FINRA Chairman and CEO Ketchum Speech: Primarily on Suitability and Structured Products (with Barrentine Comment)
FINRA Chairman and CEO, Richard Ketchum, delivered prepared remarks to the National Compliance Outreach Program for Broker-Dealers in Washington, D.C. His remarks focused on complex products and the need for firms to have heightened suitability and supervisory systems around these products and on the management by firms with conflicts of interest. In particular, Mr. Ketchum's remarks on complex products focused on structured products, closed-end funds and private placements.
Features of structured products that raise concerns include their use of unsecured debt; derivative strategies featuring pay-outs that are linked to a variety of underlying assets - which are sometimes highly volatile - such as a narrow or proprietary index or some other obscure benchmark; uncertain cash-flow characteristics and risk-adjusted rates of return; and the lack of an active secondary market, which means investors must be willing to assume considerable liquidity risk in addition to market risk and the credit risk associated with the issuer of the product.
As to closed-end funds, FINRA is concerned that retail investors may not understand that some funds are returning capital to maintain their high distribution rates, causing the closed-end funds to trade at high premiums compared to their net asset value.
With respect to private placement securities, the scarcity of independent financial information and the uncertainty surrounding the market- and credit-risk exposures associated with many private placements means that firms must conduct reasonable due diligence on prospective issuers. Due diligence should focus on the issuer's creditworthiness, the validity and integrity of their business model, and the plausibility of expected rates of return as compared to industry benchmarks.
Barrentine Comment: Firms and their financial advisers should understand the features of products of these types that they sell, how they are expected to perform under different market conditions, and the product's risks, potential benefits and costs. Representatives should describe to customers the circumstances under which the customer could lose money and not just the circumstances under which the customer would earn money. Finally, representatives should also explain carefully the direct and imputed costs which clients will incur.
View speech in full here (links externally to FINRA website).See also: FINRA Chairman and CEO Ketchum on Consumer Protection (with Lofchie Comment and Suggestion)