SEC headquarters in Washington SEC headquarters in Washington. (Photo: Diego Radzinschi/ALM)

The Securities and Exchange Commission is warning RIAs and broker dealers to “implement robust and effective policies and procedures” to prevent violation of federal securities laws when they advise on or recommend complex exchange-traded products (ETPs).

Just days after the agency settled charges with five firms including Summit Financial Networks, the largest broker-dealer in the Cetera Financial Group, and American Portfolios Financial Services for making unsuitable sales of complex ETPs to retail investors, the SEC took the unusual step of issuing a public statement admonishing firms to ensure that their financial professionals understand the risks and purpose of complex ETPs and, along with independent contractors, follow firm policies and procedures to prevent violations of laws. 

(Related: Advisor Group, Cetera and Other BDs to Pay $3M Over Sales of Risky ETPs)

The charges against the five firms, whose settlements returned a total $3 million to investors, involved VIX-related ETPs that were intended for short-term use but were held longer, causing clients financial harm. The brokerage and advisory representatives of the five firms either failed to understand the product, determine its suitability or misrepresented risks to clients. In all cases the firms failed to provide their reps with the proper training about these products.

In its public statement, the SEC noted that “under the Regulation Best Interest and an investment adviser’s federal fiduciary duty,” a financial professional recommending complex risk products should “apply heightened scrutiny” to understand the features and risks of such products, whether a particular a product fits within a client’s or customer’s risk tolerance and trading objective and whether it requires daily monitoring by the investor or the financial professional.

The responsibility, however, doesn’t rest only with the individual broker or investment advisory rep but also with the financial firm that allows its financial professionals access to the broad scope of products on investment platforms.

“A recommendation by a firm’s financial professionals is a recommendation of the firm,” according to the SEC’s statement.

To that end, the SEC said it is is “critically important for firms to implement policies and procedures” that are “reasonably designed” so that their financial professionals:

  • Understand the risks and purposes of the products they recommend to clients
  • Apply the necessary heightened scrutiny to those products
  • Only recommend products that comply with legal standards
  • Monitor investments daily, as applicable.

The SEC also noted that the Office of Compliance Inspections and Examinations will “continue to review for inappropriate use of complex investment products and evaluate the robustness and effectiveness of related supervisory policies and procedures.”