At FINRA’s Annual Conference, Richard Ketchum made wide-ranging comments and spoke about structured products. Here is an excerpt of his speech:
The increasing availability of complex and sophisticated products to retail investors, while beneficial in some ways, can present challenges to a compliance department. Investors can trade exchange-traded products that provide the ability to speculate on the volatility of the securities markets or the spread between various asset classes. The structured retail products market has grown in the last few years: Over 8,000 retail structured products were sold in 2010.
The breathtaking pace of innovation and availability of these more sophisticated and complex products pose significant challenges to firms. A solid understanding of an investment product is at the core of suitability analysis and sound sales practices. I am pleased to hear that many firms are taking this challenge extremely seriously and enhancing their product training programs.
I am also pleased that some firms are establishing new control measures around their distribution processes. At the outset, firms should determine which products they are comfortable allowing their reps to sell to retail customers. Many firms have established new product committees to vet new products and determine which ones they will prohibit. The best review programs are dynamic, and require that the firm monitor market and economic conditions that could change the firm's view about the appropriateness or suitability of a particular product.
Some firms have even established additional controls with respect to those complex products they do permit. Some firms require retail customers who are interested in purchasing these complex products to complete an option account approval process. Some firms also prequalify retail customers and require them to sign specialized investor qualification agreements. These agreements may explain product features and risks in plain English, and require customers to attest to having read the materials provided, understanding the risks and wanting to invest in the product.
The challenges posed by the growth of these products affect our regulatory programs as well. FINRA monitors product development for many of the same risk factors considered by firms. We look at the complexity of products, and assess the likelihood that investors and registered representatives will understand and appreciate the risks they present. We look at the transparency of key components of products, such as embedded leverage, optionality, counterparty risks, and fees and expenses that raise concerns.
This analysis helps us better understand where emerging risks may arise and identify opportunities to provide guidance to firms and educational materials to investors. You can learn more about new and complex products from the panel later this morning.
Effective supervision is rooted in a thorough understanding of the product risks, coupled with robust broker training regarding the clients for whom the product is appropriate. Brokers cannot rely on firm approval alone to satisfy their suitability obligations. This is particularly important with the proliferation of increasingly complex financial products, and at a time when certain investors are tempted to chase yield in today’s low interest rate environment.
Ketchum’s comments echo the themes included in many of FINRA’s recent Notices to Members as well as in FINRA’s statements relating to enforcement actions in the structured products area, including the focus on suitability, new product approval processes, training, plain English disclosures that are fair and balanced, and effective supervision.