Richard G. Ketchum, Chairman and CEO of FINRA, appeared before the securities industry trade group SIFMA at its Complex Products Forum on September 27, 2012 in New York to admonish brokerage firms about the perils and obligations involved in marketing complex investment products to investors.
According to Ketchum, while there is no legal definition of a complex product, a security “might be considered complex if the average retail investor probably will not understand how its features will interact under different market conditions, and how that interaction might affect potential risk and return.” In other words, a complex product is a financially engineered investment with an elaborate and often confusing structure. He pointed to recent FINRA enforcement actions in which firms were sanctioned for selling complex products such as leveraged and inverse ETFs, asset-backed securities, collateralized mortgage obligations and so-called structured notes. He warned firms that “if you are going to offer these types of products to retail investors, you must supervise them at every stage…It would be foolish for any firm …to distribute complex products to retail investors without ensuring that products are vetted, reps are trained and supervised and risks are disclosed in a way that the average investor can understand.”
It is essential for retail investors to understand that often complex securities are so confusing that the even the advisors and brokerages selling them are frequently at a loss to thoroughly understand them. Local news sources have publicized the more commonly known complex products like mortgage backed securities (MBS), collateralized mortgage obligations (CMO), asset backed securities (ABS), and collateralized debt obligations (CDO) which sometimes makes investors feel more familiar with them than they actually are. This familiarity can be misleading leaving retail investors as easy prey for investment firms who quickly convince that these securities are practically a sure thing.
Although Ketchum stated that the complexity of certain products did not make them inherently unsuitable for all investors, in our experience, brokerage firms are far too quick to mass market complex products that might be suitable as a small holding for a severely limited number of ultra-sophisticated clients to every Tom, Dick, and Harriett and their IRAs. Our experience in representing aggrieved investors has shown us that brokerage firms like to sell complex products because they are often stuffed with hidden fees that go to the firm and its affiliates and appear to offer a magic formula for marrying higher return with lower risk. But a wise investor knows that fees to your broker come at your expense and high returns always come with high risks. An investor whose wisdom comes from having been burned should know that losses caused by fraud, misrepresentation, failure to disclose risks, or unsuitable sales of complex financial products may be recovered through FINRA arbitration. If you have learned your lesson the hard way, feel free to give us a call to see if we can help.