On January 6, 2015, FINRA issued its annual regulatory and examination priorities letter. (http://www.finra.org/web/groups/industry/@ip/@reg/@guide/documents/industry/p602239.pdf).
As in the past few years, structured products will remain an area of FINRA focus in 2015. Many of the points raised by the letter are consistent with FINRA’s prior guidance to broker-dealers. The letter points out that issues related to product and service offerings generally include “product complexity, opacity in the market for a product or its underlying components, insufficient or generic disclosure, enticing teaser rate fee structures and insufficient training for salespersons to understand the products.” FINRA requests firms to “continue to conduct rigorous new product reviews, assess reasonable-basis and customer-specific suitability prior to offerings and permit wealth management to make independent decisions about the products and services that are best for their customers.”
In particular, the letter indicates that FINRA will continue focusing on structured products “with complex payout structures and using proprietary indices as reference assets.” The letter states that “complex features, long maturities, and linkages to less-traditional or less well-understood reference assets in some structured retail products may present investors with unique or unfamiliar risks.” FINRA points out that some products that were previously available only to sophisticated investors are now offered to retail investors. Because retail investors may not understand the complexities of structured products, retail communications are important and FINRA reminds firms to comply with the communication rules.
In addition, because distributors have an incentive to increase their distribution of structured products, potentially through distributors that may not have adequate controls, FINRA requested wholesalers to “have robust Know-Your-Distributor policies and procedures reasonably designed to ensure potential distributors have adequate controls and systems in place.” FINRA examiners will focus on additional conflicts issues when the distributor and the wholesaler are affiliates.
The letter also references a number of additional focus areas that often involve structured products, including:
- Suitability (including suitability in light of changing circumstances, such as a fall in oil prices, or investments linked to emerging and frontier market indices);
- Conflicts of interest;
- Risk disclosures;
- Interest rate-sensitive fixed income securities;
- Exchange-traded products tracking alternatively weighted indices, which may be unduly complex for some investors;
- Timely filing with FINRA of relevant FWPs, including FWPs relating to registered structured notes (when required under the FINRA rules);
- Due diligence and suitability of private placements; and
- Sales to elderly investors of products that are not suitable for them.
In connection with its fair pricing reviews, the letter notes that FINRA is “looking for instances in which firms that are intermediating transactions in structured products may not have disclosed information to their customers about how they would charge the customer.” FINRA advises in the letter that dealers “that position a trade for the purpose of taking a spread when their customer has agreed to pay the dealer an explicit fee for the transaction, should look closely at whether they are meeting the customer’s expectations about how the dealer should execute the trade and be compensated.”