Financial industry worries about Finra’s next step on complex products

Financial industry groups expressed concern about Finra’s stepped-up interest in the sales of complex products, worrying that it may go too far in trying to strengthen protections for investors who make the purchases on their own.

In March, the Financial Industry Regulatory Authority Inc. issued a request for comment about its oversight of risky, complicated investments, such as leveraged and inverse exchange-traded products and options. The deadline for input was Monday, and Finra has been posting the latest letters throughout the week.

Finra said it was seeking public input on whether it needs to update regulations to address concerns related to investors increasingly accessing complex products through self-directed online accounts rather than through a financial adviser.

Trade associations representing brokerages and mutual funds urged Finra to proceed cautiously.

The Securities Industry and Financial Markets Association acknowledged that some retail investors may not understand complex products but asserted that many do and value them for managing risk and achieving investment objectives.

“We are concerned that prospective new regulatory requirements that have the effect of restricting access to these products would deprive retail investors of these products’ significant benefits,” Kevin Carroll, SIFMA managing director and associate general counsel, wrote in a May 9 comment letter.

Carroll said the broker-dealer self-regulator and the Securities and Exchange Commission should define the term “complex product” more narrowly and go through a rulemaking process before applying it to new products.

The SEC’s broker conduct standard, Regulation Best Interest, and existing Finra rules and guidance provide enough protection for investors who buy complex products, Carroll said. He also asserted that the SEC should not extend Reg BI to cover purchases of complex products or options that investors make on their own.

The Investment Company Institute, which represents the mutual fund sector, said brokers make decisions on the suitability of an investment recommendation based on the characteristics of each investor. Adding regulatory requirements for complex products would shift regulation from being product-neutral to determining the merits of individual products.

“Heading in this direction could be the beginning of a slippery slope where the government substitutes its judgment for those of investors,” ICI officials wrote in a May 9 comment letter.

The online brokerage Robinhood provides a platform where much self-directed trading occurs. The firm said Finra’s inclination to increase regulation of complex products purchased by retail investors would undermine its efforts to “democratize finance.”

“Robinhood is concerned that many of the proposed rule changes raised in the [regulatory] notice would do just that — essentially turn back the clock to a time when important investment products, such as options, were only available to elite and privileged investors,” Steve Quirk, chief brokerage officer for Robinhood Markets Inc., wrote in a May 9 comment letter.

The Consumer Federation of America encouraged Finra to clamp down on sales of complex products because “there is abundant evidence that many retail investors are misusing them,” the organization said.

“As key gatekeepers in the market, it is entirely appropriate for broker-dealers to have heightened obligations to ensure that their customers who do not understand complex products and options do not use them,” Micah Hauptman, CFA director of investor protection, wrote in a May 9 comment letter.

The North American Securities Administrators Association, the umbrella group for state regulators, said it has conducted surveys that show that brokers continue to recommend inappropriate complex products to customers because of revenue incentives to sell them despite Reg BI.

To ensure financial firms are acting in the best interests of their retail investors, they must  “properly match complex products with appropriate investors; provide full and fair disclosures regarding the costs, risks, and conflicts associated with these products at the time of recommendation; and eliminate or mitigate compensation conflicts that incentivize firms to steer investors into complex products when lower-cost and lower-risk products are reasonably available,” Melanie Senter Lubin, Maryland Securities Commissioner and president of NASAA, wrote in a May 9 comment letter.

After reviewing the comments, Finra could propose a rule or further guidance. It’s not clear when the regulator might act.

Related Topics: North American Securities Administrators Association Inc (NASAA)