FINRA Has Its Eye on These Financial Products

Last month, the Financial Industry Regulatory Authority (FINRA) published its Regulatory and Examinations Priorities Letter. While the express purpose of this letter is to advise stock brokers and compliance officers about the focus of the accreditation exams many of them will be taking in 2015, the letter also indirectly puts investors and securities professionals on notice concerning some of the more problematic financial products out there on the market today.

Is Your Broker Providing Adequate Disclosure of Your Investments?

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Of course, it’s not the products themselves that are the issue - for the most part, they work just fine. Rather, it’s how financial advisors recommend and use (or misuse) them that can wreak havoc on investment portfolios. As FINRA letter indicates, the most common failing among stock brokers and brokerages is inadequate disclosure to customers about the nature and risks associated with certain complex financial products. Most of us understand how stocks and bonds work, but how many of us know that non-traditional ETFs track a market benchmark and perform at a multiple of that benchmark, and tend to reset on a daily basis? How many of us are aware that non-traded REITs (Real Estate Investment Trusts) contain serious liquidity risks due to their not being traded on a public market - or that they can stop paying distributions altogether, effectively locking up your investment, sometimes indefinitely?

Well, if you’re holding non-traditional ETFs or non-traded REITs in your brokerage accounts, you should know - because your broker should have informed you about these products, especially about unusual features, volatility or liquidity risks.

Financial Products on FINRA’s Radar

VARIABLE ANNUITIES. An investment product very much on the rise, variable annuities are like mutual funds, but more complex. And it is that complexity that FINRA fears investors don’t understand, because brokers aren’t explaining the products well enough. We’ve also seen a number of cases where variable annuities are improperly exchanged in order for the broker to get extra commissions.

ALTERNATIVE MUTUAL FUNDS. Mutual funds using strategies typically deployed by hedge funds. FINRA will be testing stock brokers and brokerages to make sure they are communicating with clients about how alt mutual funds work and particularly how they perform in down markets.

NON-TRADED REITs: As singled out above, Real Estate Investment Trusts are entities that control or manage large portfolios of income-producing properties. Increasingly popular, non-traded REITs do not trade on public exchanges and therefore contain liquidity risks and valuation challenges.

NON-TRADITIONAL ETFs: Weighted exchange traded funds tied to socks, commodities, and other market indices. Demand has been growing for these products, but brokers and investors alike tend to forget that many of these ETFs are designed for daily use only and may be too thinly traded.

STRUCTURED RETAIL PRODUCTS. Unsecured debt instruments that promise higher returns but contain additional liquidity risks, higher costs, and volatility issues.

FLOATING RATE BANK LOAN FUNDS. Retail investors may be exposed to these instruments when investing in certain mutual funds. FINRA wants broker to make clear to investors that these products are potentially quite illiquid, especially if a large number of investors try to make redemptions at once.

SECURITIES-BACK CREDIT. Loans that allow investors to borrow money using securities held in their brokerage accounts as collateral. Wall Street has recently fallen in love with these loans. But FINRA has repeatedly issued warnings about the risks associated with using interest rate sensitive products to secure loans. For more on this trend, see our post here.

Securities Attorneys

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