Sales of Nondeposit Investments, 30489-30494 [05-10381]

Download as PDF Federal Register / Vol. 70, No. 101 / Thursday, May 26, 2005 / Notices type of synthetic web material used in the sling. Paragraph (i)(8)(i) prohibits the use of repaired synthetic web slings until they have been proof tested by the manufacturer or equivalent entity. Paragraph (i)(8)(ii) requires the employer to retain a certificate of the proof test and make it available for examination. The information on the identification tags, markings, and codings assist the employer in determining whether the sling can be used for the lifting task. The sling inspections enable early detection of faulty slings. The inspection and repair records provide employers with information about when the last inspection was made and about the type of the repairs made. This information provides some assurance about the condition of the slings. These records also provide the most efficient means for an OSHA compliance officer to determine that an employer is complying with the Standard. Prooftesting certificates give employers, employees, and OSHA compliance officers assurance that slings are safe to use. The certificates also provide the compliance officers with an efficient means to assess employer compliance with the Standard. II. Special Issues for Comment OSHA has a particular interest in comments on the following issues: • Whether the proposed information collection requirements are necessary for the proper performance of the Agency’s functions, including whether the information is useful; • The accuracy of OSHA’s estimate of the burden (time and costs) of the information collection requirements, including the validity of the methodology and assumptions used; • The quality, utility, and clarity of the information collected; and • Ways to minimize the burden on employees who must comply; for example, by using automated or other technological information collection and transmission techniques. III. Proposed Actions OSHA proposes to extend the Office of Management and Budget’s (OMB) approval of the collection of information (paperwork) requirements necessitated by the Standard on Slings (29 CFR 1910.184). In its extension request, OSHA also is proposing to reduce the total burden hours for these requirements from 21,517 hours to 19,167 hours. The Agency will include this summary in its request to OMB to extend the approval of the collection of information requirements. VerDate jul<14>2003 19:11 May 25, 2005 Jkt 205001 Type of Review: Extension of currently approved information collection requirements. Title: Slings (29 CFR 1910.184). OMB Number: 1218–0223. Affected Public: Business or other forprofits; Not-for-profit organizations; Federal Government; State, local, or tribal government. Number of respondents: 65,000. Frequency of Response: On occasion annually; Average Time per Response: Varies from 1 minute (.02 hour) to maintain a certificate to 30 minutes (.50 hour) for a manufacturing worker to acquire information from a manufacturer for a new tag, make a new tag, and affix it to a sling. Estimated Total Burden Hours: 19,167. Estimated Cost (Operation and Maintenance): $0. IV. Public Participation—Submission of Comments on This Notice and Internet Access to Comments and Submissions You may submit comments and supporting materials in response to this notice by (1) hard copy, (2) fax transmission (facsimile), or (3) electronically through the OSHA Web page. Because of security-related problems, a significant delay may occur in the receipt of comments by regular mail. Please contact the OSHA Docket Office at (202) 693–2350 (TTY (877) 889–5627) for information about security procedures concerning the delivery of submissions by express delivery, hand delivery, and courier service. All comments, submissions and background documents are available for inspection and copying at the OSHA Docket Office at the above address. Comments and submissions posted on OSHA’s Web page are available at http://www.OSHA.gov. Contact the OSHA Docket Office for information about materials not available through the OSHA Web page and for assistance using the Web page to locate docket submissions. Electronic copies of this Federal Register notice as well as other relevant documents are available on OSHA’s Web page. Since all submissions become public, private information such as social security numbers should not be submitted. V. Authority and Signature Jonathan L. Snare, Acting Assistance Secretary of Labor for Occupational Safety and Health, directed the preparation of this notice. The authority for this notice is the Paperwork Reduction Act of 1995 (44 U.S.C. 3506 PO 00000 Frm 00080 Fmt 4703 Sfmt 4703 30489 et seq.), and Secretary of Labor’s Order No. 5–2002 (67 FR 65008). Signed at Washington, DC, on May 20, 2005. Jonathan L. Snare, Acting Assistant Secretary of Labor. [FR Doc. 05–10564 Filed 5–25–05; 8:45 am] BILLING CODE 4510–26–M NATIONAL CREDIT UNION ADMINISTRATION Sales of Nondeposit Investments National Credit Union Administration (NCUA). ACTION: Proposed Interpretive Ruling and Policy Statement No. 05–1; with request for comments. AGENCY: SUMMARY: The NCUA is proposing to adopt an Interpretive Ruling and Policy Statement (IRPS) on Sales of Nondeposit Investments. The proposed IRPS provides requirements, direction, and guidance to federally-insured credit unions on the establishment and operation of third party brokerage arrangements. The proposed IRPS updates and replaces NCUA’s Letter to Credit Unions No. 150 on the sales of nondeposit investments. DATES: Comments must be received on or before July 25, 2005. ADDRESSES: You may submit comments by any of the following methods (please send comments by one method only): • NCUA Web site: http:// www.ncua.gov/news/proposed_regs/ proposed_regs.html. Follow the instructions for submitting comments. • E-mail: Address to regcomments@ncua.gov. Include ‘‘[Your name] Comments on Proposed IRPS (Sales of Nondeposit Investments)’’ in the e-mail subject line. • Fax: (703) 518–6319. Use the subject line described above for e-mail. • Mail: Address to Mary Rupp, Secretary of the Board, National Credit Union Administration, 1775 Duke Street, Alexandria, Virginia 22314– 3428. • Hand Delivery/Courier: Same as mail address. FOR FURTHER INFORMATION CONTACT: Paul Peterson, Staff Attorney, Office of General Counsel, at the above address or telephone: (703) 518–6540. SUPPLEMENTARY INFORMATION: A. Introduction The NCUA Board is proposing to replace its Letter to Credit Unions No. 150 that contains NCUA’s current guidance on the sale of nondeposit investments. NCUA issued Letter No. E:\FR\FM\26MYN1.SGM 26MYN1 30490 Federal Register / Vol. 70, No. 101 / Thursday, May 26, 2005 / Notices 150 in 1993. Since then, there have been several changes in law and regulation affecting the sale of nondeposit investments. NCUA is proposing to update this guidance, set out certain requirements, and provide additional information in the form of an IRPS. NCUA has selected the IRPS format 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, NCUA does not seek public comment on Letters to Credit Unions but generally publishes an IRPS in proposed form with a request for public comment and, in this case, as certain provisions in the IRPS will have the force of regulation, the Administrative Procedure Act requires public notice and comment. Moreover, NCUA believes public comment on both the requirements and guidance in this IRPS will be very helpful, and NCUA encourages interested members of the public to provide their comments. B. Background Credit unions are organized to provide their members with financial services. While in the past credit unions limited member services largely to share accounts and loans, many credit unions now bring their members a full range of financial services. Some credit unions provide their members with investment options beyond share accounts, including: stocks, bonds, mutual funds, and variable annuities. These investment choices are collectively known as nondeposit investments. Complex federal and state laws govern the creation and transfer of securities, and nondeposit investments, including insurance products sold with an investment component, are subject to securities laws. In particular, Federal securities laws require that those who broker securities register with the U.S. Securities and Exchange Commission (SEC) and comply with SEC regulations. Federal law defines a securities broker as any entity ‘‘engaged in the business of effecting transactions in securities for the account of others.’’ 15 U.S.C. 78c(a)(4). The SEC interprets the concept of ‘‘effecting transactions’’ very broadly. Generally, the SEC considers not only those who buy and sell securities directly for others as securities brokers, but also those who relay instructions to buy and sell or who otherwise facilitate securities transactions and receive compensation related to the number or size of the transactions. VerDate jul<14>2003 19:11 May 25, 2005 Jkt 205001 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. 