The NCUA recently reiterated that guidance on best practices involving third-party brokerage arrangements is just that and does not carry the force of formal regulation.
In a Feb. 11 letter, NCUA General Counsel Robert Fenner responded to NACUSO regarding the regulator's 10-FCU-03 letter to federal credit unions on the sales of nondeposit investments. NACUSO had expressed concerns that the NCUA's guidance requires credit unions to perform duties outside the scope of their expertise and to interpose themselves in broker-dealer compliance issues.
"As a preliminary matter, you should note that 10-FCU-03 is guidance recommending best practices for FCUs involved in third-party brokerage arrangement. Indeed, the first sentence expressly states 'the purpose of this letter is to provide guidance to federal credit unions on the establishment and operation of third-party brokerage arrangements for the sale of nondeposit investment products.' The letter does not impose regulatory requirements on FCUs," Fenner wrote.
Fenner addressed specific concerns NACUSO had with some of the guidelines. One was that NCUA's guidance that credit unions perform qualitative analysis of the level of complexity and volatility in the investments that a credit union will permit the broker to offer members requires an improper act by an unregistered entity. NACUSO was concerned that restricting what products the broker-dealer may offer could place credit unions at a risk for liability in investor suitability claims.
The intent of the recommendation is to ensure an FCU's policies, procedures and contracts reflect the due diligence in selecting an appropriate broker that can meet the needs of its membership, Fenner said. FCU policies should contemplate and describe the overall features of the sales program and should identify the laws, regulations and other limitations and requirements, including qualitative considerations that will govern the selection and marketing of products a third-party broker may offer.
"The guidance is not intended to require FCUs to select, authorize or restrict each specific investment product that will be offered to its members; however, an FCU's policies should reflect a prudent analysis of the types of products that a broker may offer to its membership, including qualitative considerations," Fenner wrote.
NACUSO also expressed a concern that NCUA's guidance recommended FCUs maintain compliance programs, including a system that monitors member complaints, and periodically review and randomly sample member account activity to look for evidence of abuse. The association was worried it would require a credit union to act as a securities law compliance officer by inspecting investment accounts acting, which would be beyond the scope of credit unions' expertise.
Fenner said the intent of this recommendation is to ensure FCUs exercise prudent, independent oversight over the third-party brokerage arrangement to help protect their members from potential abuse.
"The guideline is not intended to impose an investigatory or policing role on FCUs nor to encourage FCUs to engage in inappropriate self-remedy," Fenner explained. "FCUs, however, should periodically and independently monitor member complaints and accounts for any signs of suspected abuse."
When conducting random samplings, for instance, red flags may include accounts with a high rate of investment turnover, those with complex investments that may be unsuitable for a member, or a combination of loan accounts and nondeposit investment accounts that might indicate a member borrowed large sums of money to finance nondeposit investments.
NACUSO said Fenner's letter is important because of the clarifications, among them that the NCUA is not requiring credit unions to approve specific investments, just the types of investments. However, the association has encouraged the regulator to continue to provide more clarity on not wanting credit unions to take over the compliance function from broker-dealers.
"[There] are concerns that some credit unions may interpret the letter in a manner where they assume some securities law compliance functions," wrote NACUSO President/CEO Jack Antonini along with the group's legislative and regulatory advocacy committee. ?