In a recent Structured Thoughts issue,2 we discussed the potential impact of the Department of Labor’s new fiduciary rules on the structured products industry. In connection with these developments, we have prepared the following checklist that should be considered when potential offerees of structured products include retirement accounts. These issues will be relevant to a variety of entities in the distribution chain: the investment banks that design and manufacture the product and determine the channels into which the products will be sold, as well as the downstream distributors that may face retirement accounts directly. 

These issues will often be useful touchstones for determining whether and how a broker-dealer can receive transactionbased compensation (a commission) in connection with a sale under the three principal exceptions: the seller’s exception, the Best Interest Contract (BIC) exemption and the Principal exemption.

What Is the “Wrapper” for the Product? 

  • For example, is the product an SEC-registered note or an exempt bank note? A Rule 144A note? A market-linked CD?
  • Recommendations related to a market-linked CD may be eligible for the “principal exemption.”3 Other structured products that qualify for this exemption are limited to debt securities issued by a U.S. corporation and offered pursuant to a registration statement under the Securities Act.
  • If the product is a “debt security” (not a market-linked CD), does the product have no greater than “moderate credit risk”? Is it “sufficiently liquid” that it could be sold at or “near” its “carrying value” within a “reasonable period of time”?
  • A Rule 144A note will be sold only to QIBs, increasing the likelihood that the sale can be fit into the “seller’s exception.” 

Who Is the Issuer of the Product? 

  • Is the issuer affiliated with the broker-dealer that is making offers to retirement accounts?
  • The BIC exemption and the principal exemption will not be available where the broker-dealer is affiliated with the issuer.

What Are the Planned Distribution Channels for the Product?

  • To what extent are “retirement investors” among the offerees?
  • Will retail clients purchase through a private bank? Will the product be sold through a private wealth channel?
  • Will other broker-dealers purchase the product? Wholesalers? Registered investment advisers?
  • Sales to some parties, such as other dealers and larger, professionally managed retirement plans, are likely to qualify for the “seller’s exception.” However, the fact that some dealer at the end of the distribution chain may face retirement accounts may limit the marketability of some structured products, unless that dealer at the end of the chain has available an exemption.
  • The BIC exemption is available only to advisers and financial institutions, and their affiliates and related entities, selling on an agency basis to plans and IRAs that do not meet the requirements for the seller’s exception.

What Is the Nature of the “Plan of Distribution” of the Product?

  • Will the broker-dealer selling the product be acting as principal (i.e., on a firm commitment basis)?  Will it be acting as agent (i.e., does it act as an agent to facilitate the sale without committing to purchase any securities)?
  • Is the broker-dealer part of an underwriting syndicate for the product?
  • What products are recommended by the broker-dealer? Is the universe of recommended products somehow limited to these products?
  • The BIC exemption would not be available if the broker-dealer is acting as principal.

What Fees or Other Benefits to the Broker-Dealer Are Associated with the Product? 

  • Proposed fees can include underwriting compensation, “trailing fees,” index licensing fees, hedging fees and others.
  • How is the “reasonableness” of the fees determined?4
  • Does the broker-dealer obtain the benefit of any exclusivity, “shelf space” or similar arrangements as to the product?
  • Does the broker-dealer limit its recommendations to proprietary products or products generating third-party payments?
  • Do financial advisers receive any special compensation as a result of recommending or selling these products?
  • Is the broker-dealer or its affiliate participating in the issuer’s hedging transactions?  Are there any material conflicts of interest?
  • If the broker-dealer is to receive transaction-based compensation, an offering to retirement accounts will require an exemption or an exception.
  • All third-party payments and material conflicts of interest will be required to be disclosed to the investors.

What Other Roles Does the Broker-Dealer or Its Affiliates Play in the Offering?

  • An affiliate of the broker-dealer may, for example, propose to serve as a calculation agent for the structured product’s payments or for an underlying asset.
  • Who is responsible for choosing the underlying reference asset?  Who is responsible for sponsoring the underlying ETF?
  • Who is responsible for sponsoring the underlying index?
  • Is the product structure “proprietary” to the broker-dealer? Does the product feature any special service mark or trade name or other marketing identifiers that are owned or used exclusively by the broker-dealer?
  • Even if the distributor is acting only as an agent, is the distributor responsible for distributing all or substantially all of the offered structured products? 

Best Interest Standards

  • How does the product compare with other available products offering similar benefits in terms of (i) fees and costs, (ii) liquidity and (iii) risk? 
  • If the product has higher fees/costs, can such higher fees/costs be justified as consistent with the best interests of the retirement investor? 
  • If the product involves more than a moderate degree of risk and/or is not fully liquid, can such features be justified as consistent with the investor’s best interests based upon potential benefits of the product?
  • Is the aggregate compensation received directly or indirectly by the broker-dealer reasonable in light of the services performed?

Compliance Procedures 

  • What guidelines are in place to ensure that financial advisors will only recommend the product if it is in the investor’s best interests?
  • What product-specific training will be required?
  • How will the best-interest determination be documented?
  • How will this documentation be retained?
  • Who will be responsible for documentation and retention?
  • Are compensation arrangements for registered representatives appropriate and structured so as not to incentivize imprudent recommendations?