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. In essence, 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. Third party brokerage arrangements can be either bilateral or multilateral. Bilateral arrangements involve an agreement between a credit union and a registered broker. The broker may or may not be a credit union service organization (CUSO). Multilateral arrangements involve an agreement between a credit union, an unregistered CUSO, and a registered broker. The SEC expects a CUSO to register as a broker if its activities rise to the level of ‘‘effecting the transfer of securities.’’ Accordingly, a credit union and brokerage firm must limit the involvement of an unregistered CUSO in the sales of nondeposit investments. . Credit unions have limited powers so, in addition to compliance with securities laws, 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 third party vendor, the broker, to its members to offer them a financial service, the purchase of investments. 12 CFR 721.3(f). State chartered credit unions must look to their own state law for authority to engage in third party brokerage activities. The antifraud provisions of applicable federal and state laws prohibit materially misleading or inaccurate representations in connection with PO 00000 Frm 00081 Fmt 4703 Sfmt 4703 offers and sales of securities. The broker could face potential liability if members are misled about the nature of nondeposit investment products, including their uninsured status. The broker could also face potential liability for other improper sales practices, such as account churning or failing to evaluate the suitability of a particular nondeposit investment for a member. While responsibility for proper sales practices falls on the broker, a credit union could also be liable if it fails to ensure that the brokerage activity is properly separated from the credit union’s other activities, such as its deposit taking and lending. Complete separation of the credit union from the nondeposit investment activities is not possible because the sales are being offered to the member through the auspices of the credit union. The broker’s sales representative, for example, will often be located on credit union premises, credit union employees may refer members to the sales representative, and credit union employees are permitted to provide literature about nondeposit investments to the member. The use of dual employee sales representatives, meaning an employee who works for both the credit union and the broker, may increase the legal risk to the credit union. Credit union management must be aware of how the member will perceive the relationship between a credit union and the broker and how the two may be connected in the member’s mind. The greater the possible connection, the more management must be involved in oversight of nondeposit investment sales practices. One federal court considered a case where an unsophisticated bank customer took out a mortgage loan to finance speculative securities purchases from the bank’s third party broker. The court concluded that various facts, including the use of a dual employee relationship, created a fiduciary relationship between the bank and the customer that the bank violated when it allowed the inappropriate mortgage and securities transaction to occur. Scott v. Dime Savings Bank, 886 F.Supp. 1073 (S.D.N.Y. 1995), aff’d 101 F.3d 107 (2d Cir. 1996), cert. den. 520 U.S. 1122 (1997). See also Conte v. U.S. Alliance Federal Credit Union, 303 F.Supp.2d 220 (D. Conn. 2004)(Existence or not of fiduciary relationship between credit union and member growing out of third party broker nondeposit investment sales is a factual question for the trial jury to decide). NCUA’s Letter No. 150, issued in 1993, contains NCUA’s current E:\FR\FM\26MYN1.SGM 26MYN1 Federal Register / Vol. 70, No. 101 / Thursday, May 26, 2005 / Notices guidance to credit unions on the sales of nondeposit investments. Several events since 1993 require that NCUA update the information in Letter No. 150. One change is NCUA’s replacement of the Group Purchasing Activities rule with the Incidental Powers rule and the elimination of some restrictions on the compensation a federal credit union may receive from its finder activities. 12 CFR part 721. Another change is a proposed Securities and Exchange Commission (SEC) regulation that would expand and clarify a credit union’s authority to participate in third party brokerage arrangements without requiring the credit union to register as a broker. SEC Regulation B, 69 FR 39682 (June 30, 2004)(Proposed). Regulation B, when finalized, will replace current SEC guidance applicable to credit unions contained in a series of ‘‘no action’’ letters. See, e.g., SEC Letter Re: Chubb Securities Corporation (Nov. 24, 1993). The SEC has not yet finalized Regulation B. If the final Regulation B differs materially from the proposed Regulation B, the NCUA Board will make appropriate changes to the text of the final IRPS. The NCUA Office of General Counsel has also issued several legal opinion letters since 1993 interpreting various aspects of the sale of nondeposit investment sales. Accordingly, NCUA has determined to update the guidance in Letter No. 150 and issue the update in IRPS form. NCUA believes that the IRPS is a better medium for the information than a letter to credit unions. The IRPS is more accessible, and is also appropriate for both mandatory requirements and guidance. C. Regulatory Procedures Regulatory Flexibility Act The Regulatory Flexibility Act requires that NCUA prepare an analysis describing any significant economic impact agency rulemaking may have on a substantial number of small credit unions. 5 U.S.C. 601 et seq. For purposes of this analysis, NCUA considers credit unions under $10 million in assets as small credit unions. Since the binding requirements in this IRPS are generally restatements of requirements in other laws and regulations, NCUA does not believe this proposed IRPS will have a significant economic impact on a substantial number of small credit unions. NCUA invites the public to comment on this issue. VerDate jul<14>2003 19:11 May 25, 2005 Jkt 205001 Paperwork Reduction Act NCUA has determined that this proposed IRPS does not increase paperwork requirements under the Paperwork Reduction Act of 1995 (44 U.S.C. chapter 35) and regulations of the Office of Management and Budget. Executive Order 13132 Executive Order 13132 encourages independent regulatory agencies to consider the impact of their regulatory actions on state and local interests. In adherence to fundamental federalism principles, NCUA, an independent regulatory agency as defined in 44 U.S.C. 3502(5), voluntarily complies with the executive order. This proposed IRPS applies to all credit unions, but does not have substantial direct effect on the states, on the relationship between the national government and the states, or on the distribution of power and responsibilities among the various levels of government. NCUA has determined that this proposed IRPS does not constitute a policy that has federalism implications for purposes of the executive order. By the National Credit Union Administration Board, on May 19, 2005. Mary Rupp, Secretary of the Board. Authority: 12 U.S.C. 1752a, 1756, 1757, 1766, 1783, 1784. Proposed Interpretive Ruling and Policy Statement No. 05–1; Sales of Nondeposit Investments I. Introduction This Interpretive Ruling and Policy Statement (IRPS) provides requirements, direction, and guidance to federallyinsured credit unions offering their members nondeposit investments through third party brokerage arrangements. Among other things, this IRPS discusses the relationship between the credit union and the brokerage firm and the responsibilities of each, the separation of investment sales activities from the receipt of deposits or shares, contacts with members concerning securities sales, compensation and referral fees, the use of dual employees, sales to nonmembers, and related issues and concerns. The information in this IRPS comes from a variety of sources, including the Securities and Exchange Commission (SEC), the National Association of Securities Dealers (NASD), and NCUA. This IRPS addresses the SEC’s requirements and related guidance first. The IRPS concludes with additional NCUA requirements and guidance. PO 00000 Frm 00082 Fmt 4703 Sfmt 4703 30491 II. Purpose This IRPS supersedes NCUA’s Letter to Credit Unions No. 150, Sales of Nondeposit Investments. The information in this IRPS is intended to help credit unions conduct third party brokerage activities in a manner that is legal, protects members from potential securities fraud and abuse, and minimizes safety and soundness concerns for the credit union. The use of the word ‘‘must’’ in this IRPS reflects a legal requirement for credit