Earlier this year, the SEC’s Office of Compliance Inspections and Examinations (the “OCIE”) indicated branch offices and structured products as two of its priorities.1 As one consequence of this focus, in an August 2015 risk alert, the OCIE identified several deficiencies in the controls that certain branch offices had put into place in connection with sales of structured notes.

The full risk alert may be found at the following link: http://www.sec.gov/about/offices/ocie/risk-alert-bd-controls-structured- securities-products.pdf

In its examination, the OCIE sought to determine whether these firms effectively supervised and monitored activities and risks associated with sales of structured notes to retail investors. The OCIE indicated that its analysis revealed discrepancies in the practices within each firm and discrepancies in the effectiveness of the controls.

The report does not necessarily shed any light on the practices of any institutions as a whole, but does indicate that some institutions have not have a uniform degree of compliance across their branches.

Scope of Review

In connection with the risk alert, the OCIE examined ten branch offices. Their identity, size and significance were not disclosed in the risk alert. However, the OCIE noted that one or more of them were affiliated with structured note issuers. The examination related to a variety of types of structured notes, but not exchange traded notes.

The review period was generally January 1, 2011 to December 31, 2012. Accordingly, the issues discussed in the risk alert may not reflect the current operations of the examined branch offices, or the industry as a whole. Many broker- dealers have undertaken significant additional compliance efforts during the past several years.


The OCIE analyzed 26,600 note sales, with a notional amount of more than $1.25 billion.2 The OCIE reviewed the account documentation of the relevant customers, including data on risk tolerance and investment objective, age, and any approval for options trading. The OCIE reviewed:

  • the predominant types of customers that had purchased these notes at each firm and branch office;
  • resales of the notes in these accounts in order to gauge the frequency and price at which the notes were resold prior to maturity; and
  • the frequency with which each firm’s transactions exceeded internal policies and procedures governing suitability, as well as supervisors’ documentation approving overrides of internal suitability guidelines.

The OCIE sought to employ data analytics in connection with its review. The analysis identified the predominant types of customers that purchased structured notes at each firm and branch office, and the OCIE further scrutinized branch offices and representatives that had made high numbers of sales. For example, in the case of one broker, the OCIE observed that the firm sold more structured notes in its most conservative investment objective category than it did to customers in its most aggressive investment objective category, by almost a nine-to-one margin.

Deficiencies Identified

The OCIE indicated that it had found deficiencies in the areas of suitability and supervision with respect to all of the relevant firms’ note sales to retail investors. According to the OCIE, these firms:

  • did not maintain or enforce adequate controls relating to determining the suitability of the note recommendations; and
  • did not conduct both compliance and supervisory reviews of registered representatives’ determinations of customer suitability, as was required by their internal controls.

The OCIE noted that all of the firms in question had policies and procedures governing suitability, processes for product development and approval, and training of representatives. The OCIE apparently did not review or comment on the adequacy of these policies and procedures. Rather, the OCIE found instances in which these controls were inadequately or inconsistently implemented.3

The OCIE identified two firms in which there was significant structured note activity in the accounts of elderly customers, and in the accounts of customers for whom the firm did not have any age information. One of the firms apparently did not collect information about customer age, meaning that representatives could not consider that information when making a suitability determination, which would call into question the adequacy of the determination.

A Few Noted Practices

Several of the practices discussed would be problematic as to the sale of virtually any investment product:

  • The OCIE identified e-mails indicating that representatives were appearing to mischaracterize the attributes of the products in light of the goals of the investors, particularly to investors that did not speak English.
  • The OCIE identified a firm in which representatives had retroactively changed customers’ investment objectives in their account documentation, without the customers’ approval, in order to justify concentrated positions of structured products.


The OCIE reported that all of the examined firms did not enforce their written supervisory procedures (“WSPs”) relating to reviews of suitability determinations. In addition, the implementation of the firms’ review procedures was not consistent across firm branches.

The risk alert provides only one example. At one branch, a majority of structured note purchases exceeded the firm’s concentration guidelines. The firm had a system to alert representatives and supervisors of breaches of concentration guidelines, which required a review and documentation of the reasons for an override of the firm’s guidelines. However, in this case, all of these transactions were approved by the branch manager or complex risk officer with little or no documented explanation, other than generic approval language.5

Resales at a Loss

The OCIE’s review of trading history indicated that a significant number of investor sales of structured products during the two year review period resulted in a loss. Focusing on “reverse convertible notes,” the OCIE found that the branch offices examined liquidated almost 25% of the purchases that representatives had sold to their customers. Over 35% of these liquidations were at prices below 80% of the principal amount.6 (The report does not note what amounts were paid on these notes at maturity, or whether an investor in these products would have lost principal at maturity.)


In connection with the risk alert, the OCIE reminded brokers to take note of the importance of the implementation of controls, as well as their design, on the effectiveness of these controls. The OCIE expects that this risk alert will raise awareness of certain types of weaknesses, in order for brokers to consider them in their own compliance programs. The report reminds us that, even with proper policies and WSPs, consistent implementation remains important to the industry’s regulators.