UNITED STATES OF AMERICA Before the SECURITIES AND EXCHANGE COMMISSION SECURITIES ACT OF 1933 Release No. 7532 / May 4, 1998 SECURITIES EXCHANGE ACT OF 1934 Release No. 39947 / May 4, 1998 ADMINISTRATIVE PROCEEDING File No. 3- 9596 In the Matter of : : ORDER INSTITUTING CEASE-AND- NATIONSSECURITIES : DESIST PROCEEDINGS PURSUANT TO and : SECTION 8A OF THE SECURITIES NATIONSBANK, N.A. : ACT OF 1933 AND SECTIONS:15(b)(4) AND : 21C OF THE SECURITIES EXCHANGE ACT OF Respondents. : 1934 AND FINDINGS AND : ORDER OF THE COMMISSION : : I. The Commission deems it appropriate and in the public interest to initiate public administrative proceedings pursuant to Section 8A of the Securities Act of 1933 ("Securities Act") and Sections 15(b)(4) and 21C of the Securities Exchange Act of 1934 ("Exchange Act") against NationsSecurities and NationsBank, N.A. ("NationsBank") (collectively, the "respondents"). In anticipation of the institution of these proceedings, the respondents have submitted Offers of Settlement ("Offers") for the purpose of disposing of the issues raised by these proceedings. Solely for the purpose of these proceedings and any other proceeding brought by or on behalf of the Commission or to which the Commission is a party, and prior to a hearing pursuant to the Commission's Rules of Practice, the respondents, without admitting or denying the matters set forth herein, consent to the issuance of this Order Instituting Cease-and-Desist Proceedings Pursuant to Section 8A of the Securities Act of 1933 and Sections 15(b)(4) and 21C of the Securities Exchange Act of 1934 and Findings and Order of the Commission ("Order") as set forth below. The Commission has determined that it is appropriate and in the public interest to accept the respondents' Offers and accordingly is issuing this Order. II. FACTS On the basis of this Order and NationsSecurities' and NationsBank's Offers of Settlement, the Commission finds[1] the following: A.Respondents NationsSecurities, a broker-dealer registered with the Commission, commenced operations on June 7, 1993, as a joint venture between operating subsidiaries of Dean Witter and NationsBank. Dean Witter's interest in the joint venture was purchased by a subsidiary of NationsBank on November 15, 1994. NationsBank is an indirect subsidiary of NationsBank Corporation, a North Carolina corporation which has common stock registered with the Commission pursuant to Section 12(b) of the Exchange Act and is listed on the New York Stock Exchange ("NYSE"). NationsBank Corporation is a bank holding company registered under the Bank Holding Company Act of 1956, with its principal assets being the stock of its subsidiaries. NationsBank is the successor entity of a group of affiliated banks located in, inter alia, North Carolina, Florida, Georgia, South Carolina, Virginia, Maryland and the District of Columbia. [2] NationsSecurities registered representatives were placed in many of NationsBank's 2,000 retail banking centers. NationsBank of North Carolina, N.A. was the investment adviser for two closed-end bond funds called Term Trusts. B.Summary This matter concerns flaws in the operation and sales activities of NationsSecurities and NationsBank, relating to two closed-end bond funds, called Term Trusts. Some of NationsSecurities' registered representatives used materially false and misleading sales practices, including mischaracterizing the Term Trusts as straightforward U.S. Government bond funds, when, in fact, they were highly leveraged and invested in interest-rate-sensitive derivatives. These NationsSecurities registered representatives received such information from some of their supervisors at the broker-dealer, the National Sales Manager ("Sales Manager") for the family of funds then advised by NationsBank, and wholesalers employed by Stephens, Inc., the underwriter for the Term Trusts. NationsBank failed to implement adequate measures to avoid the potential for customer confusion inherent in the operation of a broker-dealer on the premises of a bank. Some employees of NationsBank and NationsSecurities engaged in marketing and sales practices that blurred the distinction between the bank and the broker-dealer and their respective products. The combination of improper sales practices and practices that blurred the distinction between the bank and the broker dealer and their respective products culminated in unsuitable purchases by investors. NationsSecurities and NationsBank have offered to settle this matter by consenting to the entry of an administrative order finding that: NationsSecurities violated Section 17(a) of the Securities Act and Section 10(b) of the Exchange Act and Rule 10b-5 thereunder, and that NationsSecurities failed reasonably to supervise registered representatives, including their interactions with the Sales Manager and the wholesalers, and requiring payment of a civil penalty in the amount of $4 million;[3] and NationsBank was a cause of NationsSecurities' violations of Section 17(a)(2) and (3) of the Securities Act. C.Background 1.Creation Of NationsSecurities NationsSecurities began operations on June 7, 1993, as a joint venture between NationsBank and Dean Witter. NationsBank obtained permission from the OCC to create a new operating subsidiary that would serve as Dean Witter's partner in the joint venture. This permission was conveyed in April of 1993 in the form of OCC Interpretive Letter 622. The Interpretive Letter required the bank to provide appropriate disclosures to customers concerning the nature of the products being sold and the relationship of the involved entities to the products. Soon after NationsSecurities began operations, the OCC issued Banking Circular 274 to provide guidance to all national banks concerning the sale of investment products on bank premises. This circular described the procedural protections that banks would have to develop to keep customers fully informed as to the nature of non- deposit retail investments. For example, the circular addressed procedures to: protect against the blurring of bank and brokerage products; ensure suitable investments for the customer; ensure that compensation programs do not operate as an incentive for salespeople to sell retail non-deposit investment products over more suitable investment alternatives; and ensure that bank and non-bank activities are separate. 