A recent exam by the Securities and Exchange Commission of 10 broker-dealers’ branch offices revealed “significant deficiencies” in the BDs’ suitability and supervision of sales of structured securities products to investors.
Violations included an over-concentration of sales to customers who were non-English speaking, elderly or had a conservative investment objective. One firm had even retroactively changed customers’ stated investment objectives in order to sell them more structured products.
The SEC’s Office of Compliance Inspections and Examinations released Tuesday a risk alert detailing the findings of exams conducted on 10 branch offices of registered broker-dealers that distribute SSPs issued by their parents or affiliates or by unaffiliated third parties.
While significant deficiencies were found in the suitability and supervision of such sales, BDs also failed to maintain and/or enforce adequate controls relating to determining the suitability of SSP recommendations, and failed to review reps’ determinations of customer suitability in the SSPs.
The SEC notes that SSPs have been increasingly marketed to retail investors as they search for income in the persistently low-yield interest-rate environment. SSPs also may offer “attractive attributes” such as partial or full principal protection or exposure to a particular asset class.
SSPs derive their value from, and provide exposure to, a variety of underlying asset classes such as a single security, baskets of securities, indexes, options, commodities, and/or foreign currencies. The products, which may or may not be listed on an exchange, typically have some form of embedded derivatives and may supply, among other things, principal protection, interest payments, or leveraged exposure to the referenced assets, the SEC explains.
The products “may be more complex than a simple debt instrument with a stated interest rate,” the SEC states.
Indeed, Jon Henschen of the broker-dealer recruiting firm Henschen & Associates says that advisors and broker-dealers “need to step up education and due diligence on more complex products in general, especially when they are intermixed with embedded derivatives that make it difficult to measure levels of additional risk.”