SEC warns brokerages to monitor risky products better

Agency finds a significant number of inappropriate sales

Aug 25, 2015 @ 12:54 pm

By Mark Schoeff Jr.

The Securities and Exchange Commission is warning brokerages to better monitor the sales of risky complex investments to retail clients.

In an alert issued Monday, the agency said an analysis of 26,600 transactions totaling $1.25 billion of structured securities products revealed a significant number of instances in which the investments were inappropriate for the purchasers.

Brokers must adhere to the suitability standard, which requires that investment products they sell meet a client's objectives and risk tolerance.

“In these examinations, staff observed not only indications that the examined firms' suitability controls may be weak, but also significant weaknesses in supervision and implementation of internal suitability and supervisory procedures across branches of the same firm,” the alert states. “The risk alert is intended to raise awareness of these types of weaknesses in order for registrants to consider them in their own compliance programs.”

The SEC reviewed 10 branch offices of broker-dealers. In four branches of one firm, they found $96 million of structured-product sales to conservative investors, compared to $11 million to those who described themselves as aggressive. In one of the branches, sales were targeted to non-English-speaking clients.

At two other examined firms, the SEC found high concentrations of structured products in the accounts of elderly customers. At one of the firms, registered representatives changed the investment objectives in the customer profiles after the sales, without the customers' permission, to justify the complex products in their portfolios.

The SEC said a large number of liquidations of structured products occurred at prices well below their face value. The examinations were conducted from January 2011 through the end of 2012.

Structured products, which are often bond-like instruments linked to derivatives, have become popular because they promise higher returns at a time of low interest rates. They often offer principal protection. They also produce high commissions for brokers.

The SEC and the Financial Industry Regulatory Authority Inc. both put the vehicles on their examination priority list this year.

“You've got to think twice before you sell structured products to retail customers, because there's an enhanced suitability requirement,” said Todd Cipperman, principal at Cipperman Compliance Services. “You've got to put a lot of restrictions around sales.”

The SEC said all of the firms examined had written policies and procedures for suitability. But the controls were “inadequately or inconsistently implemented” and could vary from branch to branch.

“The message here is that [brokerages] need better supervision of complex products,” said Amy Lynch, president of FrontLine Compliance, a consulting firm. “They need to better monitor how their reps are selling them across the board. They need to conduct more training for reps.”

Some brokerages may even want to consider abandoning structured products.

“The issue is whether the compliance is worth the commission,” Mr. Cipperman said.


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