2.Creation Of The Term Trusts NationsSecurities' management asked NationsBank of North Carolina, N.A. to design term trust products for NationsSecurities to offer to NationsBank customers. Following this request, portfolio managers at NationsBank created Nations Government Income Term Trust 2003 ("Term Trust 2003") and, later, Nations Government Income Term Trust 2004 ("Term Trust 2004") (collectively the "Term Trusts"). The Term Trusts were designed to generate, at least in their early years, competitive yields of between 1% and 1.5% above the yield on then-issued ten year Treasury notes, and to return their full $10 per share investment at the end of their ten year term. While the Term Trusts were comprised to some extent of traditional government securities, they also included less conservative components intended to help the funds achieve their income and yield goals. The Term Trusts had the ability to invest up to 40% of their net assets in inverse floaters and to use leverage of up to 33% of their net assets, to hedge against interest rate changes and to produce the premium yield. The leverage created by these components helped make the net asset values of the Term Trusts highly sensitive to changes in interest rates. [4] NationsSecurities made Term Trusts 2003 and 2004 its first two "focus products." Wholesalers made presentations to NationsSecurities registered representatives on how to sell the Term Trusts, and monetary incentive programs were offered to registered representatives for sales of the Term Trusts. Between August and September 1993, NationsSecurities offered the Term Trust 2003; Term Trust 2004 was offered during January and February 1994. 3.The Sales Effort For The Term Trusts NationsBank arranged for the Term Trusts to retain Stephens, the underwriter, as its master selling agent for the sale of the Term Trusts. NationsSecurities and Stephens were responsible for generating sales of these products. Four Stephens wholesalers made presentations to the NationsSecurities registered representatives who would be selling the Term Trusts, and Stephens assigned one of its vice presidents to supervise the wholesalers. The Sales Manager assumed significant involvement in the promotion of the Term Trusts. The Sales Manager, who was involved with the Term Trusts at an early stage, provided information and sales instruction to the NationsSecurities registered representatives and educated the Stephens wholesalers concerning the products. He also coordinated the promotional efforts of the Stephens wholesalers, and had significant input in how they performed their assignments. NationsSecurities considered the Term Trusts sales effort a success: 16,682,139 shares of Term Trust 2003 were sold during the August and September 1993 offering period for total proceeds of $166,821,390. The shares were sold primarily by NationsSecurities registered representatives, which resulted in approximately $9,175,176.40 in sales concessions and fees that were shared by NationsSecurities and Stephens. Term Trust 2004 sold 13,748,939 shares during its offering period of January and February 1994 for total proceeds of $137,489,390. Term Trust 2004 sales generated approximately $7,561,916.40 in combined sales concessions and fees for NationsSecurities and Stephens. NationsBank was entitled to receive advisory and administrative fees for its participation with the Term Trusts. NationsBank has waived its advisory and administrative fees during the period from June 1995 through the present. Shares of both Term Trusts were sold to investors for $10 per share in the initial public offerings ("IPO"). In 1994, significant interest rate increases adversely affected the net asset value of the Term Trusts' portfolios. By November 18, 1994, Term Trust 2003 had fallen to a low of $6 per share on the NYSE, primarily due to rising interest rates. Similarly, by November 14, 1994, Term Trust 2004 had fallen to a low of $6.50 per share. This drop in share value generated a large number of complaints from investors who complained that they had not been informed by their registered representatives, at the time they purchased the Term Trusts, that their investments were sensitive to interest rate changes, and were uninsured. Both Term Trusts are currently trading in the range of $8.65625 per share, with a net asset value in the range of $9.74 per share. [5] D.Materially False And Misleading Sales Practices Culminated in Unsuitable Purchases of the Term Trusts 1.NationsSecurities' Marketing Program Contributed To Unsuitable Purchases of the Term Trusts Registered representatives were encouraged to, and did, solicit customers, who had formerly invested in certificates of deposit ("CDs"), to be investors in the Term Trusts. For example, during a taped conference call in which branch managers participated, a registered representative stated that, "I have developed a pretty successful referral program here in NationsBank with the CD folks." Another registered representative stated that, "[O]ne of the first questions I ask [customers] is do they invest in anything other than CDs. If they say no, they are