unions. The use of the word ‘‘should’’ indicates guidance as to best practices. III. Scope The scope of this IRPS is sales of nondeposit investments to members through third party brokerage arrangements. This IRPS does not cover: • No-load money market mutual fund transactions through a sweep account arrangement; • Securities safekeeping activities, such as IRA custodianships; • Nondeposit investment transactions for the credit union’s own investment account; and • Transactions in insurance products that do not include an investment component. Examples of these insurance products generally include whole life insurance and insurance sold in connection with loans. IV. Conduct of Third Party Brokerage Arrangements: SEC Requirements Sales of nondeposit investments are subject to the securities laws and the regulation and oversight of the SEC. This section contains the SEC’s regulatory requirements for the conduct of third party brokerage arrangements at credit unions. After each SEC requirement are additional direction and guidance from National Association of Securities Dealers (NASD) Rule 2350 and the NCUA. SEC Requirement: 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 must clearly identify to members that it is providing the brokerage services, not the credit union. Any materials a credit union or broker uses to advertise or promote the availability of brokerage services under the arrangement must comply with federal securities laws. Advertising and promotional material must also clearly indicate that the brokerage services are being provided by the broker and not by the credit union. The credit union or broker must also inform each customer that the securities being offered are not E:\FR\FM\26MYN1.SGM 26MYN1 30492 Federal Register / Vol. 70, No. 101 / Thursday, May 26, 2005 / Notices shares or other obligations of the credit union, are not guaranteed by the credit union, and are not insured by the National Credit Union Administration or any other federal agency. Credit unions and the brokerage firms must market nondeposit investment products in a manner that does not mislead or confuse members as to the nature or risks of these uninsured products. To avoid member confusion about these products, credit union policies should specifically address the locations at which sales will take place. The best practice is that deposit-taking be physically separated from nondeposit sales functions. 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. When selling, advertising, or otherwise marketing uninsured investment products to members, members must be informed that the products offered: • 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. These disclosures must be clear and conspicuous, and 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. Abbreviated versions of the disclosures may be used in certain advertising media as described in NASD Rule 2350. The sales representative should also, when discussing nondeposit investments with a member face-to-face, 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. VerDate jul<14>2003 19:11 May 25, 2005 Jkt 205001 SEC Requirement: 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. SEC Requirement: 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 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. In this context, ‘‘nominal’’ generally means that the payment may not exceed the greater of twenty-five dollars or the wages the employee is paid for one hour of work. The SEC’s Regulation B indexes the maximum amount of a referral fee to inflation, so credit unions seeking to set referral fees as high as the SEC permits should consult with qualified counsel. SEC Requirement: 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. V. Conduct of Third Party Brokerage Arrangements: Additional NCUA Requirements, Direction, and Guidance The SEC’s regulatory requirements are primarily intended to protect the customer. This section contains additional guidance that is not dictated by or directly related to the SEC’s requirements. Much of this guidance relates to the safety and soundness of the credit union. Risks to the Credit Union As with any business activity, a credit union’s directors must evaluate the risks associated with nondeposit investment activities. The risks include: • Legal Risk: The credit union could be held liable for abusive sales practices perpetrated by nondeposit investment sales representatives. PO 00000 Frm 00083 Fmt 4703 Sfmt 4703 • Reputation Risk: The credit union could be damaged by association with abusive sales practices, even if not liable for the practices. • Economic Risk: The credit union could lose money if it commits itself to pay any expenses associated with the nondeposit investment activity and the sales and associated revenue are insufficient to pay those expenses. Due Diligence in Selecting an Appropriate Brokerage Firm Before entering into a third party brokerage arrangement, credit unions must take care to select an appropriate brokerage firm. For each firm under consideration, the credit union should: • Ensure the firm can provide the services that credit union members need. • Review the firm’s financial statements and capital adequacy. • Determine if the firm can adequately supervise its sales representatives at the credit union’s location. • Ask the firm to provide references, preferably other depository institutions, and talk with those references. • Conduct 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 concerning the brokerage arrangement. Many of these policies and procedures should be reflected in the contract with the brokerage firm. At a minimum, the policies, procedures, and contracts should address: • The features of the sales program. Credit union policies should describe 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. Qualitative considerations include an analysis of the level of complexity and volatility in the investments that you will permit the broker to offer your members. • A description of the relative responsibilities of the credit union and the brokerage firm. The credit union’s policies and the contract between the brokerage firm and the credit union must make clear that the brokerage firm is primarily responsible for ensuring that the nondeposit sales function is conducted in compliance with all E:\FR\FM\26MYN1.SGM 26MYN1 Federal Register / Vol. 70, No. 101 / Thursday, May 26, 2005 / Notices 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. Credit unions policies should require a specific and unambiguous contractual agreement from the brokerage firm to indemnify the credit union for any monetary damages arising from nondeposit sales activities, including but not limited to improper sales practices. • The roles of credit union employees. Credit union policies should describe 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 roles of brokerage firm employees. Credit union policies should require the brokerage firm to provide the credit union with a written document that explains the duties of its sales representatives and gives the credit union the names, contact information, and specific duties of those who will supervise the sales representatives. • The location of nondeposit sales. Credit union policies should describe where nondeposit sales may take place and how those sales will be separated from deposit-taking activities. • The use of credit union member information. The credit union’s policies should describe the information that may be transferred between the credit union and the brokerage firm or the brokerage firm’s sales representative. The policies and contracts should describe 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. 12 CFR parts 716 and 748. The brokerage firm must agree in writing to comply with the credit union’s policies on information practices. • Termination of the contract. The contract should contain a provision that permits the credit union to terminate the contract for both cause and for the convenience of the credit union. Failure by the brokerage firm to adequately supervise its sales representative should be included as a specific for-cause reason for contract termination. • Compliance with the requirements in this IRPS and applicable law and regulation. Credit unions must maintain programs to monitor compliance by the broker, its salespeople, and other VerDate jul<14>2003 19:11 May 25, 2005 Jkt 205001 entities involved in the sales of nondeposit investments. 