FINRA Warns BDs on Alt Fund Sales Practices

The Financial Industry Regulatory Authority is reminding broker-dealers of their sales practice obligations when recommending alternative mutual funds, also referred to as “alt funds” or “liquid alts.”

FINRA notes in a Regulatory Notice that it has taken enforcement actions recently against several firms for failing to establish or maintain a reasonably designed supervisory system for recommendations of alternative mutual funds.

FINRA states that it continues to note such deficiencies in its exams and communications reviews of these products.

In recent exams and communications reviews, FINRA explains that it has found:

Inadequate Written Supervisory Procedures

Firms did not address alt funds in their WSPs or maintained WSPs that mentioned the funds but did not include detailed sales practice and review procedures (and, as a result, did not conduct heightened investigation into the funds — including reviewing their unique risks and features — before approving the fund for sale to customers).

Inadequate Alt Funds Oversight

Firms did not implement effective oversight of registered reps’ recommendations of alt funds.

For example, firms failed to limit recommendations of Alt Funds to customers with an appropriate risk tolerance, tailor their trading surveillance and systems to address the unique risks and characteristics of Alt Funds and identify Alt Funds transactions for additional reviews.

Insufficient Review of Communications With the Public

Firms did not review whether retail communications they used to market alt funds provided a sound basis for evaluating the facts with respect to these products.

For example, FINRA says, they promoted the funds based on their use of complex strategies, like short selling, derivatives, options trading or leverage, but failed to explain clearly how the strategies worked and their risks.

The notice, according to FINRA, is intended to remind BDs of their obligations and provide them with ideas and questions that they can use to enhance their supervisory programs.

FINRA notes that industry participants, including broker-dealers, “have marketed or recommended alt funds to retail customers as products with sophisticated, actively managed hedge fund-like strategies that will perform well in a variety of market environments.”

While these funds may be appropriate for some investors, FINRA states that it “has consistently emphasized the importance of member firms’ sales practice obligations for these and other products, especially when such products may carry additional risks for customers.”