a 2004 term trust candidate." For many of the former CD investors, however, the Term Trusts were unsuitable investments. [6] Many CD investors seek absolute safety of principal and thus sacrifice rate of return to obtain this security. In contrast, an investor in the Term Trusts was subject to a high degree of risk resulting from the Trusts' extreme sensitivity to interest rate changes, as well as the risk that shares of the Term Trusts would trade at a discount to their net asset values. Many closed-end funds frequently trade at a significant discount to their net asset values. An investor in the trusts also was subject to the additional risks resulting from the Term Trusts' investments in derivatives. Thus, there was a limited possibility that an investor in the Term Trusts not interested in holding until maturity could achieve full return of principal by selling into the secondary market given the likelihood that the funds, like most closed-end bond funds, would trade at a discount to their net asset value. The age, financial position and investment objectives of many of the investors made the Term Trusts an unsuitable investment. NationsBank assisted registered representatives in the sale of the Term Trusts by giving the representatives maturing CD lists. This provided the registered representatives with lists of likely prospective clients. Registered representatives also received other NationsBank customer information, such as financial statements and account balances. These NationsBank customers, many of whom had never invested in anything other than CDs, were often not informed by their NationsSecurities registered representatives of the risks of the Term Trusts that were being recommended to them. Some of the investors were told that the Term Trusts were as safe as CDs but better because they paid more. Registered representatives also received incentives for their sale of the Term Trusts. Under the NationsSecurities compensation structure, registered representatives received higher commissions for selling proprietary funds such as the Term Trusts than for selling non-proprietary funds, stocks or bonds. Some registered representatives felt they had to sell proprietary funds to make a living at NationsSecurities. [7] NationsSecurities also used sales contests as a way to encourage registered representatives to sell the Term Trusts. [8] NationsSecurities and NationsBank also adopted an improper referral fee system that entitled bank employees to receive incentives in the form of fees for customer referrals to NationsSecurities. Under this program, NationsSecurities paid NationsBank five percent of NationsSecurities' gross commission for making referrals to NationsSecurities. NationsBank then paid the referring bank employee. The payment was conditioned on closing a sale of securities and was proportional to the size of the sale. In some instances, bank employees substantially increased their monthly compensation during this period by making referrals to NationsSecurities. These payments to bank employees were contrary to the guidance provided by the OCC which states that bank employees could only receive payment in exchange for referrals that are nominal in nature and not based on a completed sale. 2.Materially False And Misleading Statements a.The Risks Of The Term Trusts Were Not Disclosed NationsSecurities' and NationsBank's marketing efforts involved the dissemination of materially false and misleading statements in connection with the offer and sale of the Term Trusts. As a result, some of the registered representatives gave customers misleading information concerning such material facts as the composition of the Term Trusts, risks associated with the Term Trusts, and the stability of the Term Trusts as an investment. This misinformation was disseminated to NationsSecurities registered representatives during conference calls and meetings, as well as through the circulation of several sales scripts. [9] NationsSecurities' sales representatives attended presentations during which they were told that the Term Trusts were safe investments because they were backed by the U.S. Government. Representatives were also falsely told that NationsBank would not allow its customers to lose principal. On a number of occasions, the Sales Manager held up a picture of the Term Trust 2003 brochure which contained a picture of the U.S. Capitol Building on it, and said that NationsBank stated that "if the Capitol is standing in 10 years, these people [investors] will get their money back." Some of the registered representatives were also told that the Term Trusts were as safe as CDs or were "guaranteed" to return an investor's $10 share price at the end of the ten year term. The Sales Manager misrepresented the suitability of the Term Trusts during his sales presentations, stating they were suitable for everyone. These misrepresentations were repeated by some NationsSecurities branch managers and wholesalers. For example, registered representatives were told that the Term Trusts were safe, had low risk and low volatility, and were suitable for everyone, even elderly people. The Sales Manager also understated the risks of an investment in the Term Trusts, and rather than discuss the use of derivatives and leverage in the Trusts, he emphasized the high returns that investors could expect. Some registered representatives were told that the 2003 was a "plain vanilla" product. The Stephens wholesalers made similar misrepresentations in several of their presentations to the NationsSecurities registered representatives. During at least two presentations, registered representatives were told that the Term Trust 2004 was "guaranteed" to return $10 in ten years. One wholesaler also