Wednesday, July 27, 2011

SEC Press Release: Structured Products

SEC Staff Issues Summary Report of Sweep Examination of Structured Products Sold to Retail Investors

The Securities and Exchange Commission (SEC) issued a press release today announcing that it had
issued a report identifying common weaknesses seen in sales of structured securities products and describing measures by broker-dealers to better protect retail investors from fraud and abusive sales practices.
The report is a result of studies in the structured products business of 11 broker-dealers. The report found that broker-dealers might have made unsuitable recommendations of structured products to customers, sold products at prices that hurt customers, “engaged in questionable sales practices”, and “omitted material facts” about structured products from customers. Moreover, the Staff (that wrote the report) suspects that broker-dealers failed to provide adequate supervision of, and training for, their brokers who marketed and sold structured products. The report can be found here.

Almost six years ago, we saw the Financial Industry Regulatory Authority (FINRA) publish guidance notes to members concerning their obligations in relation to the sale of structured products. Four such obligations are worth noting. First, members are required to “perform a reasonable-basis suitability determination.” Second, members must “deal fairly with customers with regard to derivative products.” Third, firms must “supervise and maintain a supervisory control system.” Fourth, firms must “train associated persons” (p.1).

Evidently, six years have passed and more than a few brokers have failed to meet such obligations. For example, it was only six days ago that the state of Georgia subpoenaed UBS AG, Morgan Stanley and Ameriprise Financial Inc. requesting information from these brokerage firms in an investigation into whether these firms violated state securities’ laws in the sale of reverse convertibles, a structured product.

From the report we can see that the structured products market is in need of more adequate supervision. Investors can better protect themselves by looking more closely at the hidden risks and costs of structured products. Investors should fully understand, amongst other things, a structured product’s payoff structures, all associated fees, liquidity and credit risks, and risks associated with the reference asset before committing to purchasing it.

SLCG has a dedicated website providing papers, notes and calculation tools on a variety of structured products which may be of help to investors. Related papers include:

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