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Structured Products: Legal and Regulatory Materials

FINRA Communications Rules

Issuers, distributors and others involved in the creation and sale of structured products cannot ignore the growing body of statements and actions by regulators relating to structured products. Due to the variety of structured products and that issuers may be different types of financial institutions, there is no single regulation or body of regulation applicable to the issuance, sale and marketing of structured products. You will find below many of the most significant US legal resources applicable to the issuers, structurers and distributors of these products. This is not a complete collection of the regulatory reference materials that may be relevant to structured products; however, these materials are intended as useful references for market participants.

 

FINRA Releases and Publications Relating to Structured Products

  • 2/2018 FINRA Annual Regulatory and Examination Priorities Letter
    This FINRA 2018 Regulatory and Examination Priorities Letter identifies topics that FINRA will focus on in 2018, and these include some new topics as well as others that remain ongoing areas of focus. In this letter, one of the topics, suitability, relates to structured products. Also mentioned is new FINRA Rule 2165, which protects against financial exploitation of vulnerable investors, such as seniors.
  • 10/2017 FINRA Regulatory Notice 17-32, Volatility-Linked Exchange-Traded Products
    In this regulatory notice, FINRA reminds its members  of their sales practice obligations in connection with volatility-linked exchange traded products (ETFs and ETNs) including, without limitation, that recommendations to customers must be based on a full understanding of the terms, features and risks of the product recommended, sales materials must be fair and accurate, and firms must have reasonable supervisory procedures in place to ensure that these obligations are met when recommending these products to investors, with a particular focus on retail investors.
  • 10/2017 FINRA Consent Agreement Relating to Volatility Products
    In this action, FINRA fined a broker-dealer for unsuitable recommendations, training and supervision relating to sales of volatility-linked products.
  • 8/2017 FSC Securities Corporation
    A broker-dealer was sanctioned by FINRA for insufficient procedures and supervision relating to the sale of leveraged and inverse ETFs to retail investors. The broker-dealer allowed these non-traditional ETFs to be treated as “buy-and-hold” investments by certain customers who lost significant sums.
  • 6/2017 Coastal Equities, Inc.
    This broker-dealer was sanctioned by FINRA for insufficient due diligence and post-sale reviews in connection with the sale of leveraged and inverse ETFs.  The dealer had written procedures for sales of those products, but did not follow them.
  • 6/2016 Remarks from the SIFMA Complex Product Forum, Thomas Selman, Executive Vice President Regulatory Policy, FINRA
    Mr. Selman addresses issues for broker-dealers arising in connection with offerings of products that feature multiple contingencies, such as “worst of” features.
  • 2/2016 Investor Alert— High-Yield CD Offers Can Be Bait for High-Commission Investments
    FINRA warns investors that advertisements promoting CDs with high rates may be a bait and switch tactic used to interest investors in completely different investments with high commission structures, such as fixed or equity-indexed annuities. The alert resulted from calls made to FINRA’s helpline for senior investors.
  • 8/2015 Sweep Letter Relating to Broker-Dealer Compensation
    A letter to FINRA member firms requesting information about their broker compensation practices, including the identification of conflicts of interest arising from compensation policies.
  • 10/2013 FINRA Report on Conflicts of Interest 
    This report focuses on broker-dealers’ approaches to identifying and managing conflicts in three critical areas: enterprise-level frameworks to identify and manage conflicts of interest; approaches to handling conflicts of interest in manufacturing and distributing new financial products; and approaches to compensating associated persons, particularly those acting as brokers for private clients.
  • 4/22/2013 Interpretive Guidance Regarding the Use of Pre-Inception Index Performance in Institutional Communications
    This interpretive letter to ALPS Distributors relates to the use of back-tested or hypothetical performance data for a new market measure in advertising and provides guidance for the use of that data in institutional communications.
  • 4/9/2013 Remarks From the National Compliance Outreach Program for Broker-Dealers
    Chairman and CEO Richard G. Ketchum addresses regulatory concerns regarding complex and structured products and conflicts of interest.
  • 12/2012 FINRA Regulatory Notice 12-55 – Suitability
