Brokerages must step up their supervision of the sales of alternative mutual funds, Finra warned this week.
The Financial Industry Regulatory Authority Inc. said in an April 19 regulatory notice that it has seen lax oversight of their registered representatives’ recommendations of the complex funds, also known as liquid alts, in recent examinations.
The products use assets other than stocks and bonds — such as real estate, commodities and derivatives — to give retail investors exposure to alternative investments in a vehicle that can be traded daily. They are touted as a way to beat market returns but also can be risky and expensive.
Finra member firms are not taking appropriate care to ensure “alt funds” are sold only to appropriate customers, the broker-dealer self-regulator said.
“For example, firms failed to limit recommendations of alt funds to customers with an appropriate risk tolerance, tailor their trading surveillance and systems to address the unique risks and characteristics of alt funds and identify alt funds transactions for additional reviews,” Finra said in the regulatory notice.
Finra also found firms lacked written supervisory procedures for sales of alternative mutual funds. If they did mention alt funds in their policies and procedures, they failed to follow through and understand the funds' features and risks before selling them.
Recent enforcement actions have centered on deficiencies in policies and procedures for selling alternative funds as well as inadequate training for reps, Finra said.
The warning about liquid alts is another example of Finra’s increased scrutiny of complex products. Last month, Finra released a request for comment regarding oversight of leveraged and inverse exchange-traded products, options and other complex investments in an environment where investors can buy them on trading apps and over the internet.
The regulatory notice on liquid alts serves as an admonishment to brokerages but does not create new regulatory or legal obligations. Like most notices, it included best practices for firms to follow to stay in compliance, such as sales restrictions and enhanced trading surveillance and training
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