FINRA Tells Financial Firms to Heighten Supervision of Complex Products

The Financial Industry Regulatory Authority has put out a formal notice to stockbrokers to let them know that complex financial products must come under the focus of heightened supervision. According to the SRO, a complex product is one with numerous features that can impact its investment returns depending on different scenarios-especially if the average retail investor can’t be expected to easily comprehend what these features are and how they can lead to an investment return.

Examples of complex products:

• Investments linked to the way the markets perform, such as certain exchange-traded products that can expose investors to the volatility of the stock market and products that create leveraged or inverse exposure.

• Products with complicated formulas or limits for calculating investor gains.

• Products that have only partial or conditional principal protections.

• Products with structures that may exhibit significantly different performances than what an investor expected.

• Structured notes that come with “worst off” features and payoffs that can be impacted by a pre-specified group’s worst performance index.

• Products that have contingencies found in losses or gains-especially when multiple mechanisms are involved.

• Products with a hard to comprehend embedded derivative component.

• Asset-backed securities that are secured by a collateral pool, such as consumer credit card payments, mortgages, or future royalties on music.

It is important to note that there are number of products that don’t exhibit these traits but still warrant heightened compliance and supervision because of the risks they present. FINRA says that it is up to financial firms to engage in the enhanced oversight of complex products and ones similar to them or the types of performances they can exhibit.

Brokers should not recommend financial products that they don’t fully understand and are therefore unable to properly explain to someone else. It is also important to make sure that an investor understands the products in which he/she will be investing.

While FINRA isn’t banning complex product, it wants brokerage firms to have written policies in place that would include a customized determination regarding whether a client should be offered them for purchase. Also, those that sell complex products need to be properly trained.

FINRA wants financial firms to establish a proper system of internal controls that allows for the periodic reassessment of complex products so there is current knowledge about their performance and risk profiles, which can affect how they are sold. It also wants broker-dealers to heighten their supervision of how and to whom complex products are sold.

FINRA says that before a complex product is recommended to a retail investors, the right questions should be answered, including:

• Who is the product for?
• How will it be controlled?
• Who shouldn’t the product be offered to?
• What is the product’s investment goal?
• Are their less complex products that can fulfill the same objectives?
• What are the risks involved in investing?
• How will the financial firm and its registered representatives be compensated in exchange for offering the product?
• Are any conflicts of interest involved?
• Is the product liquid?

FINRA wants financial firms to consider developing procedures to oversee how well the product does after they receive approval.

If you’ve suffered financial losses because of a complex product that your investment adviser or broker recommended that was unsuitable for you, you may be able to recoup your money. Contact our stockbroker fraud law firm today.

Read FINRA’s Regulatory Notice

More Blog Posts:
FINRA Vows to Step Up Internal Compliance Procedures, Stockbroker Fraud Blog, October 30, 2011
FINRA Cannot Enforce Disciplinary Actions Through the Courts, Says Federal Appeals Court, Stockbroker Fraud Blog, October 6, 2011
FINRA Tells Congress It Is Ready to Act as SRO for Investment Advisors, Stockbroker Fraud Blog, September 13, 2011