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Alternative Investments on Regulators’ Radar

Complex investments like non-traded REITs, structured notes and private placements are increasingly capturing the attention of investors for their potential to produce high returns. But they’re also garnering unwanted scrutiny from regulators, many of whom believe that some buyers of these investments fail to fully understand their many risks, as well as hidden costs and fees.

As reported Aug. 15 by the Wall Street Journal, some state securities regulators – as well as the Financial Industry Regulatory Authority (FINRA) – are ramping up their examinations and investigations of the sales practices of securities firms that sell alternative investments. Several say they may file civil enforcement actions by the end of the year.

“With these things, it can be like giving a 6-year-old a circular saw,” said Brad Bennett, FINRA’s enforcement chief, in the WSJ article. “Most mom-and-pop investors “don’t understand the risks they’re taking.”

As for the firms that market and sell alternative products, they claim such investments can add balance to investors’ portfolios along with some protection if the markets go into a free fall. They also believe that many alternative investments give retail investors access to products that were once available only to the very wealthy.

Driving the popularity of alternative investments is demand from investors searching for attractive yields and a desire to diversify away from securities that plummeted in the financial crisis, says the Wall Street Journal story. The article goes on to report that most alternative products have trailed far behind the S&P 500-stock index this year, but investors and experts say the aim is to earn reasonable returns in good times or high yields and diversification.

Regulators, however, contend that while alternative investments may be typically fine as a small part of a sizable portfolio, they aren’t suitable for many people because of their costs, volatility and, in some products, lack of liquidity.

FINRA’s Bennett says regulators are increasingly concerned about whether brokers are selling alternative investments to clients who don’t meet the suitability standards and don’t understand the risks.

Last year, FINRA fined a group of banks for selling billions of dollars of leveraged exchange-traded funds improperly, in some cases targeting conservative investors who were seeking investments that offered stability.

More recently, Massachusetts censured and ordered restitution from LPL Financial Holdings and Ameriprise Financial for selling unqualified investors non-traded real estate investment trusts that had commission rates as high as 7%.

Adding to regulators’ concerns about alternative investments is the recent decision by the Securities and Exchange Commission to permit hedge funds to advertise, for the first time, to the general public.

“Our concern is there’s a different atmosphere now,” said William Galvin, Massachusetts’ Secretary of the Commonwealth. “Regulations have been eased on advertising, and these firms are using more aggressive sales tactics.”

Galvin’s office sent subpoenas to 15 securities firms last month demanding information on their sales practices of alternative products to seniors.

Heath Abshure, Arkansas’s securities commissioner and president of the North American Securities Administrators Association, said alternative investments are “one of our biggest investment problems, and all our members are looking at them.”



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