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. When conducting sampling, compliance personnel should look for evidence such as: Æ Accounts with a high rate of investment turnover, which may indicate the sales representative is churning accounts to generate commissions; Æ Accounts with complex investments that may be unsuitable for the particular member; and Æ A combination of loan accounts and nondeposit investment accounts that might indicate a member borrowed large sums of money from the credit union to finance nondeposit investment purchases. Credit unions should consult with qualified counsel for further information about what to review when examining member accounts. The intensity of the credit union’s compliance effort will depend on the nature and extent of nondeposit investment sales, evidence of the effectiveness of the broker’s compliance systems, and the level of member complaints. Whether the credit union can obtain an unambiguous indemnification agreement from the brokerage firm should also affect the intensity of the compliance effort. The Use of Dual Employees Credit unions may establish a third party brokerage arrangement using dual employees. These arrangements create additional risk for the credit union and must be designed, operated, and monitored carefully. • Separation of duties. 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 duties performed for the credit union should be unrelated to the sale of nondeposit investments. The duties performed for the credit union should not bring the employee into contact PO 00000 Frm 00084 Fmt 4703 Sfmt 4703 30493 with members that might also purchase nondeposit investments. The dual employee should have no management or policy-setting responsibilities within the credit union related to nondeposit investments. • Separation of employment descriptions when interacting with members. 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. For example, dual employees should use separate business cards for their credit union and nondeposit investment sales functions. Likewise, dual employees should use separate stationary for nondeposit investment correspondence and credit union correspondence and, when conducting nondeposit investment business, dual employees should not reference their positions at the credit union. • Dual employee compensation. 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. • Indemnification. The use of dual employees increases the risk a credit union may be held liable for abusive sales practices. At the same time, the brokerage firm may have less incentive to supervise nondeposit sales activities properly when conducted by a dual employee. Accordingly, the credit union should seek an indemnification agreement from the brokerage firm as described above. 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 of Nondeposit Investments to Nonmembers Because credit unions may only provide services to members, a credit union may generally only accept income and pay expenses associated with nondeposit investment sales to its members. NCUA realizes, however, that in some cases it may be difficult for a credit union to connect particular E:\FR\FM\26MYN1.SGM 26MYN1 30494 Federal Register / Vol. 70, No. 101 / Thursday, May 26, 2005 / Notices income to a transaction involving a member. For example, some sales representatives may have generated sales that occurred before the representative joined the brokerage arrangement. These representatives may bring with them a stream of trailer income that cannot now be associated with any particular person or is not otherwise attributable to members of the credit union. A similar situation may arise in brokerage arrangements involving multiple credit unions working with one broker and sales made to members of the various credit unions. To address these situations, 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 minimus means 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. A similar issue may arise if a credit union pays expenses associated with the sales of nondeposit investments. 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. VI. Applicable Law and Regulation • The Federal Credit Union Act, 12 U.S.C. 1751 et seq. • The Securities and Exchange Act of 1934, § 3(a)(4), 15 U.S.C. 78a et seq. • Regulation B, Securities Activities of Banks and Other Financial Institutions, 15 CFR 242.710 et seq. • NASD Rule 2350, Broker/Dealer Conduct on the Premises of Financial Institutions. • NASD Rule 3040, Private Securities Transactions of an Associated Person. [FR Doc. 05–10381 Filed 5–25–05; 8:45 am] BILLING CODE 7535–01–P NATIONAL SCIENCE FOUNDATION Agency Information Collection Activities: Comment Request National Science Foundation. Submission for OMB Review; Comment Request. AGENCY: ACTION: SUMMARY: The National Science Foundation (NSF) has submitted the following information collection VerDate jul<14>2003 19:11 May 25, 2005 Jkt 205001 requirement to OMB for review and clearance under the Paperwork Reduction Act of 1995, Pub. L. 104–13. This is the second notice; the first notice was published at 70 FR 13544 and no comments were received. Comments regarding (a) whether the collection of information is necessary for the proper performance of the functions of the agency, including whether the information will have practical utility; (b) the accuracy of the agency’s estimate of burden including the validity of the methodology and assumptions used; (c) ways to enhance the quality, utility and clarity of the information to be collected; and (d) ways to minimize the burden of the collection of information on those who are to respond, including through the use of appropriate automated, electronic, mechanical, or other technological collection techniques or other forms of information technology should be addressed to: Office of Information and Regulatory Affairs of OMB, Attention: Desk Officer for National Science Foundation, 725 17th Street, NW., Room 10235, Washington, DC 20503, and to Suzanne H. Plimpton, Reports Clearance Officer, National Science Foundation, 4201 Wilson Boulevard, Suite 295, Arlington, Virginia 22230 or send e-mail to splimpto@nsf.gov. Comments regarding these information collections are best assured of having their full effect if received within 30 days of this notification. Copies of the submission(s) may be obtained by calling (703) 292– 7556. NSF may not conduct or sponsor a collection of information unless the collection of information displays a currently valid OMB control number and the agency informs potential persons who are to respond to the collection of information that such persons are not required to respond to the collection of information unless it displays a currently valid OMB control number. SUPPLEMENTARY INFORMATION: Title of Collection: National Science Foundation Applicant Survey. OMB Approval Number: 3145–0096. Type of Request: Intent to seek approval to extend an information collection for three years. Proposed Project: The current National Science Foundation Applicant survey has been in use for several years. Data are collected from applicant pools to examine the facial/sexual/disability composition and to determine the source of information about NSF vacancies. Use of the Information: Analysis of the applicant pools is necessary to PO 00000 Frm 00085 Fmt 4703 Sfmt 4703 determine if NSF’s targeted recruitment efforts are reaching groups that are underrepresented in the Agency’s workforce and/or to defend the Foundation’s practices in discrimination cases. Burden on the Public: The Foundation estimates about 8,000 responses annually at 1 minute per response; this computes to approximately 133 hours annually. Dated: May 20, 2002. Suzanne H. Plimpton, Reports Clearance Officer, National Science Foundation. [FR Doc. 05–10484 Filed 5–25–05; 8:45 am] BILLING CODE 7555–01–M NATIONAL SCIENCE FOUNDATION Agency Information Collection Activities: Comment Request National Science Foundation. Submission for OMB review; Comment request. AGENCY: ACTION: SUMMARY: Under the Paperwork Reduction Act of 1995, Pub. L. 104–13 (44 U.S.C. 3501 et seq.), and as part of its continuing effort to reduce paperwork and respondent burden, the National Science Foundation (NSF) is inviting the general public and other Federal agencies to comment on this proposed continuing information collection. This is the second notice for public comment; the first was published in the Federal Register at 70 FR 9981 and no comments were received. NSF is forwarding the proposed submission to the Office of Management and Budget (OMB) for clearance simultaneously with the publication of this second notice. Comments regarding these information collections are best assured of having their full effect if received by OMB within 30 days of publication in the Federal Register. ADDRESSES: Written comments regarding (a) Whether the collection of information is necessary for the proper performance of the functions of NSF, including whether the information will have practical utility; (b) the accuracy of NSF’s estimate of burden including the validity of the methodology and assumptions used; (c) ways to enhance the quality, utility and clarity of the information to be collected; or (d) ways to minimize the burden of the collection of information on those who are to respond, including through the use of appropriated automated, electronic, mechanical, or other technological collection techniques or other forms of DATES: E:\FR\FM\26MYN1.SGM 26MYN1

