The
Financial Industry Regulatory Authority Inc. is turning up the heat on complicated investment products.
In a regulatory
noticethis week, Finra outlined characteristics of what it calls “complex products,” which could include structured notes, inverse or leveraged exchange-traded funds, hedge funds and securitized products such as asset-backed securities.
Brokerage firms should have formal written procedures covering everything from the initial due diligence to post-sale performance, Finra said.
The notice specifically identifies duties that fall to individual brokers in understanding complicated products and explaining them to customers.
It also said that registered representatives should consider whether less complex and cheaper products might achieve the same objectives.
“Finra is letting it be known that recommendations of complex products will be given even more scrutiny going forward,” said Mary Harris-King, co-founder of Comprehensive Securities Compliance Solutions Inc.
The notice doesn't create any new standards or rules, said Joel Beck, founder of The Beck Law Firm LLC, and a former Finra attorney.
But it does “put firms on notice that they need to review their internal supervisory procedures relating to these complex products at every stage,” he said.
“I think regulators will look closely at non-traditional investments [whenever they are] sold to a retail investor,” Mr. Beck said.
“I don't think the notice is all that different or inconsistent with what Finra has been saying for a number of years in this area,” said Anna Pinedo, a partner at Morrison & Foerster LLP, who represents the Structured Products Association.
The one thing that might be different is that Finra seems to be moving toward labeling products as complex or not, Ms. Pinedo said.
“This is the first time I've seen a U.S. regulatory agency come up with something along the lines of what European regulators have done, in trying to group products” by riskiness and complexity, she said.
“I don't find that helpful, because it paints [products] with a very broad brush,” Ms. Pinedo added.
In its notice, Finra reviewed what a number of European regulators had done in characterizing various complex products.
The notice also said that registered representatives should consider unbundling structured products.
“Registered representatives should compare a structured product with embedded options to the same strategy through multiple financial instruments on the open market, even with any possible advantages of purchasing a single product,” Finra said in the notice.
That was good news to Robert Gordon, chief executive at Twenty-First Securities Corp., which replicates structured notes by buying underlying instruments like zero-coupon Treasuries and options on ETFs.
“It looks like Finra is saying that brokers can't say this [structured note] is simpler — that's not a good excuse” to buy it, he said.
Buying the components of a note that guarantees principal is 2% to 3% cheaper than buying the package, offers tax advantages, and lessens counterparty risk, Mr. Gordon said.
