RIA Compliance Blog
Earlier this month, the Financial Industry Regulatory Authority (FINRA) released a letter addressing broker-dealer’s practices in recommending high-yield products to clients. The letter states, “FINRA is informing its examination priorities against the economic environment that investors have faced since 2008, as these circumstances have steadily contributed to conditions that foster an increased risk of aggressive yield chasing, inappropriate sales practices, unsuitable product offerings, and misappropriation and fraud.” The purpose of the letter is to warn broker-dealers not to engage in practices intended to beat the market and instead to promote what is suitable for the investor.
Investors are being urged by their brokers to engage in yield chasing, which means they are seeking higher returns on their investments. The investors in this situation may not completely understand the risk versus reward tradeoffs by investing in this manner especially when brokers are recommending more complex products as discussed in a previous blog, FINRA Wants Heightened Supervision of Complex Products. FINRA’s concerns include the full disclosure of material risks, mispricing and overcharging issues, and the suitability of products based on those underlying risks. It urged firms to increase their supervisory systems to ensure that firms are complying with regulations.
As well as yield chasing, FINRA is concerned with lack of liquidity and inadequate cash flow. It also wants to ensure that transparent and accurate details of the cash flows and financial condition are available to the investor at the time of investment.
FINRA also emphasized that suitability reviews will be of continued importance in the coming year since the new Suitability Rule and Know Your Customer Rule, previously mentioned in our blog, SEC Postpones “Fiduciary Duty Rule” Again, will become effective on July 9. It oversees about 4,460 broker-dealers and enforces the suitability standard, which requires brokers to sell products that fit their clients’ investment needs, timelines and risk appetites.
FINRA identified products that are susceptible to concerns in relation to suitability. The following products are not intended to be an exclusive list, but they raise the most concerns when sold to retail investors:
- Residential mortgage-backed securities and commercial mortgage-backed securities,
- Non-traded REITs;
- Municipal securities;
- Complex exchange-traded products;
- Variable annuities;
- Structured products;
- Securities offered through private placement;
- Unregistered securities acquired in secondary markets;
- Church bonds;
- Promissory notes; and
- Life settlements.
On the issue of fees, FINRA states, “We remain concerned about firms charging retail investors hidden, mislabeled or excessive fees. Fair dealing with customers requires that firms charge only reasonable fees and disclose those fees up front in a manner that retail investors can make informed investment decisions.” FINRA brought cases against several broker-dealers in 2011 for charging excessive fees.
FINRA’s letter addresses many other issues facing brokers-dealers, some of which we have previously discussed such as more regulation in relation to branch office inspections and social media and electronic communications. The purpose of the letter was to put broker-dealers on notice to enhance their supervisory and compliance programs in order to mitigate risk and protect investors.
Parker MacIntyre provides legal and compliance services to investment advisers, broker-dealers, registered representatives, hedge funds and issuers of securities, among others. Our regulatory practice group assists financial service providers with the complex issues that arise in the course of their businesses, including compliance with federal and state laws and rules.