Agencies

[Federal Register Volume 70, Number 101 (Thursday, May 26, 2005)]
[Notices]
[Pages 30489-30494]
From the Federal Register Online via the Government Printing Office [www.gpo.gov]
[FR Doc No: 05-10381]


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NATIONAL CREDIT UNION ADMINISTRATION


Sales of Nondeposit Investments

AGENCY: National Credit Union Administration (NCUA).

ACTION: Proposed Interpretive Ruling and Policy Statement No. 05-1; 
with request for comments.

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SUMMARY: The NCUA is proposing to adopt an Interpretive Ruling and 
Policy Statement (IRPS) on Sales of Nondeposit Investments. The 
proposed IRPS provides requirements, direction, and guidance to 
federally-insured credit unions on the establishment and operation of 
third party brokerage arrangements. The proposed IRPS updates and 
replaces NCUA's Letter to Credit Unions No. 150 on the sales of 
nondeposit investments.

DATES: Comments must be received on or before July 25, 2005.

ADDRESSES: You may submit comments by any of the following methods 
(please send comments by one method only):
     NCUA Web site: http://www.ncua.gov/news/proposed_regs/
proposed_regs.html. Follow the instructions for submitting comments.
     E-mail: Address to regcomments@ncua.gov. Include ``[Your 
name] Comments on Proposed IRPS (Sales of Nondeposit Investments)'' in 
the e-mail subject line.
     Fax: (703) 518-6319. Use the subject line described above 
for e-mail.
     Mail: Address to Mary Rupp, Secretary of the Board, 
National Credit Union Administration, 1775 Duke Street, Alexandria, 
Virginia 22314-3428.
     Hand Delivery/Courier: Same as mail address.

FOR FURTHER INFORMATION CONTACT: Paul Peterson, Staff Attorney, Office 
of General Counsel, at the above address or telephone: (703) 518-6540.

SUPPLEMENTARY INFORMATION:

A. Introduction

    The NCUA Board is proposing to replace its Letter to Credit Unions 
No. 150 that contains NCUA's current guidance on the sale of nondeposit 
investments. NCUA issued Letter No.

