Pictured: FINRA sign in lobby at Brookfield Place in New York. Photo: FINRA
The Financial Industry Regulatory Authority said Tuesday that it has launched a sweep of broker-dealers' practices related to supervision of concentrations in non-principal protected "worst-of" structured notes, a higher risk structured product.
The broker-dealer self-regulator said that it is examining how firms ensure compliance with Regulation Best Interest — including Reg BI's care and conflict of interest obligations — and with FINRA rules when BDs permit their registered representatives to recommend those products.
"Worst-of" structured notes, FINRA explains, "refers to principal-at-risk structured notes that may result in a reduction or cessation in interest payments, and/or a reduced return of principal at maturity, based on the worst-performing asset in a group of two or more reference assets."
FINRA said in a statement that it has identified "multiple instances where firm representatives have concentrated their customers' assets in structured products that increase complexity and risk. This includes characteristics such as a lack of principal protection and "worst-of" features, among others."
While only a "subset" of firms will be affected by the sweep, FINRA said that it "encourages all firms that recommend these products to review the questions in the letter and evaluate their practices."
FINRA is seeking information related to this activity between Jan. 1, 2022, through Dec. 31, 2025.
Firms are asked to provide, for instance, copies of the firm's written supervisory procedures related to structured notes and complex products, and to describe how the firm categorized structured notes for supervision purposes, including classifications, if any, based on product risk such as principal protection or "worst-of" features.
Also, BDs should provide "any restrictions or limitations the firm placed on recommendations of structured notes (including non-principal protected, worst-of structured notes), including but not limited to concentration limitations." FINRA is also looking for as "any supervisory alerts/exceptions the firm had in place for structured notes (including but not limited to any concentration alerts or Reg BI/suitability alerts) and the corresponding trigger criteria."
The request list from FINRA Tuesday "shows the all-encompassing approach to Reg BI inquiries, ranging from compliance program to surveillance to training to compensation," said Valerie Mirko, partner and leader of the securities regulation and litigation practice at Armstrong Teasdale in Washington.
"It further underscores that an effective Reg BI program needs to take a holistic approach," Mirko added. "The focus here is both on the principal protection aspects of the notes at hand, specifically, and more broadly, Reg BI programs and how they are structured."
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