FINRA's Podcast on Examination Priorities: "Complex Products" (with Lofchie Comment)
FINRA's first podcast in a three-part series on its 2013 regulatory and examination priorities focuses on the suitability of complex products. According to FINRA, due to low yields in fixed-income products, brokers and customers alike have been looking for higher yields through complex products. FINRA's concern is that brokers may not fully understand these products and, thus, fail to communicate adequately such products' risks and returns to customers.
The podcast notes that examiners will place greater scrutiny on recommendations of the following products: business development companies, leveraged loans, commercial MBS, structured products, non-traded REITS, and rated municipal bonds. FINRA's concern with recommending these investments is that their underlying market, credit, and liquidity risks may be unsuitable for customers based on their tolerance for such risks.
In determining the suitability of recommendations in complex products, examiners will focus on the following:
- A broker's knowledge of the specific product recommended;
- The broker's level of due diligence in assessing the suitability of the recommendation in light of the customer's risk tolerance and liquidity needs;
- The broker's level of disclosure of material risks of the investment to the customer; and
- The disparity in broker compensation in recommending a complex product over competing investments.
Lofchie Comment: It very much behooves all firms dealing with retail investors to examine their compliance processes around sales practices and suitability reviews, including, but not limited to, transactions in the products enumerated in the podcast. Richard Ketchum, the head of FINRA, has made a number of significant statements on the issue of suitability, including one which takes the view that broker-dealers should be subject to a fiduciary standard in making any recommendation to a retail customer. See, e.g., "FINRA Chairman and CEO Ketchum on Consumer Protection (with Lofchie Comment and Suggestion)" (March 14, 2013). In short, everyone should be aware that any inadequacy of compliance procedures as to sales practices puts a firm at risk.
See: FINRA Podcast, Chapter 5 of Broker-Dealer Guide, FINRA Rule 2111.