[[Page 30490]]

150 in 1993. Since then, there have been several changes in law and 
regulation affecting the sale of nondeposit investments. NCUA is 
proposing to update this guidance, set out certain requirements, and 
provide additional information in the form of an IRPS. NCUA has 
selected the IRPS format 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, NCUA does not 
seek public comment on Letters to Credit Unions but generally publishes 
an IRPS in proposed form with a request for public comment and, in this 
case, as certain provisions in the IRPS will have the force of 
regulation, the Administrative Procedure Act requires public notice and 
comment. Moreover, NCUA believes public comment on both the 
requirements and guidance in this IRPS will be very helpful, and NCUA 
encourages interested members of the public to provide their comments.

B. Background

    Credit unions are organized to provide their members with financial 
services. While in the past credit unions limited member services 
largely to share accounts and loans, many credit unions now bring their 
members a full range of financial services. Some credit unions provide 
their members with investment options beyond share accounts, including: 
stocks, bonds, mutual funds, and variable annuities. These investment 
choices are collectively known as nondeposit investments.
    Complex federal and state laws govern the creation and transfer of 
securities, and nondeposit investments, including insurance products 
sold with an investment component, are subject to securities laws. In 
particular, Federal securities laws require that those who broker 
securities register with the U.S. Securities and Exchange Commission 
(SEC) and comply with SEC regulations. Federal law defines a securities 
broker as any entity ``engaged in the business of effecting 
transactions in securities for the account of others.'' 15 U.S.C. 
78c(a)(4). The SEC interprets the concept of ``effecting transactions'' 
very broadly. Generally, the SEC considers not only those who buy and 
sell securities directly for others as securities brokers, but also 
those who relay instructions to buy and sell or who otherwise 
facilitate securities transactions and receive compensation related to 
the number or size of the transactions.
    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. 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. In essence, 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.
    Third party brokerage arrangements can be either bilateral or 
multilateral. Bilateral arrangements involve an agreement between a 
credit union and a registered broker. The broker may or may not be a 
credit union service organization (CUSO). Multilateral arrangements 
involve an agreement between a credit union, an unregistered CUSO, and 
a registered broker. The SEC expects a CUSO to register as a broker if 
its activities rise to the level of ``effecting the transfer of 
securities.'' Accordingly, a credit union and brokerage firm must limit 
the involvement of an unregistered CUSO in the sales of nondeposit 
investments. .
    Credit unions have limited powers so, in addition to compliance 
with securities laws, 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 third 
party vendor, the broker, to its members to offer them a financial 
service, the purchase of investments. 12 CFR 721.3(f). State chartered 
credit unions must look to their own state law for authority to engage 
in third party brokerage activities.
    The antifraud provisions of applicable federal and state laws 
prohibit materially misleading or inaccurate representations in 
connection with offers and sales of securities. The broker could face 
potential liability if members are misled about the nature of 
nondeposit investment products, including their uninsured status. The 
broker could also face potential liability for other improper sales 
practices, such as account churning or failing to evaluate the 
suitability of a particular nondeposit investment for a member.
    While responsibility for proper sales practices falls on the 
broker, a credit union could also be liable if it fails to ensure that 
the brokerage activity is properly separated from the credit union's 
other activities, such as its deposit taking and lending. Complete 
separation of the credit union from the nondeposit investment 
activities is not possible because the sales are being offered to the 
member through the auspices of the credit union. The broker's sales 
representative, for example, will often be located on credit union 
premises, credit union employees may refer members to the sales 
representative, and credit union employees are permitted to provide 
literature about nondeposit investments to the member. The use of dual 
employee sales representatives, meaning an employee who works for both 
the credit union and the broker, may increase the legal risk to the 
credit union.
    Credit union management must be aware of how the member will 
perceive the relationship between a credit union and the broker and how 
the two may be connected in the member's mind. The greater the possible 
connection, the more management must be involved in oversight of 
nondeposit investment sales practices. One federal court considered a 
case where an unsophisticated bank customer took out a mortgage loan to 
finance speculative securities purchases from the bank's third party 
broker. The court concluded that various facts, including the use of a 
dual employee relationship, created a fiduciary relationship between 
the bank and the customer that the bank violated when it allowed the 
inappropriate mortgage and securities transaction to occur. Scott v. 
Dime Savings Bank, 886 F.Supp. 1073 (S.D.N.Y. 1995), aff'd 101 F.3d 107 
(2d Cir. 1996), cert. den. 520 U.S. 1122 (1997). See also Conte v. U.S. 
Alliance Federal Credit Union, 303 F.Supp.2d 220 (D. Conn. 
2004)(Existence or not of fiduciary relationship between credit union 
and member growing out of third party broker nondeposit investment 
sales is a factual question for the trial jury to decide).
    NCUA's Letter No. 150, issued in 1993, contains NCUA's current

[[Page 30491]]

guidance to credit unions on the sales of nondeposit investments. 
Several events since 1993 require that NCUA update the information in 
Letter No. 150. One change is NCUA's replacement of the Group 
Purchasing Activities rule with the Incidental Powers rule and the 
elimination of some restrictions on the compensation a federal credit 
union may receive from its finder activities. 12 CFR part 721.
    Another change is a proposed Securities and Exchange Commission 
(SEC) regulation that would expand and clarify a credit union's 
authority to participate in third party brokerage arrangements without 
requiring the credit union to register as a broker. SEC Regulation B, 
69 FR 39682 (June 30, 2004)(Proposed). Regulation B, when finalized, 
will replace current SEC guidance applicable to credit unions contained 
in a series of ``no action'' letters. See, e.g., SEC Letter Re: Chubb 
Securities Corporation (Nov. 24, 1993). The SEC has not yet finalized 
Regulation B. If the final Regulation B differs materially from the 
proposed Regulation B, the NCUA Board will make appropriate changes to 
the text of the final IRPS. The NCUA Office of General Counsel has also 
issued several legal opinion letters since 1993 interpreting various 
aspects of the sale of nondeposit investment sales.
    Accordingly, NCUA has determined to update the guidance in Letter 
No. 150 and issue the update in IRPS form. NCUA believes that the IRPS 
is a better medium for the information than a letter to credit unions. 
The IRPS is more accessible, and is also appropriate for both mandatory 
requirements and guidance.

