As investors gain more access to risky, complicated investments online, Finra is mulling whether it should change its rules pertaining to complex products.
Earlier this week, the Financial Industry Regulatory Authority Inc. released a regulatory notice that included a request for public comment regarding oversight of leveraged and inverse exchange-traded products, options and other complex investments in an environment where investors can buy them on trading apps and over the internet.
The broker-dealer self-regulator is seeking public input on “whether the current regulatory framework, which was adopted at a time when the majority of individuals accessed financial products through financial professionals, rather than through self-directed platforms, is appropriately tailored to address current concerns raised by complex products and options,” the regulatory notice states.
Complex products are a regulatory priority for Finra this year. The regulatory notice says that the number of accounts “trading in complex products and options has increased significantly in recent years.”
The regulator has addressed risks associated with the vehicles through guidance on sales practices, investor alerts and rules for specific products and options. But it appears to be getting more intense about oversight.
“When you’re questioning your current regulatory framework, that seems to me to suggest you might have to update your rules,” said Bradley Berman, counsel at Mayer Brown. “They’re concerned about this new danger of retail investors buying options, and possibly structured products, all by themselves.”
There’s no formal definition for complex products, according to Finra. Generally, they’re investments that you can't explain to your mother. They have complicated payout mechanisms, hidden risks and performance that doesn't track the market. Some of them have built-in protections under securities laws and others don’t.
In the notice, Finra emphasized that under Regulation Best Interest, the broker standard adopted by the Securities and Exchange Commission, registered representatives must understand the features and risks of complex products before they recommend them to customers.
Finra also suggested it may look overseas for ideas on how to regulate complex products. For instance, it noted that European Union rules require financial firms to put in place “robust and objective procedures, methodologies and tools” to assess the risks of the investments and whether they fit an investor’s profile.
Following Europe’s example would be “a significantly different approach,” Berman said. “We have a regulatory light touch compared to what’s going on in the EU.”
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