instructed registered representatives to work around the question regarding FDIC insurance by not answering it directly and focusing instead on the issue of safety. In addition, the Term Trust was described misleadingly as an "alternative to a certificate of deposit for conservative bank customers." NationsSecurities also disseminated information concerning the Term Trusts through sales scripts designed for registered representatives to use during "call nights." [10] One script emphasized the safety and predictability of the Term Trust but failed to disclose any risks. [11] A document that a NationsSecurities senior manager ("Senior Manager") distributed to the firm's branch managers recommended that registered representatives use the phrase "SPR" which stood for "safety, predictability and return" in reference to the Term Trusts. A sales script used at call nights in the Metro District of Columbia region stated that the Term Trust 2003 provided "certainty in an uncertain world -- return of $10 in 10 years." b.Other Misrepresentations Concerning The Term Trusts NationsSecurities' and NationsBank's marketing efforts involved the dissemination of a variety of other misrepresentations to investors concerning the Term Trusts. Some NationsSecurities registered representatives were instructed to tell investors that because the Term Trusts were designed to return the entire $10 investment in ten years, in effect there were no commissions on the Term Trusts. This misrepresentation, in a slightly different form, was used in some of the Term Trust sales scripts. Such statements omitted the fact that there was a 5.5% sales concession built into the $10 share price. NationsSecurities' registered representatives also were encouraged to make statements creating a false sense of urgency concerning an investor's purchase of the Term Trusts. E.Blurring The Distinction Between The Bank And The Broker-Dealer And Their Respective Products NationsBank and NationsSecurities engaged in practices that "blurred" the differences between the bank and the broker-dealer and between the FDIC-insured products sold by bank employees and riskier investment products sold by NationsSecurities registered representatives. Registered representatives were told by NationsSecurities' senior management, the Sales Manager and the wholesalers during orientation and subsequent meetings that bankers were trusted more than brokers and they should use their location in the bank to build on that trust. The sales scripts also blurred the distinction between the bank and the broker-dealer and their respective products. The Branch Manager's misleading sales document advised registered representatives to tell potential customers that the Term Trust 2004 was an "account managed by [the] NationsBank Trust Department. Managed $ since 1894." It stated that you used to have to be Texas A&M or have the wealth of Ross Perot to get access to this quality of management but, now, "NationsBank has made this expertise available to you, our retail customers." As one registered representative stated, "[t]he thrust of the [document] was to convince the customer that because the Term Trust was managed by NationsBank, he or she could trust the investment as being safe." The Branch Manager also encouraged registered representatives to "use fear to sell" securities. According to a registered representative's notes from an orientation meeting, the Branch Manager suggested that representatives could ask customers: "Is this your risky money or safe money - if this is risky I know a guy at Merrill or Dean Witter." This recommended approach falsely implied that securities purchased at a bank were somehow safer than securities purchased at a brokerage. NationsSecurities encouraged its representatives during orientation sessions to make every effort to blend into the bank and to become "a face at the bank." [12] Some NationsSecurities registered representatives sat at desks in NationsBank banking centers next to bank employees with no signage or other physical demarcation indicating they were NationsSecurities employees, or that the products they sold were not FDIC insured. NationsBank's practice of providing maturing CD lists to NationsSecurities representatives also created the risk of confusion that the representatives were employees of the bank when contacting potential investors. It was reasonable for customers to assume that these people calling "from the bank" with bank information were bank employees. NationsSecurities also marketed the securities in a manner that blurred the distinction between NationsSecurities and NationsBank. For example, Term Trust 2003 was announced by NationsBank through a mass mailing to approximately one million of its customers. A similar NationsBank mailing was sent to approximately 500,000 of its customers for the Term Trust 2004 offering. The NationsBank mailing was made in envelopes bearing the official NationsBank logo and colors, much like envelopes used to convey bank notices. Indeed, the Term Trusts' marketing brochures and pamphlets that NationsSecurities registered representatives distributed included pictures of an American flag that used the same red, white and blue colors as NationsBank's color scheme. Further, NationsSecurities told registered representatives that "[a] letter about [NationsSecurities] will often have more credibility with a bank customer if it goes out on NationsBank letterhead under a bank employee's signature." On some occasions, NationsBank employees sent out letters introducing the NationsSecurities registered representative in their branch by name and explaining some of the products the registered representative could offer them. Contrary to written bank policies, at times