C. Regulatory Procedures

Regulatory Flexibility Act

    The Regulatory Flexibility Act requires that NCUA prepare an 
analysis describing any significant economic impact agency rulemaking 
may have on a substantial number of small credit unions. 5 U.S.C. 601 
et seq. For purposes of this analysis, NCUA considers credit unions 
under $10 million in assets as small credit unions. Since the binding 
requirements in this IRPS are generally restatements of requirements in 
other laws and regulations, NCUA does not believe this proposed IRPS 
will have a significant economic impact on a substantial number of 
small credit unions. NCUA invites the public to comment on this issue.

Paperwork Reduction Act

    NCUA has determined that this proposed IRPS does not increase 
paperwork requirements under the Paperwork Reduction Act of 1995 (44 
U.S.C. chapter 35) and regulations of the Office of Management and 
Budget.

Executive Order 13132

    Executive Order 13132 encourages independent regulatory agencies to 
consider the impact of their regulatory actions on state and local 
interests. In adherence to fundamental federalism principles, NCUA, an 
independent regulatory agency as defined in 44 U.S.C. 3502(5), 
voluntarily complies with the executive order.
    This proposed IRPS applies to all credit unions, but does not have 
substantial direct effect on the states, on the relationship between 
the national government and the states, or on the distribution of power 
and responsibilities among the various levels of government. NCUA has 
determined that this proposed IRPS does not constitute a policy that 
has federalism implications for purposes of the executive order.

    By the National Credit Union Administration Board, on May 19, 
2005.
Mary Rupp,
Secretary of the Board.

    Authority: 12 U.S.C. 1752a, 1756, 1757, 1766, 1783, 1784.

Proposed Interpretive Ruling and Policy Statement No. 05-1; Sales of 
Nondeposit Investments

I. Introduction

    This Interpretive Ruling and Policy Statement (IRPS) provides 
requirements, direction, and guidance to federally-insured credit 
unions offering their members nondeposit investments through third 
party brokerage arrangements. Among other things, this IRPS discusses 
the relationship between the credit union and the brokerage firm and 
the responsibilities of each, the separation of investment sales 
activities from the receipt of deposits or shares, contacts with 
members concerning securities sales, compensation and referral fees, 
the use of dual employees, sales to nonmembers, and related issues and 
concerns.
    The information in this IRPS comes from a variety of sources, 
including the Securities and Exchange Commission (SEC), the National 
Association of Securities Dealers (NASD), and NCUA. This IRPS addresses 
the SEC's requirements and related guidance first. The IRPS concludes 
with additional NCUA requirements and guidance.

II. Purpose

    This IRPS supersedes NCUA's Letter to Credit Unions No. 150, Sales 
of Nondeposit Investments. The information in this IRPS is intended to 
help credit unions conduct third party brokerage activities in a manner 
that is legal, protects members from potential securities fraud and 
abuse, and minimizes safety and soundness concerns for the credit 
union. The use of the word ``must'' in this IRPS reflects a legal 
requirement for credit unions. The use of the word ``should'' indicates 
guidance as to best practices.

III. Scope

    The scope of this IRPS is sales of nondeposit investments to 
members through third party brokerage arrangements. This IRPS does not 
cover:
     No-load money market mutual fund transactions through a 
sweep account arrangement;
     Securities safekeeping activities, such as IRA 
custodianships;
     Nondeposit investment transactions for the credit union's 
own investment account; and
     Transactions in insurance products that do not include an 
investment component. Examples of these insurance products generally 
include whole life insurance and insurance sold in connection with 
loans.

IV. Conduct of Third Party Brokerage Arrangements: SEC Requirements

    Sales of nondeposit investments are subject to the securities laws 
and the regulation and oversight of the SEC. This section contains the 
SEC's regulatory requirements for the conduct of third party brokerage 
arrangements at credit unions. After each SEC requirement are 
additional direction and guidance from National Association of 
Securities Dealers (NASD) Rule 2350 and the NCUA.
    SEC Requirement: 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 must clearly identify to members that it is providing 
the brokerage services, not the credit union. Any materials a credit 
union or broker uses to advertise or promote the availability of 
brokerage services under the arrangement must comply with federal 
securities laws. Advertising and promotional material must also clearly 
indicate that the brokerage services are being provided by the broker 
and not by the credit union. The credit union or broker must also 
inform each customer that the securities being offered are not

[[Page 30492]]

shares or other obligations of the credit union, are not guaranteed by 
the credit union, and are not insured by the National Credit Union 
Administration or any other federal agency.
    Credit unions and the brokerage firms must market nondeposit 
investment products in a manner that does not mislead or confuse 
members as to the nature or risks of these uninsured products. To avoid 
member confusion about these products, credit union policies should 
specifically address the locations at which sales will take place. The 
best practice is that deposit-taking be physically separated from 
nondeposit sales functions.
    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. When 
selling, advertising, or otherwise marketing uninsured investment 
products to members, members must be informed that the products 
offered:
     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.
    These disclosures must be clear and conspicuous, and 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. 
Abbreviated versions of the disclosures may be used in certain 
advertising media as described in NASD Rule 2350.
    The sales representative should also, when discussing nondeposit 
investments with a member face-to-face, 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.
    SEC Requirement: 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.
    SEC Requirement: 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 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. In 
this context, ``nominal'' generally means that the payment may not 
exceed the greater of twenty-five dollars or the wages the employee is 
paid for one hour of work.
    The SEC's Regulation B indexes the maximum amount of a referral fee 
to inflation, so credit unions seeking to set referral fees as high as 
the SEC permits should consult with qualified counsel.
    SEC Requirement: 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.

