The Financial Industry Regulatory Authority (FINRA) is conducting a review of firm practices related to higher-risk structured products
The review will examine how firms supervise concentrations in these products, particularly non-principal protected “worst-of” structured notes. The review will examine how they comply with Regulation Best Interest and FINRA rules when their registered representatives recommend these products to investors.
Structured products are designed to meet specific investment objectives for retail investors, such as growth, income or risk management. Typically, they combine a traditional security, like a bond, with a derivative component. However, unlike a mutual fund or exchange-traded fund, a structured note does not hold an actual underlying portfolio of investments. Instead, the note issuer promises to pay a return based on a formula that incorporates the performance of one or more reference assets.
FINRA notes that structured products have unique risks and can be more complex, which may warrant heightened supervisory scrutiny. Certain structured products, particularly those that provide payoffs that depend upon the worst performing reference asset in a pre-specified group, commonly referred to as “worst-of” notes, have especiually complex features.
FINRA has identified multiple cases where firm representatives have concentrated their customers’ assets in structured products that increase complexity and risk. These highly concentrated investments can pose risk, and that risk is heightened when the concentrated investment is a complex product.
FINRA’s review of firm supervision for concentration in higher-risk structured products will only affect a subset of member firms. However, FINRA encourages all firms that recommend these products to review the questions in the letter and evaluate their practices. Guidance on complying with rules and regulations applicable to these and other products is available at www.finra.org.