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SEC Issues Warning on Complex Investment Products

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Securities and Exchange Commission Chairman Jay Clayton issued a warning Wednesday about expanded access to self-directed accounts and complex investment products and how they’re marketed to retail investors, and signaled tighter controls may be in the offing.

In a joint statement with the heads of the SEC’s Divisions of Investment Management, Trading and Markets, and Corporation Finance, Clayton stated that retail investors “have a wide array of investment options available to them, including an increasing number and type of investment products that are more complex than conventional stock and bond investments.”

These complex products may be exchange-traded or sold directly to investors — including “leveraged/inverse” products, which seek to provide leveraged or inverse exposure to an underlying index by a specified multiple generally on a daily basis, as well as products that provide investment exposure to less conventional assets, including commodity prices, Clayton and the SEC officials said.

“We believe that these leveraged/inverse products and other complex products may present investor protection issues — particularly for retail investors who may not fully appreciate the particular characteristics or risks of such investments, including the risks that holding such products may pose to their investment goals,” the statement said.

The officials noted that Regulation Best Interest’s standard of conduct for brokers and an investment advisor’s fiduciary duty “apply to transactions in complex products where the transaction is recommended to a retail customer.”

Related: SEC Chief: Firms ‘Meeting Their Obligations’ on Reg BI

A broker-dealer or an advisor “recommending or advising on such products must have a reasonable basis to believe that the recommendation or advice provided is in the best interest of the retail investor,” the officials said. “A broker-dealer, moreover, cannot establish a reasonable basis to recommend complex products to retail customers without understanding the terms, features and risks of these products.”

In commenting on the statement, Jim Lundy, partner in Faegre Drinker’s Chicago office, told ThinkAdvisor via email Wednesday that “the SEC has disliked complex products being marketed to retail investors for some time; going back to when I was on the staff.”

Now, with Reg BI, Lundy said, “they have a new weapon in their arsenal to combat this. When the SEC issues public statements like this, risk alerts, or FAQs, the examination and enforcement staff use these and the points made therein to support certain positions taken in examinations of registrants and enforcement investigations.”

For firms that do business in this area with retail investors, Lundy added, “they should analyze this public statement closely, apply it to their practices, and make improvements where necessary.”

The SEC officials noted the “dynamic, expanding and ever-changing marketplace,” and stated that they would be mulling “whether existing protections can be improved, including examining whether such protections, and our oversight and enforcement of those protections, are sufficient to address the investor protections concerns raised by the expanded retail investor access to self-directed accounts and complex investment products.”

Based on the review, SEC “staff will make recommendations to the Commission for potential new rulemakings, guidance or other policy actions, if appropriate,” the officials said.

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