Legal Bulletins

Given some of the recent events that have buffeted the financial services industry, the competition for solid and profitable long-term customer relationships is more intense than ever. Attracting customers – and customer loyalty - is hard work. One popular bank marketing officer’s tool in meeting this goal is the time-honored tradition of the sales promotion. These events are designed to attract customers, highlight a new branch opening or just raise an institution’s profile in the community. Sales promotions take various forms, including bonuses, contests, sweepstakes and giveaways. The effort can be very successful, however, it’s important to consider all of the relevant legal and regulatory issues involved in any promotion to ensure that your “feel good” event does not result in unwanted legal, regulatory or reputational costs.

There are various federal banking laws, U.S. Postal Service mailing regulations and state laws governing lotteries and gifts and prizes that cover these types of events, so doing your homework is important. State laws in these areas typically are not subject to federal preemption for federally chartered entities because they do not purport to regulate the underlying business. Rather, these laws were enacted long ago to regulate against the perceived social evils of gambling and other vices. In addition, sweepstakes and other prize contests are the frequent source of consumer complaints and the penalties for violating the various laws can be significant.

Avoiding the Lottery Pitfall

Before launching your next promotion event, you should determine what kind of event it will be, and how it will advertised and marketed. Legal and compliance professionals should be included at the planning stage to insure that that all applicable laws and regulations are identified and the contest rules are written to be legal.

Certain contests, such as lotteries, are illegal and it’s important to structure a promotion to avoid running afoul of federal and state law prohibitions. The well-developed definition of a lottery is any arrangement that includes three elements: a prize offered and won by chance in exchange for consideration paid by the participants. Financial institutions are prohibited from participating in or advertising the existence of lotteries under federal banking laws. In addition, lotteries are illegal under nearly every state’s law unless operated by the state.

Sweepstakes, on the other hand, are permissible games of chance that could be a lottery, except that the element of consideration has been eliminated. The challenge in developing a legal sweepstakes is knowing what constitutes consideration. Keep in mind that consideration may mean more than money. While courts in some states have held that consideration is limited to monetary consideration, courts in other states have interpreted the term more broadly to cover other indirect forms of consideration. The general rule on indirect forms of consideration is the greater the effort required by the consumer, the greater the risk it will be considered a form of consideration. A common test is whether the required act on the part of contest participant benefits the sponsoring business. Examples of indirect benefit may include requiring a visit to increase branch traffic or the collection of useful market data through a lengthy survey. Bank regulators have opined in the past that requiring a customer to open an account or establish a customer relationship likely would be a form of indirect consideration. If consideration is present along with the prize and chance, you have present all the elements of an illegal lottery.

Of course, the whole point of any promotional event is not to just give away prizes, but to attract new customers or get existing customers to sign-up for new services, such as online banking or direct deposit. In order to steer the right course between a legal sweepstakes and an illegal lottery, sponsors need to provide two ways to enter: an automatic means of entry that serves the marketing goal, i.e., entering everyone who signs up for direct deposit during the month of May, and an alternative means of entry that helps insure the element of consideration is eliminated. The most common alternative means of entry is the mailed post card entry, in which the person can mail in a 3x5 post card to enter the drawing. You should insure that the contest operates in practice to give alternative entries a legitimate shot at selection.

Other Promotions

Sweepstakes are not the only popular bank promotion. Many banks offer bonuses to customers who open new deposit accounts or add services to existing accounts. As a reminder, bonuses worth $10 or more on deposit accounts should comply with the disclosure requirements of the federal Truth in Savings Act, and there also are IRS reporting requirements. In addition, the payment of a bonus on a demand deposit account raises questions of permissibility under Federal Reserve Board Regulation Q. You will need to determine whether the bonus is properly categorized as a legitimate marketing expense versus a prohibited payment of interest.

Contests and giveaways also are popular promotions. A contest is a game of skill that eliminates the element of chance from the lottery equation. Examples might include an essay contest or a 5K run sponsored by the bank. For a contest to be legitimate, skill must determine the final outcome, which should be judged and scored by objective criteria. Entrance fees can be charged but be careful not to inadvertently trip back over the lottery wire by adding back the element of chance, such as deciding a tie score with a random drawing. Like contests, there is no element of chance in a prize giveaway because the prize is guaranteed. Although it seems obvious, to avoid claims of deceptive advertising, you should plan to have sufficient supplies on hand to meet the demand of your prize giveaway and your materials should note that the giveaway is available only while supplies last.

The Fine Print

After you have developed your sales promotion, you also need to consider how it will be marketed and advertised. Different rules apply, depending upon the medium you choose. Regardless of medium, all advertising and marketing materials should be free of deceptive or misleading terms and language. Free should really mean free, and any terms, conditions or requirements to claim the prize should be clearly and conspicuously set forth in the materials, and not buried in a footnote. Promotion materials and rules should clearly set out the limitations and requirements.

If your sweepstakes or contest promotion will involve a direct mail component, you need to comply with U.S. Postal Service rules and any applicable state law. To be “mailable” under Postal Service rules, the entry materials need to include the address and telephone number of the sponsor, explain that the recipient can elect not to receive future mailings and how to opt out of future mailings. In addition, sweepstakes entry materials need to state that no purchase is necessary and that a purchase will not improve the odds of winning. Other contest rules and prize details must be included, as well. Similar requirements apply to entry materials for skill contests.

As noted above, state law can complicate planning a sweepstakes promotion because of varying interpretations of what is consideration. In addition, some states, such as Maryland, have additional disclosure requirements that apply to sweepstakes and other prize promotions. Still other states may impose restrictions on the prize itself or have additional advertising rules. If you operate across state lines, you need to consider your regulatory footprint when planning a promotion.

Clearly identifying the type of contest you want, identifying all applicable requirements and preparing the right set of rules will help your sales promotion be a winner without the bank ending up a loser.