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Understanding Complex Investments in Era of Innovation

As investors search for better yields with their investments and firms look for innovative financial products to meet that demand, the potential for sales practices abuses also becomes bigger than ever. Richard Ketchum, Chairman and CEO of the Financial Industry Regulatory Authority (FINRA), recently offered comments on this topic at the Securities Industry and Financial Markets Association’s Complex Products Forum in New York.

In his remarks, Ketchum drew attention to today’s growing array of new and complicated investment products and the importance of customer suitability, financial advisor and investor education, due diligence, and the role they play in the sale of complex products to retail investors.

Among other things, Ketchum said broker/dealer firms that offer products such as private placements, structured notes, non-traded real estate investment trusts (REITs) and inverse and leveraged exchange-traded funds (ETFs) must step up their efforts to supervise sellers at every stage of the investment process.

“In the words of the great American philosopher, Casey Stengel: “Most ball games are lost, not won,” Ketchum said. “A baseball game is more likely lost through unforced errors, poor judgment and boneheaded play. Often, the team’s management will properly be held accountable. As we have seen in recent years, a firm that becomes unduly aggressive about the products it sells will forfeit its reputation, its customers and, ultimately, its market share.”

Ketchum noted the need for continuing education for financial advisers who sell complex investments to make sure they are qualified to do so. He also advised firms to more closely review any special incentives provided to their advisers and whether those incentives influence their recommendations or selling methods.

Ketchum concluded his remarks by calling for a heightened awareness on the part of advisors to ensure customers who purchase complex products understand their basic features.

“Some firms only permit the sale of these products to customers who are qualified to trade options,” Ketchum said. “The sale of complex products through discretionary accounts is a particular issue. As we have repeatedly stated, financial advisers should discuss the basic features of these products with retail customers, and include in the discussion the potential risks of those products under different market scenarios. Other additional steps might be needed to ensure that the recommendation of the structured note is consistent with the investment objectives and risk tolerance of particular customers.”

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