FINRA has previously noted that it expects broker-dealers to conduct a post-approval review for offerings of new products, including retail structured notes. This review is typically conducted by a broker-dealer’s “new product committee” or similar body. For example, FINRA Notice 05-26 states that broker-dealers should:
- track and monitor customer complaints and grievances relating to new products;
- reassess the firm's training needs regarding a product on a continuing basis;
- establish procedures to monitor, on an ongoing basis, firm-wide compliance with any terms or conditions that have been placed on the sale of the product;
- periodically reassess the suitability of the product; and
- review any product lifting any restrictions or conditions on the sale of the product.
Similarly, FINRA Notice 12-03 states that a “well-designed system of internal controls should include a process to periodically reassess complex products a firm offers to determine whether their performance and risk profile remain consistent with the manner in which the firm is selling them.”
More recently, FINRA’s 2013 Report Relating to Conflicts of Interest states that an “effective practice for product manufacturing firms is to implement post-launch reviews to identify potential issues with a product that may not have been apparent during the initial review process, which could lead to conflicts of interest or reputational risk. Such issues could include unexpected product performance, subsequent activity by the manufacturer that may specifically influence the performance of the product, use by investors for whom the product was not intended, or use that is inappropriate or unanticipated.”
In this article, with these principles in mind, we provide a sample framework and checklist for conducting this postapproval review. Each relevant broker-dealer will of course need to consider its processes in light of its own business model, including the nature of its investor base, and the types of products that it sells. In addition, if a broker-dealer sells any of its products outside of the United States, the laws and practices of the relevant jurisdictions may need to be considered.
Selection Process for Review
- The broker-dealer may consider selecting notes for review:
- By underlying reference asset to ensure a variety of reference asset exposures are considered;
- By date (i.e., some issued in first quarter of the most recent year, some issued in third quarter);
- By pay-off feature (principal-protected, buffered, etc.), with an emphasis on the most complex structures;
- By distribution channel; based on sales volumes, retail focus of distributor, or other relevant criteria; or
- Any other reasonable sampling basis.
Proposed Procedures for Post-Approval Review
The new product committee should be provided with data, including:
- Amounts offered,
- Distribution channel,
- Types of investors,
- Product performance,
- Any distribution or investor complaints or inquiries,
- Any inquiries received from regulators on the product type, marketing materials used, offering documents used, and the initial new product committee approval submission.
The committee may wish to consider the extent to which:
- The product is described appropriately in marketing and disclosure documents, particularly as to the disclosure of the relevant risk factors;
- Whether the product description in the original new product committee submission remains accurate;
- Whether the product has performed as contemplated at the time of approval;
- Whether any additional training of representatives or distributors is advisable;
- Whether the performance is consistent with any relevant hypothetical back-tested data and/or any sensitivity or similar tests;
- Whether the objective of the products remains valid or addresses a market need;
- Whether investors have attempted to liquidate the product prior to maturity to a greater extent than other products;
- Whether any operational issues have arisen;
- Any compliance issues that have arisen, including any unexpected conflicts of interest;
- Whether peer firms are offering similar products;
- Whether any other products are offered that are advantageous as compared to the relevant product, for example, with fewer fees, greater liquidity, etc.;
- Whether the distribution channel should be changed, minimum purchase amounts required, or other precautions taken.