V. Conduct of Third Party Brokerage Arrangements: Additional NCUA 
Requirements, Direction, and Guidance

    The SEC's regulatory requirements are primarily intended to protect 
the customer. This section contains additional guidance that is not 
dictated by or directly related to the SEC's requirements. Much of this 
guidance relates to the safety and soundness of the credit union.
Risks to the Credit Union
    As with any business activity, a credit union's directors must 
evaluate the risks associated with nondeposit investment activities. 
The risks include:
     Legal Risk: The credit union could be held liable for 
abusive sales practices perpetrated by nondeposit investment sales 
representatives.
     Reputation Risk: The credit union could be damaged by 
association with abusive sales practices, even if not liable for the 
practices.
     Economic Risk: The credit union could lose money if it 
commits itself to pay any expenses associated with the nondeposit 
investment activity and the sales and associated revenue are 
insufficient to pay those expenses.
Due Diligence in Selecting an Appropriate Brokerage Firm
    Before entering into a third party brokerage arrangement, credit 
unions must take care to select an appropriate brokerage firm. For each 
firm under consideration, the credit union should:
     Ensure the firm can provide the services that credit union 
members need.
     Review the firm's financial statements and capital 
adequacy.
     Determine if the firm can adequately supervise its sales 
representatives at the credit union's location.
     Ask the firm to provide references, preferably other 
depository institutions, and talk with those references.
     Conduct 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 
concerning the brokerage arrangement. Many of these policies and 
procedures should be reflected in the contract with the brokerage firm. 
At a minimum, the policies, procedures, and contracts should address:
     The features of the sales program. Credit union policies 
should describe 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. Qualitative considerations include an analysis of the level 
of complexity and volatility in the investments that you will permit 
the broker to offer your members.
     A description of the relative responsibilities of the 
credit union and the brokerage firm. The credit union's policies and 
the contract between the brokerage firm and the credit union must make 
clear that the brokerage firm is primarily responsible for ensuring 
that the nondeposit sales function is conducted in compliance with all

[[Page 30493]]

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. Credit unions 
policies should require a specific and unambiguous contractual 
agreement from the brokerage firm to indemnify the credit union for any 
monetary damages arising from nondeposit sales activities, including 
but not limited to improper sales practices.
     The roles of credit union employees. Credit union policies 
should describe 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 roles of brokerage firm employees. Credit union 
policies should require the brokerage firm to provide the credit union 
with a written document that explains the duties of its sales 
representatives and gives the credit union the names, contact 
information, and specific duties of those who will supervise the sales 
representatives.
     The location of nondeposit sales. Credit union policies 
should describe where nondeposit sales may take place and how those 
sales will be separated from deposit-taking activities.
     The use of credit union member information. The credit 
union's policies should describe the information that may be 
transferred between the credit union and the brokerage firm or the 
brokerage firm's sales representative. The policies and contracts 
should describe 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. 12 CFR parts 716 and 748. The 
brokerage firm must agree in writing to comply with the credit union's 
policies on information practices.
     Termination of the contract. The contract should contain a 
provision that permits the credit union to terminate the contract for 
both cause and for the convenience of the credit union. Failure by the 
brokerage firm to adequately supervise its sales representative should 
be included as a specific for-cause reason for contract termination.
     Compliance with the requirements in this IRPS and 
applicable law and regulation. Credit unions must maintain programs to 
monitor compliance by the broker, its salespeople, and other entities 
involved in the sales of nondeposit investments. 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. When conducting sampling, compliance 
personnel should look for evidence such as:
    [cir] Accounts with a high rate of investment turnover, which may 
indicate the sales representative is churning accounts to generate 
commissions;
    [cir] Accounts with complex investments that may be unsuitable for 
the particular member; and
    [cir] A combination of loan accounts and nondeposit investment 
accounts that might indicate a member borrowed large sums of money from 
the credit union to finance nondeposit investment purchases.
    Credit unions should consult with qualified counsel for further 
information about what to review when examining member accounts. The 
intensity of the credit union's compliance effort will depend on the 
nature and extent of nondeposit investment sales, evidence of the 
effectiveness of the broker's compliance systems, and the level of 
member complaints. Whether the credit union can obtain an unambiguous 
indemnification agreement from the brokerage firm should also affect 
the intensity of the compliance effort.
The Use of Dual Employees
    Credit unions may establish a third party brokerage arrangement 
using dual employees. These arrangements create additional risk for the 
credit union and must be designed, operated, and monitored carefully.
     Separation of duties. 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 duties performed for the credit 
union should be unrelated to the sale of nondeposit investments. The 
duties performed for the credit union should not bring the employee 
into contact with members that might also purchase nondeposit 
investments. The dual employee should have no management or policy-
setting responsibilities within the credit union related to nondeposit 
investments.
     Separation of employment descriptions when interacting 
with members. 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. For example, dual employees should use 
separate business cards for their credit union and nondeposit 
investment sales functions. Likewise, dual employees should use 
separate stationary for nondeposit investment correspondence and credit 
union correspondence and, when conducting nondeposit investment 
business, dual employees should not reference their positions at the 
credit union.
     Dual employee compensation. 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.
     Indemnification. The use of dual employees increases the 
risk a credit union may be held liable for abusive sales practices. At 
the same time, the brokerage firm may have less incentive to supervise 
nondeposit sales activities properly when conducted by a dual employee. 
Accordingly, the credit union should seek an indemnification agreement 
from the brokerage firm as described above. 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 of Nondeposit Investments to Nonmembers
    Because credit unions may only provide services to members, a 
credit union may generally only accept income and pay expenses 
associated with nondeposit investment sales to its members. NCUA 
realizes, however, that in some cases it may be difficult for a credit 
union to connect particular

[[Page 30494]]

income to a transaction involving a member. For example, some sales 
representatives may have generated sales that occurred before the 
representative joined the brokerage arrangement. These representatives 
may bring with them a stream of trailer income that cannot now be 
associated with any particular person or is not otherwise attributable 
to members of the credit union. A similar situation may arise in 
brokerage arrangements involving multiple credit unions working with 
one broker and sales made to members of the various credit unions.
    To address these situations, 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 minimus means 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.
    A similar issue may arise if a credit union pays expenses 
associated with the sales of nondeposit investments. 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.

VI. Applicable Law and Regulation

     The Federal Credit Union Act, 12 U.S.C. 1751 et seq.
     The Securities and Exchange Act of 1934, Sec.  3(a)(4), 15 
U.S.C. 78a et seq.
     Regulation B, Securities Activities of Banks and Other 
Financial Institutions, 15 CFR 242.710 et seq.
     NASD Rule 2350, Broker/Dealer Conduct on the Premises of 
Financial Institutions.
     NASD Rule 3040, Private Securities Transactions of an 
Associated Person.

[FR Doc. 05-10381 Filed 5-25-05; 8:45 am]
BILLING CODE 7535-01-P