, and corrective action involving fines and bank personnel may have a detrimental effect on the bank's overall business. Thus, problems with non-deposit investment products, even though separate from bank products and activities, could have a detrimental effect on the bank itself. Even without incurring actual losses, the bank may lose customers representing current and future business. FDIC is concerned when a bank's name is featured in press stories that are about how consumers lost money.

The mission of the FDIC has been to protect the deposits of bank customers up to the specified amount of deposit insurance coverage. For more than half a century, the FDIC and other bank regulatory agencies have worked to build faith in the nation's banking system. In fact, the promise of safety was the primary competitive edge that deposit insurance provided to banks.

Efforts to build faith in the banking system have worked so well that customers now do not "hear" what they are being told about non-traditional products that are not protected by deposit insurance. This becomes the basis of liability. Consumers, after losing on their investment, claim that they were never told or never understood that their investment was at risk. They felt safe because the "deposit" was made in a bank.

Because liability may be passed on to the bank, the bank should be careful in developing relationships with vendors. Examination procedures include a close review of the contract with the broker/dealer. In developing these contracts the bank should remember that it is fully responsible for the terms of the contract and may be considered fully responsible for the actions of the broker/dealer - even if the contract provides that the bank is not.

In selecting a vendor and in reaching a contract with the vendor, the bank should take full responsibility for reviewing the credentials, qualifications, business practices, and compliance procedures of the vendor. This is not something that can be contracted away.

ACTION STEPS

If your bank is considering non-deposit investment products, take steps to inform management about compliance requirements and expectations. Include a briefing on how the agencies view the risk of these products.
Network with banks that are already offering non-deposit investment products. Find out how their program works. In particular, see if you can get tips for ways to comply successfully.
Visit a broker/dealer office and discuss the purchase of mutual funds or stock. Take careful note of how the broker/dealer presents and describes the product. Then, think about how this transaction would seem in a bank lobby.