OTC Derivatives: Additional Oversight Could Reduce Costly Sales Practice Disputes
GGD-98-5
Published: Oct 02, 1997. Publicly Released: Oct 09, 1997.
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Highlights
Pursuant to a congressional request, GAO reviewed the sales practices for over-the-counter (OTC) derivatives, mortgage-backed securities (MBS), and structured notes, focusing on the: (1) federal sales practice requirements applicable to these products and the dealers marketing them; (2) extent of end-user satisfaction with sales practice, product use, and related disputes and the costs of these disputes; (3) views of end-users and dealers on the nature of their relationship and responsibilities; (4) actions dealers and end-users have taken to reduce the potential for sales practice disputes; and (5) actions regulators have taken to address sales practice issues.
Recommendations
Recommendations for Executive Action
| Agency Affected | Recommendation | Status |
|---|---|---|
| Department of the Treasury | The Secretary of the Treasury, as Chairman of the President's Working Group on Financial Markets, should ensure that the members of the Working Group establish a mechanism for systematically monitoring developments in the OTC derivatives markets to assess whether developments warrant introducing specific federal sales practice requirements. |
Closed – Not Implemented
According to Treasury Department officials that coordinate issues for the President's Working Group on Financial Markets, the majority of the Working Group members did not accept GAO's call for them to create a more formal mechanism for monitoring sales practice issues. Instead, they will address this issue on an as-needed basis.
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| Department of the Treasury | The Secretary of the Treasury, as Chairman of the President's Working Group on Financial Markets, should lead the members of the Working Group in considering the extent to which it should assist end-users and dealers in reaching agreement on the nature of their relationship in transactions involving OTC derivatives. |
Closed – Not Implemented
Although various regulatory or congressional actions are pending which may affect how dealers of OTC derivatives are regulated, these proposals do not generally change the nature of the sales practice responsibilities of these dealers. Since the time GAO made this recommendation, few additional disputes have arisen and the end-user community has not subsequently made calls for regulators to revise their approach to OTC derivative sales practice issues. The members of the President's Working Group on Financial Markets considered but chose not to take action regarding the status of dealer and end-user relationships.
|
| Board of Governors | The Chairman of the Federal Reserve Board should implement planned revisions to the Federal Reserve examination guidance, which are to more specifically address the need to assess the adequacy of banks' policies and controls related to disclosing risks, creating advisory relationships, and supervising marketing personnel. |
Closed – Implemented
In February 1998, the Federal Reserve issued the latest version of its "Trading and Capital Markets Activities Manual" that included additional detail. The new manual indicates that banks should have policies and controls to ensure that the counterparties they deal with adequately understand the risks of the transactions involved and that sales materials also accurately discuss such risks. It also indicates that banks should have policies that direct bank staff to avoid actions that create the appearance of advisory relationships with a counterparty where none is intended. The manual also discusses the need for banks to provide guidance and training to marketing personnel, have procedures and mechanisms to document analyses of transactions and disclosures to counterparties, and have internal controls to ensure ongoing adherence to disclosure and customer appropriateness policies and procedures. Examiners are directed to determine how compliance with sales practice policies are monitored by banks.
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| Commodity Futures Trading Commission | The Chairpersons, SEC and CFTC, should establish a mechanism for determining that participating firms are following the sales provisions of the Framework for Voluntary Oversight. |
Closed – Implemented
CFTC continues to be in dialogue with other regulators about the role that it plays regarding OTC derivatives, including regarding the applicability of any of its sales practice regulations. Since the report was issued, few additional disputes have arisen and the end-user community has not subsequently made calls for regulators to revise their approach to OTC derivative sales practice issues. However, Securities and Exchange Commission and CFTC officials have conducted discussions with dealer firms regarding their sales practices for OTC derivatives and intend to periodically address these issues with these firms in the future.
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| United States Securities and Exchange Commission | The Chairpersons, SEC and CFTC, should establish a mechanism for determining that participating firms are following the sales provisions of the Framework for Voluntary Oversight. |
Closed – Implemented
Since the report was issued, few additional disputes have arisen and the end-user community has not subsequently made calls for regulators to revise their approach to OTC derivative sales practice issues. SEC has approved rules that will allow securities firms currently conducting OTC derivatives in unregulated affiliates to register with the agency. These firms' activities would thus be subject to a modified form of SEC regulation, including reporting and capital requirements, although any activities involving non-securities OTC derivatives would continue to remain outside of the sales practice portions of the securities regulations. However, SEC and Commodity Futures Trading Commission officials have conducted discussions with dealer firms regarding their sales practices for OTC derivatives and intend to periodically address these issues with these firms in the future.
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Banking regulationDerivative securitiesFuturesInformation disclosureInteragency relationsLossesMortgage-backed securitiesSecurities arbitrationSecurities fraudSecurities regulation