NationsBank employees sent these letters on letterhead containing the "Member FDIC" legend. NationsBank employees also occasionally mailed letters to bank customers using NationsSecurities letterhead, despite the fact that NationsSecurities registered representatives were instructed to prevent such an occurrence. NationsSecurities' and NationsBank's advertising materials also contributed to the blurring. Early NationsSecurities posters that appeared in NationsBank banking centers contained the slogans, "Invest in Tomorrow Where You Bank Today," and "Introducing the Investment Firm You Can Bank On." The NASD told NationsSecurities to remove these posters due to the possibility of confusion, and NationsSecurities complied. Finally, NationsSecurities trained its registered representatives to use the terminology commonly used by bank employees to downplay the differences between the two organizations. The Sales Manager, the wholesalers, and the Branch Manager encouraged registered representatives to avoid using brokerage firm terms. For example, some NationsSecurities registered representatives were trained to refer to shares in the Term Trusts as "accounts" or "accounts at the bank" rather than as mutual funds or securities. Some registered representatives also were taught to refer to NationsSecurities as the "investment division" of NationsBank and to tell NationsBank customers they were calling "from the bank." NationsSecurities registered representatives also were called "Investment Officers" rather than brokers or account executives. [13] The Sales Manager favored the use of bank language because it would make a bank customer more comfortable, although he also conceded that he would not have instructed registered representatives at a stand-alone non-bank broker-dealer office to use the same terminology. Indeed, the Sales Manager dictated a sales script to a Tampa registered representative that told the representative to use blurring language, including such statements as "[I'm] [c]alling from NationsBank branch. I'm with NationsSecurities which is the bank's investment division . . . [D]o you have a relationship w/us here at NationsBank? . . . If we had a higher return than [Bank X] or any other bank in town[,] wh[at] type of asset would you have available over the next 3 weeks to place in this account?" According to the Sales Manager, avoiding investment "lingo" would be helpful to bank customers because they would find bank terminology more familiar and thus "less alarming" than investment terminology. This blurring conduct, taken together, created an atmosphere in which a bank customer could conclude that the NationsSecurities registered representative was a bank employee and that, therefore, the product purchased was a bank product. Indeed, numerous investor complaints reflect the belief that they were buying a bank product or that the NationsSecurities registered representative was a bank employee. **FOOTNOTES** [1]: The findings herein are solely for the purpose of these proceedings and are not binding on any other person in this or any other proceeding. [2]: This Order also applies to all other federally chartered banks affiliated with NationsBank, N.A., including NationsBank of Texas, N.A., NationsBank of Tennessee, N.A., and NationsBank of Kentucky, N.A. [3]: Simultaneous with the issuance of this Order, the National Association of Securities Dealers Regulation, Inc. ("NASDR") issued a settled order in the following matter: Letter of Acceptance, Waiver and Consent, NationsSecurities, Charles King, Daniel Wroble and Jamie Atkinson, CAF980020 (May 4, 1998) (the NASDR alleges that NationsSecurities violated NASD Conduct Rules, Section 10(b) of the Exchange Act and Rule 10b-5; the NASDR also alleges that King, Atkinson and Wroble violated NASD Conduct Rules. Without admitting or denying the allegations, NationsSecurities consented to a censure, certain undertakings with respect to sales scripts and advertising, and payment of a $2 million fine; King, Atkinson and Wroble each consented to a censure, fines of $50,000, $35,000 and $100,000 respectively, and varying suspensions). In addition, the Office of the Comptroller of the Currency ("OCC") issued settled orders in the following matters: In the Matter of NationsBank, N.A., OCC Stipulation and Consent Order (May 4, 1998) (the OCC found that NationsBank violated a condition in an OCC Approval Letter and thereby failed to adhere to an OCC Banking Circular which provided guidance to all national banks concerning the sale and marketing of investment products on bank premises). Without admitting or denying the charges, NationsBank consented to pay a civil money penalty of $750,000. The OCC also issued an Order pursuant to 12 U.S.C. 1818(b) against Wroble and obtained Commitment Letters from King and Atkinson. The Order and Commitment Letters provide that all three shall not participate in any securities sales activities at any insured depository institution during the period of each individual's NASDR suspension. [4]: The leverage in the Term Trusts was accomplished by using certain derivative securities such as dollar rolls and inverse floaters. [5]: The current share price reflects NationsSecurities and NationsBank's infusion of $20 million into the Term Trusts as the result of a settlement in a class action lawsuit filed in January 1995. As part of that settlement, NationsBank Corporation also paid $4 million to compensate investors who realized losses on sales of the Term Trusts. [6]: Many Term Trust investors were elderly: sixty-five percent of the 13,316 investors were over sixty years old, thirty-six percent were over seventy years old, and eleven percent were over eighty years old. The reported annual incomes