WealthManagement.com: What investments is FINRA looking at closely this year?
Gerri Walsh: We are focused on complex products, including structured notes, reverse convertibles and inverse or leveraged ETFs. These investments may include derivative-like features that may make it difficult for a retail investor to understand the essential characteristics of the product and its risks. We are also focused on costly and potentially illiquid investments like non-traded REITs and private placements.
WealthManagement.com: Why those investments? What’s risky or dangerous about them?
GW: With yields on many fixed-income investments at historically low levels and a volatile stock market, investors may be tempted to chase returns by investing in complex, costly or illiquid products that promise high returns. Investors have to look beyond a product’s return, whether past or projected. Higher returns come with higher risk.
WealthManagement.com: Do you have any advice for advisors in avoiding arbitration or litigation related to the use of these products? Should they just avoid these products altogether?
GW: FINRA has frequently reminded firms of their obligation to assess the potential risks associated with products that raise specific investor protection concerns. FINRA Regulatory Notice 12-03 on complex products might be a good place to start. Notice 12-03 also links to previous regulatory notices on specific products, including leveraged and inverse ETFs and structured notes with principal protection.
WealthManagement.com: Do you think these products have a place in investors’ portfolios?
GW: There is no product that is either right or wrong for all investors. Retail investors in particular need to make sure they understand how a product works before they invest in it. They need to understand how risky, costly and liquid their investments are. If an investor does not understand a product, he or she should think twice about investing in it.
WealthManagement.com: Recently, what is the biggest action FINRA has brought against an advisor or broker/dealer related to one of these investments?
GW: In May, FINRA announced that it sanctioned Citigroup Global Markets; Morgan Stanley & Co.; UBS Financial Services; and Wells Fargo Advisors a total of more than $9.1 million for selling leveraged and inverse ETFs without reasonable supervision and for not having a reasonable basis for recommending the securities. The firms were fined more than $7.3 million and are required to pay a total of $1.8 million in restitution to certain customers who made unsuitable leveraged and inverse ETF purchases.
WealthManagement.com: What can investors do to better protect themselves against investment blow-ups or fraud?
GW: We urge all investors to use BrokerCheck to check out the background of both investment professionals and firms. Investors should also check to make sure the investment they are considering is in the SEC’s EDGAR database. Most fraud involves unlicensed professionals and/or unregistered products.
Diversification, with its emphasis on variety, allows investors to manage nonsystematic risk by tapping into the potential strength of different subclasses, which, like the larger asset classes, tend to do better in some periods than in others. Diversification can also help limit the damage done by fraud.
WealthManagement.com: What should investors look for in a broker they’re looking to hire? What questions do they and should they ask?
GW: Investors should start by identifying their own financial needs. Having a clear understanding of what they are looking for in an investment professional can prevent them from paying for services they don't really require—or from choosing someone who cannot provide all the services they need. Investors should interview financial professionals and ask questions like:
- What investment products and services do you recommend to your clients? Why?
- Are there any products or services you don’t recommend? Why?
- How much will I have to pay for your services? What is your usual hourly rate, flat fee, or commission?
- Are you compensated any other way for handling my account? If so, how and how much?
- Will you or your firm receive any additional compensation for selling me a particular product, service, or type of account?
FINRA.org/investors has a step-by-step guide that to help investors choose a professional that meets their needs.
WealthManagement.com: What other investor education initiatives does FINRA have on the horizon this year?
GW: We will continue to grow Investor Protection Campaign as well as our Military Financial Education and Teen Financial Literacy projects. And, in consultation with the President’s Advisory Council on Financial Capability, the U.S. Department of the Treasury and others, we will conduct a second wave of the National Financial Capability Study, a robust analysis of the financial behaviors, attitudes and knowledge of nearly 30,000 Americans.