Rick Ketchum, Chairman and CEO of the Financial Industry Regulatory Authority (FINRA), recently spoke at the CCOutreach BD National Seminar. Ketchum addressed some specific product concerns:
Over the last couple of years, FINRA has issued a number of Regulatory Notices related to products that have raised concerns for us from an investor protection standpoint. As I’ve said time and again, firms must make sure that all the products they offer—proprietary and non-proprietary—are appropriate for individual customers in light of their needs, goals and current financial situation. However, we continue to see some firms selling products that are not in the best interest of their customers:
Private Placements & Private Self Offerings
First, we’re looking at retail sales of private placement interests, including those issued by broker-dealers and control affiliates. Our examinations and investigations have identified significant failures in firms’ compliance with suitability, supervision and advertising rules, as well as potential instances of fraud and participation in illegal distributions of unregistered securities. A number of these investigations have led to enforcement actions.
Last year, we reminded firms of their obligations to conduct reasonable investigations into “Reg D” offerings. And we highlighted a number of specific practices relating to these offerings that firms should consider. But the bottom line is that the responsibility and the commitment to know what you’re selling—whether it is from a legal or reputational standpoint—is more important than ever. Recently, we have also proposed changes and are requesting comment on an expansion of the provisions of our private placements rule, to provide investors with additional protection from fraud and abuse….
…Non-Conventional Investments
Third, we are looking at firms that sell structured products and certain riskier asset-backed securities to retail investors. Recent enforcement cases highlight the importance of training brokers on products sold and reasonable supervision to ensure suitable recommendations. Brokers must understand the risks and costs associated with the products recommended and disclose them to customers. For instance, collateralized mortgage obligations present a variety of risks, including credit and default risk, interest-rate risk, prepayment risk and extension risk. CMOs are structured into different tranches, each with their own set of rules by which interest and principal get distributed. So it is important for brokers to understand the features of the tranche they are selling and the rules governing its income stream as these affect the product’s risk.
FINRA’s regulatory push into unsafe investment products is welcome. The emphasis on private placements and nonconventional investments should remind investors that just because a client has money (i.e., is an “accredited investor”), brokerage firms are not free to mislead or to solicit investments in investments that are not suited to the client’s needs and objectives. Even a wealthy and sophisticated investor can have the wool pulled over his eyes. Remember Bernie Madoff’s victim? And, just as importantly, if a client (even a rich one who can take a risk) desires safety, the investments recommended to him or her should actually be safe.
By the way, hallelujah to FINRA’s Rich Ketchum for announcing that brokers who sell collateralized mortgage obligations (CMOs) must understand tranches. Tranches are the slices of CMOs (pools of mortgages) that are sold like bonds. The bottom tranches only get paid after the higher level tranches are paid and are deemed adequately protected. These subordinate tranches are the toxic waste produced by Wall Street’s financial meth labs. Our experience in cross-examining brokers in arbitration cases convinces us that virtually no brokers understand these risks.
If you believe you have suffered losses resulting from product concerns, please contact Smiley Bishop & Porter LLP to discuss your rights at 770-829-3850 or toll-free (800) 697-4514. Smiley Bishop & Porter LLP represents individual and institutional investors in securities arbitration and business litigation. The firm focuses on cases involving defrauded investors, suitability claims, and mismarketeted investment products. Smiley Bishop & Porter LLP is available for a free initial consultation. Please visit us at www.sbpllplaw.com to obtain additional information.