of Term Trust investors similarly indicate that many Term Trust investments may have been unsuitable. For example, eighty-one percent of the investors had annual incomes of less than $50,000, forty-seven percent had annual incomes of less than $25,000, and nineteen percent had annual incomes of $15,000 or less. Although factors such as an individual's entire portfolio, investment objectives, financial sophistication, and risk tolerance are also relevant to determining suitability, the age and income of the investors here should have raised suitability concerns. [7]: A NationsSecurities branch manager ("Branch Manager") instructed registered representatives to recommend the Term Trust 2004 during its offering period over the Term Trust 2003, which was trading at a discount on the market and was arguably a better deal for customers. The stated reason for this was because the registered representatives would make more money. [8]: NationsSecurities provided training to NationsBank employees concerning its products and services, which in some cases resulted in non-registered bank employees making improper sales presentations to customers. [9]: The Sales Manager also discouraged the use of prospectuses in connection with sales of the Term Trusts. Registered representatives were told that the prospectus is useful if you are having "trouble falling asleep," and that selling with a prospectus is like asking people who are about to fly to sign a waiver saying that they may crash. [10]: A "call night" was an evening on which a group of NationsSecurities registered representatives called prospective investors from the hub, usually with a wholesaler present. [11]: This script also instructed registered representatives to respond to customers' concerns that a ten year investment was too long by stressing the liquidity of the Term Trust as a result of its trading on the NYSE. The script did not disclose that the price obtainable on the NYSE might well be less than the original purchase price. [12]: A registered representative stated that a NationsSecurities manager had told him that people would think he was a bank employee because "if it walks like a duck and quacks like a duck, then it's probably a duck." [13]: In December 1993, the NASD directed NationsSecurities to stop using this title for their registered representatives because of the possibility of customer confusion. F.NationsSecurities' Failure To Supervise NationsSecurities adopted a "hub and spoke" organizational structure and a supervisory and compliance system based on Dean Witter's policies and procedures. Under the hub and spoke structure, supervisors worked in hubs while the registered representatives worked in spokes located in many of the over 2,000 individual NationsBank banking centers scattered throughout the surrounding area. The branch managers, who were located in the hubs, supervised anywhere from fifteen to thirty registered representatives who were located in the surrounding spokes. [14] The spokes were frequently located in remote areas miles from the hub. These features of the hub and spoke system increased the need for more centralized and focused supervisory and compliance systems. Although the supervisory system, as implemented at NationsSecurities, may have been suitable for a traditional brokerage firm, it was not, under these circumstances, reasonably designed to detect and prevent improper sales practices. 1.Blurring NationsSecurities' practices and procedures to prevent blurring were inadequate to prevent investor confusion between bank products and the Term Trusts. Although the firm's manuals identified such appropriate disclosures as products "are not FDIC insured" and "are not obligations of the bank," NationsSecurities did not always adequately differentiate its employees from NationsBank employees and the Term Trusts from insured bank products. The requirement of annual visits by branch managers to spoke offices was inadequate to assure that effective anti- blurring measures were in place. 2.Improper Sales Practices NationsSecurities' supervisory and compliance system was inadequate to provide timely detection or prevention of improper sales practices. NationsSecurities required only annual visits by its branch managers to each spoke office. This decentralized and infrequent system of review failed to deter adequately improper sales practices by some individual representatives. The use of two hundred inexperienced representatives in spoke offices increased the potential for improper sales practices. There also was no effective mechanism in place to supervise the interactions of the registered representatives with the Sales Manager and the wholesalers. 3.Suitability NationsSecurities' supervisory and compliance systems were inadequate to prevent unsuitable sales. In many cases, NationsSecurities failed to collect sufficient data on customer risk tolerance and investment horizon or failed to properly utilize the information that had been received. Although management was aware of the suitability risks of price volatile proprietary closed-end funds, such as the Term Trusts, the broker-dealer failed to create controls to ensure suitability. In addition, NationsSecurities failed to maintain in a readily accessible fashion detailed and current customer information which made it difficult for branch managers to supervise adequately suitability determinations made by registered representatives at the spoke locations. Further, NationsSecurities' supervisory and compliance systems failed to create an adequate suitability review for new accounts. Under the hub and spoke system, personnel at headquarters in Charlotte reviewed the new accounts for completeness and approved the trade based on that review