Amid concerns that retail investors may be harmed by high concentrations in risky structured products, the U.S. Financial Industry Regulatory Authority Inc. (FINRA) is launching a compliance review targeting the industry’s sales of complex structured notes.
The U.S. industry self-regulatory organization said that it will be reviewing firms’ practices when dealing in so-called “worst-of” structured notes — products whose returns are geared to the poorest performing asset in a specified group of assets — due to its investor protection concerns with these risky, complex products.
The SRO said that it has “identified multiple instances where firm representatives have concentrated their customers’ assets in structured products that increase complexity and risk” — in particular, notes that don’t carry principal protection, and notes that use “worst-of” features.
“Highly concentrated investments can pose risk, and that risk is heightened when the concentrated investment is a complex product,” it said. “Some investors have lost significant portions of their portfolios through such concentrated positions,” it added.
In its review, FINRA will be examining how firms supervise clients’ concentration in these risky products, and how firms are complying with the requirements of “Regulation Best Interest” (RegBI) and other SRO rules — including the duty of care and conflict of interest obligations set out in these rules — when their reps recommend these products to investors.
“While structured products may have the potential for higher returns than their reference assets, they also have unique risks,” it said. “Their terms and features can be different and significantly more complex, which may warrant heightened supervisory scrutiny.”