Broker-dealers have been engaging in sales practices for structured securities products that hurt retail investors, according to a Securities and Exchange Commission report released on Wednesday.
In sweep examinations of 11 broker-dealers, the SEC found that the firms may have steered clients into the complex products even though they were not suitable for their portfolios. (Click on the following link to
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The SEC also noted instances where broker-dealers charged prices that were too high, did not adequately disclose risks related to them and misrepresented them on customer account statements.
The agency recommended that broker-dealers improve disclosure about structured securities products, establish procedures and controls to prevent abuses in the secondary market and conduct specialized training for their representatives who sell the instruments.
Structured securities products are derivatives whose value is based on other securities, baskets of indexes, options, commodities, debt issuances and foreign securities. Sales to retail investors rose to $45 billion in 2010 from $34 billion in 2009, as customers have been seeking higher returns in a market characterized by low interest rates and uneven growth.
One of the riskiest structured products, according to the SEC report, is a reverse convertible note, which is a security with an embedded put option.
“There were numerous instances at these firms where the sale of RCNs did not appear to coincide with the customers' stated investment objectives and financial profile,” the report states. “In addition, the firms solicited the purchase of RCNs without adequately disclosing to customers the material risks associated with investing in RCNs. Many of the customers experienced significant losses in these securities as the value of the underlying equity securities diminished.”
Carlo di Florio, director of the SEC Office of Compliance Inspections and Examinations, said the report is designed to help broker-dealers strengthen their compliance programs.
“Beyond this report, we are monitoring the way in which these products evolve, and are considering additional steps in the near future relating to structured securities products that may further bolster investor protection,” he said in a statement.
The SEC report follows a recent warning to investors from the
Financial Industry Regulatory Authority Inc. to be careful when considering the purchase of complex investment products.
“This [SEC] report is fairly consistent with comments and observations that Finra has made in the last year,” said Anna Pinedo, a partner at Morrison & Foerster LLP and counsel to the Structured Products Association. “There are no surprises here.”
Although the report does point out deficiencies in sales practices for structured instruments, it doesn't indicate the scope of the problem.
“These products can be sold in a responsible manner,” said Ms. Pinedo, whose firm represents broker-dealers. “It's difficult to assess from the SEC study how prevalent some of the concerns they raise are. I'm sure market participants will use this report as an opportunity for self-examination to assess their procedures.”