alone. Although the branch manager was required to sign off on the new account form and trade ticket, this procedure was not completed until after the trade had already been approved by the person in Charlotte. The practical result of this system was that the branch manager frequently did not question the suitability of initial trades. III. OPINION A.NationsSecurities Violated Section 17(a) Of The Securities Act, Section 10(b) Of The Exchange Act And Rule 10b-5 Thereunder As described above, NationsSecurities engaged in false and misleading sales practices with regard to its sales of the Term Trusts. Sales of the Term Trusts were made to NationsBank customers, many of whom had typically invested in CDs. For some of the investors -- particularly those who sought or needed preservation of principal, a guaranteed return, or a short-term investment -- the Term Trusts were unsuitable. Such investments were unsuitable, in large part, because the Term Trusts' leverage and sensitivity to interest rates were incompatible with such investors' risk tolerance and investment goals. Materially false and misleading information about the Term Trusts was disseminated to the NationsSecurities registered representatives by the Sales Manager, the wholesalers, and by some of NationsSecurities' managers, both verbally and through distribution of sales scripts. This information concerning the safety and suitability of the Term Trusts was, in turn, conveyed to many investors. The blurring practices contributed to customer confusion regarding the distinction between insured bank products and uninsured securities products. These statements and practices were material because they obscured facts concerning the safety and suitability of the Term Trusts that would have played a significant role in a reasonable person's investment decision. NationsSecurities acted with reckless disregard that such deceptive conduct was likely to occur. Accordingly, NationsSecurities violated Section 17(a) of the Securities Act, Section 10(b) of the Exchange Act and Rule 10b-5 thereunder. B.NationsSecurities Failed Reasonably To Supervise The Registered Representatives As described above, NationsSecurities' decentralized supervisory and compliance system allowed blurring, improper sales practices, and unsuitable sales to go undetected and largely undeterred. NationsSecurities' supervision of the "spoke" offices was inadequate. The hub and spoke structure, although not inherently flawed, did require diligent, focused supervision and adequate centralized control to detect and deter improper practices. [15] The fact that a significant portion of the NationsSecurities' sales force was composed of inexperienced representatives underscored the broker-dealer's need for enhanced supervisory control and effective compliance. [16] NationsSecurities failed to address effectively the need for adequate supervision. NationsSecurities' controls were inadequate to prevent unsuitable sales. Although NationsSecurities installed a computer system capable of collecting basic customer information, that information often was not readily accessible and therefore was essentially unavailable for suitability analysis. Further, some branch managers failed adequately to question registered representatives about suitability. Failure to supervise violations frequently follow upon the existence of "red flags" that should have put the broker-dealer on notice of underlying problems. In this case, however, the absence of such warnings reflects the inability of NationsSecurities to detect the unsuitable trades in the Term Trusts that resulted from improper sales practices. The Commission has recognized that the inadequacy of a broker- dealer's supervisory system may preclude the appearance of red flags: While the presence of `red flags' warning of possible irregularities may often be an aggravating factor, the absence of such warning signs is not a defense where the gravamen of the supervisory deficiency is a failure to have reasonable procedures. [17] C.NationsSecurities' Failure Reasonably To Supervise The Registered Representatives Extended To Their Interactions With The Sales Manager And The Wholesalers NationsSecurities had responsibility for ensuring that its registered representatives were properly trained and informed. NationsSecurities failed to take appropriate steps to ensure that the presentations made by the Sales Manager and the wholesalers did not contain materially false and misleading information. NationsSecurities could have taken such steps because the conduct at issue occurred at NationsSecurities' offices, at meetings sponsored by NationsSecurities, or on telephone conference calls conducted for the benefit of NationsSecurities registered representatives. All of these meetings and calls were arranged by NationsSecurities employees. Furthermore, when such meetings occurred, some NationsSecurities' branch managers did not take adequate steps to limit the conduct of the Sales Manager and the wholesalers as they interacted with NationsSecurities employees. D.Violations By NationsBank NationsBank employees engaged in activities that blurred the distinction between the bank and the brokerage firm and their respective products. Although certain of these practices were not, per se, illegal, taken together and in conjunction with the false and misleading sales practices described herein, they contributed to customer confusion and unsuitable securities purchases. The referral fee program helped to blur the distinction between the bank and the brokerage by encouraging bank employees to discuss specific securities products with bank customers. In some instances, NationsBank allowed NationsSecurities' registered representatives to sit at