IOSCO Publishes Suitability Requirements for Distribution of Complex Financial Products (with dissenting statements by SEC Commissioners) (with Lofchie Comment)
The International Organization of Securities Commissions ("IOSCO") published a final report on Suitability Requirements with respect to the Distribution of Complex Financial Products, which sets out principles relating to the distribution by intermediaries of complex financial products to retail and non-retail customers. The report introduces nine principles that cover the following areas related to the distribution of complex financial products by intermediaries:
- Classification of customers
- General duties irrespective of customer classification
- Disclosure requirements
- Protection of customers for non-advisory services
- Suitability protections for advisory services (including portfolio management)
- Compliance function and internal suitability policies and procedures
- Incentives
- Enforcement
In their dissenting statement as to the final report, SEC Commisioners Paredes and Gallagher said that they "objected" to the publication of the report, that the report "does not accurately reflect the relevant law in the U.S.," and that, ultimately, U.S. law should "[not] conform" to the report, the "substance of which we disagree with in key respects." The dissenting statement concludes by saying, "We especially disagree with the Final Report's failure to properly respect the distinction between retail and institutional investors when determining the suitability requirements that should apply."
Lofchie Comment: According to the report, a significant motivator of its production was the material loss suffered by retail investors globally on the purchase of various Lehman mini-bonds, which the report says were not sold in the United States. Although the U.S. obviously has a well-developed set of rules around suitability (see generally Lofchie's Guide to Broker-Dealer Regulation, Customers Chapter), primarily through FINRA, it is certainly possible that this report could play a role in the discussion over the imposition of a fiduciary obligation on broker-dealers. The report advocates, among other things, that sell-side firms should have some level of obligation even in connection with financial products as to which the firms had made no recommendation ("recommendation" is not a defined term in the report); and the report also suggests that certain products might be prohibited for sale to retail customers. The report also indicates that the definition of "retail customer" (meaning the class of persons entitled to additional productions) potentially should be quite broad and might vary with the relevant product.What is interesting to me intellectually is the attempt to find the appropriate level of obligation that sell-side firms owe to their customers and the specificity of that obligation. If the bar of obligation is set too low, retail investors are bound to make lots of foolish investments. On the other hand, if the bar of obligation is set too high, or if the level of the bar is indeterminate and is subject to reset after an investor has lost money, retail investors may be locked out of the market because the costs or risks of providing them with financial services are simply too high to bear.
View IOSCO Report in full here (links externally to IOSCO website).View Press Release in full here (links externally to IOSCO website).See also: [Dissenting] Statement by Commissioners Paredes and Gallagher.