SEC Issues Investor Bulletin on Structured Notes (with Foster Comment)
The SEC Office of Investor Education and Advocacy issued an Investor Bulletin to inform investors about the features and risks of structured notes.
The SEC explained that structured notes are issued by financial institutions whose returns are based on, among other things, other securities and a broad range of types of commodities, including various indices. Common types of structured notes sold to individual investors include principal protected notes, reverse convertible notes, enhanced participation or leveraged notes, and hybrid notes that combine multiple characteristics.
The SEC noted that while structured notes may enable individual retail investors to participate in investment strategies that typically are not offered to them, these products can be very complex and have significant investment risks. The SEC also noted other considerations regarding structured notes, including the market risk of a structured note that may include changes in equity or commodity prices, changes in interest rates or foreign exchange rates, or market volatility.
The SEC also noted that, in addition to market risk, structure notes may not be resold on a daily basis and, thus, may be difficult to value given their complexity. The SEC recommended that an investor either must be prepared to hold a structured note to its maturity date or risk selling the note at a discount to its value at the time of sale. Other considerations regarding structured notes include payoff structure, credit and call risk, and tax risk disclosures.
The SEC provided a list of recommended questions that a potential investor should ask his or her investment advisor before purchasing structured notes.
Foster Comment: The bulletin describes generic features and risks of structures notes, with an emphasis on suitability issues. It follows the January 6, 2015 release of FINRA's Regulatory and Examinations Priorities Letter, which cited concerns about familiarity of brokers with the complexities of structured retail products and their ability to conduct sound suitability reviews. Creators and distributors of structured products would be well advised to review again their internal training and suitability criteria as well as their know-your-distributor policies in respect of downstream brokers.