desks in bank lobbies without signs or other demarcations distinguishing them from the bank; mailed marketing materials in envelopes that appeared to enclose bank notices; directed bank employees to send letters to customers introducing the registered representatives; permitted bank employees to make improper sales presentations to customers; and provided registered representatives with bank- account information to use in making sales calls. In addition, the Sales Manager and the wholesalers he trained made materially false and misleading statements to the NationsSecurities registered representatives regarding the Term Trusts and encouraged the representatives to engage in blurring and misleading sales practices. Accordingly, NationsBank contributed to and therefore was a cause of NationsSecurities' violations of Section 17(a)(2) and (3) of the Securities Act. E.Conclusion With the marked increase in the involvement of financial institutions in securities activities, there is a corresponding increase in the risk that some investors may be unaware of the distinction between bank products and securities products. Brokerage and financial institutions must be acutely sensitive to the potential for customer confusion inherent in the operation of a broker-dealer on the premises of a bank. Because the very nature of a brokerage firm operating in a bank environment poses a risk of investor confusion, broker-dealers in this situation must implement adequate protective measures to ensure suitability and detect and deter improper sales practices. Likewise, financial institutions with broker-dealer affiliates in situations similar to that described here, must ensure adequate separation of the banking and brokerage activities to avoid blurring and to prevent improper sales practices. IV. FINDINGS Based on the above, the Commission finds that NationsSecurities[18] willfully violated Section 17(a) of the Securities Act and Section 10(b) of the Exchange Act and Rule 10b-5 thereunder and failed reasonably to supervise its registered representatives within the meaning of Section 15(b)(4)(E) of the Exchange Act; and that NationsBank was a cause of NationsSecurities' violations of Section 17(a)(2) and (3) of the Securities Act. V. OFFERS OF SETTLEMENT NationsSecurities and NationsBank have submitted settlement offers in this proceeding which the Commission has determined to accept. NationsSecurities, in its Offer, consents to this Order making findings, as set forth above, and ordering NationsSecurities to cease and desist from committing or causing violations of Section 17(a) of the Securities Act, and Section 10(b) of the Exchange Act and Rule 10b-5 thereunder, and directing payment of a civil monetary penalty of $4 million. NationsBank, in its Offer, consents to this Order making findings, as set forth above, and ordering NationsBank to cease and desist from committing or causing violations of Section 17(a)(2) and (3) of the Securities Act. VI. ORDER Accordingly, IT IS HEREBY ORDERED, pursuant to Sections 8A of the Securities Act and Sections 15(b)(4) and 21C of the Exchange Act, that: 1.NationsSecurities be, and hereby is, censured; 2.NationsSecurities cease and desist from committing or causing any violation of, and committing or causing any future violation of Section 17(a) of the Securities Act and Section 10(b) of the Exchange Act and Exchange Act Rule 10b-5; 3.NationsSecurities pay a civil penalty in the amount of $4 million pursuant to Section 21B of the Exchange Act; and 4.NationsBank cease and desist from committing or causing any violation of, and committing or causing any future violation of Section 17(a)(2) and (3) of the Securities Act. By the Commission. Jonathan G. Katz Secretary **FOOTNOTES** [14]: As of June 1994, NationsSecurities had approximately 25 hubs and 607 spokes throughout the southeastern United States. [15]: In In re Royal Alliance Associates, Inc., Sec. Exch. Act. Rel. No. 38174, 1997 SEC Lexis 113 (Jan. 15, 1997), the Commission stated that where representatives work alone in offices without the physical presence of managers, "firms organized in such a fashion, and individual supervisors at those firms, [must] meet the same high standards of supervision as at more traditionally organized firms." The Commission also has emphasized that the need for central control increases as branch offices become more numerous, dispersed and distant. See, e.g., In re Dickinson, Sec. Exch. Act Rel. No. 36338, 1995 SEC Lexis 2665 (Oct. 5, 1995) (citing Shearson, Hamill & Co., Sec. Exch. Act Rel. No. 7743, 42 SEC 811, 843 (1965)); In re Grayson, Sec. Exch. Act Rel. No. 33298, 1993 SEC Lexis 3403 at *8 (Dec. 8, 1993) at *10 (citing In re Parodi, Sec. Exch. Act Rel. No. 27299, 44 SEC Docket 1337, 1346 (Sept. 27, 1989)). [16]: See In re GKN Securities Corp., Sec. Exch. Act Rel. No. 38173, 1997 SEC Lexis 111 at *8 (Jan. 15, 1997) (the Commission stated that "there is a particularly strong and obvious need" for adequate supervisory and compliance systems where a broker-dealer has hired relatively inexperienced sales representatives); accord Grayson at *10 (citation omitted). [17]: In re Giordano, Sec. Exch. Act Rel. No. 36742, 1996 SEC Lexis 71 at *12 (Jan. 19, 1996) (citing In re Chambers, Sec. Exch. Act Rel. No. 27963, 46 SEC Docket 200 (Apr. 30, 1990); In re Blinder, Robinson & Co., Sec. Exch. Act Rel. No. 19057, 26 SEC Docket 238 (Sept. 17, 1982). The Commission reiterated this position in Royal Alliance, 1997 SEC Lexis 113 at *14 (Jan. 15, 1997). [18]: Since the activities described herein, NationsSecurities was acquired by NationsBanc Investments, Inc. The findings and sanctions contained herein apply to NationsBanc Investments, Inc. and to any future successor entity.