FINRA Regulatory Notice: Complex Products

By Tim Husson, PhD

FINRA recently released Regulatory Notice 12-03: Heightened Supervision of Complex Products, outlining their increased scrutiny of a wide variety of alternative investments including structured products, inverse or leveraged exchange traded funds, and asset-backed securities. Here at SLCG, we’ve done research on each of those subjects, and have a variety of ongoing projects that bear directly on the issues highlighted by the Notice.

The products identified include:

• Asset-backed securities and non-traded REITs; 
• CMS-rate linked structured products; 
• ‘Steepener’ and ‘flattener’ products; 
• Reverse convertibles; 
• Range accruals; 
• ‘Worst-of’ structured products, whose payoff is linked to basket of securities; 
• Products linked to complex indexes such as the VIX; 
• Principal protected notes; 
• Leveraged and inverse ETFs, 
• Other products with complex payoff formulas. 

Our research strongly supports the notion that these products demand increased scrutiny by both regulators and investors themselves, as we have documented numerous examples of overpricing and complex risk factors. The FINRA Notice recognizes the need for proper due diligence, broker and investor education, internal controls, and extensive suitability analysis before selling these products to retail investors. It is our opinion that structured products are virtually never suitable for unsophisticated investors; however, we hope the FINRA Notice will at least increase standards for selling these products in the retail market.