On June 16, 2016, Thomas Selman, FINRA’s Executive Vice President, Regulatory Policy, delivered a speech at SIFMA’s annual Complex Product Forum in New York City. The text of his speech can be found at the following link: https://www.finra.org/newsroom/speeches/061616-remarks-sifma-complex-product-forum.

Analogizing from a hypothetical menu of different options at a deluxe Parisian restaurant, Mr. Selman explained the potential difficulty that retail investors may have in understanding, selecting and comparing different complex financial products. The problem can be particularly significant where different contingencies may be difficult and time-consuming to value.

Different contingencies can render it challenging to compare products with different features. For example, an investor may value “principal protection” differently than “currency exchange risk.” The problem can be exacerbated when a product involves multiple contingencies, such as, in Mr. Selman’s example, a non-principal protected range accrual note in which both (a) the payment of interest depends upon the level of the applicable underlying asset at different times and (b) the payment at maturity may be less than par if the underlying asset decreases in value. The difficulty would be even more challenging in the case of a “worst of” structure that involves underlying assets with different risk profiles.

Mr. Selman’s analysis is noteworthy in part because of its discussion not only as to how a financial advisor can advise an investor as to a single individual product, but how a financial advisor may potentially need to understand and explain multiple products, with different terms, features and underlying assets, when advising a client. He noted: 

“To summarize these points, the complexity of a financial adviser’s investment selection often will depend upon the answer to three questions:

  • How many approved investment choices is the adviser expected to consider?
  • How many of these investment choices have one or more embedded options?
  • How many of these embedded options refer to reference assets that are unrelated to the essential features of the product?” 

In the course of his discussion, Mr. Selman also reviewed some of FINRA’s historic guidance as to what features would render a product “complex,” and the need for financial advisors to understand products well enough to explain to investors their payoffs under different circumstances prior to offering them.

Mr. Selman also reminded the audience to be sensitive to the possibility that a financial services company might be issuing complex products to retail investors in order to manage its own risk. He noted, “[s]ome commenters have asserted that structured notes may be used as a mechanism to shift particular risks to retail investors. Such activity could present serious regulatory issues.” 

Mr. Selman reiterated FINRA’s position that it is not necessarily questioning the utility of complex products. However, FINRA will continue to focus on the need for heightened training and supervision of financial advisors who do offer them.