    FINRA Rule 2111 (Suitability) became effective on July 9, 2012. In May 2012, FINRA issued Regulatory Notice 12-25, which provides guidance on the rule in a "frequently asked questions" format. This Notice addresses two issues discussed in Regulatory Notice 12-25: the scope of the terms "customer" and "investment strategy." In addition, FINRA has created a suitability Web page at http://www.finra.org/industry/suitability, which locates in one place questions and answers regarding FINRA Rule 2111.
  • 7/10/2012 FINRA Investor Alert: Exchange-Traded Notes—Avoid Unpleasant Surprises
    This investor alert describes ETNs, leveraged and reverse ETNs, ETN trading, issuance, and redemption. This alert also warns investors of the difference between an ETN’s indicative value and its market price, as well as other risks associated with ETNs.
  • 5/2012 FINRA Regulatory Notice 12-25 - Suitability
    This notice provides additional guidance on FINRA’s new suitability rule, Rule 2111. Some of the additional guidance applies to sales practices in the structured products industry.
  • 1/2012 FINRA Regulatory Notice 12-03 - Complex Products
    FINRA Regulatory Notice 12-03 is one of FINRA’s most significant statements relating to structured products, and discusses the heightened supervision of complex products, gives guidance to firms about supervision, and attempts to identify the characteristics that render a product “complex.”
  • 11/16/2011 FINRA Investor Alert: The Grass Isn’t Always Greener—Chasing Return in a Challenging Investment Environment
    This investor alert discusses high yield investment products such as floating rate loans, structured retail products, and leveraged products. The alert advises investors to ask certain key questions before changing investments, as well as to be wary of fraudulent high-yield investments.
  • 11/2011 FINRA Targeted Examination Letter: Spread- Based Structured Products
    FINRA conducts an inquiry regarding spread-based structured products.
  • 5/2011 FINRA Regulatory Notice 11-25 - Know Your Customer & Suitability
    This Notice announced the new implementation date of July 9, 2012 for FINRA’s rules governing know-your-customer and suitability obligations, and provides guidance in response to some industry questions and concerns.
  • 1/2011 FINRA Regulatory Notice 11-02 - Know Your Customer and Suitability
    The text of FINRA’s new know-your-customer and suitability rules is set forth in an attachment to this Notice.
  • 10/2010 FINRA Regulatory Notice 10-51 - Commodity Futures-Linked Securities
    This Regulatory Notice focuses on four areas: (1) possible deviation between the performance of the commodity futures-linked security and the performance of the referenced commodity; (2) ensure communications are fair and balanced and provide appropriate disclosures; (3) conduct reasonable suitability assessments prior to recommending commodity futures-linked securities to customers; and (4) supervision and training of the firm’s registered representatives.
  • 10/2010 FINRA Regulatory Notice 10-52 - Free Writing Prospectuses
    The content standards, principal review requirements and applicable filing requirements contained in NASD Rules 2210 (Communications with the Public) and 2211 (Institutional Sales Material and Correspondence ) now apply to free writing prospectuses distributed by broker-dealers in a manner reasonably designed to lead to their broad unrestricted dissemination, as described in Rule 433 of the Securities Act. As a result, FINRA is withdrawing, in part, previous interpretative guidance from August 2006 that excluded FWPs from the requirements of Rules 2210 and 2211.
  • 2/2010 FINRA Regulatory Notice 10-09 - Reverse Convertibles
    This Regulatory Notice discusses communications with the public regarding the promotion of reverse convertibles; ensuring a firm’s registered representatives review suitability before recommending reverse convertibles to any customers; and the supervision and training of a firm’s registered representatives.
  • 12/2009 FINRA Regulatory Notice 09-73 - Principal-Protected Notes
    This Regulatory Notice discusses ensuring that communications are fair and balanced and providing appropriate disclosures; ensuring a firm’s registered representatives conduct reasonable suitability assessments prior to recommending principal-protected notes to customers; and training the firm’s registered representatives.
  • 11/2009 FINRA FAQ - Non-Traditional ETFs
    This FAQ describes leveraged/inverse ETFs, the effects of the reset feature of a leveraged or inverse ETF on suitability, the requirements for suitability analysis, the suitability of leveraged and inverse ETFs for retail investors, concerns about treating leveraged or inverse ETFs as long term investments, guidance for firms as new complex or non-traditional ETFs are introduced to the market, and similar analysis applicable to leveraged or reverse mutual funds.
  • 9/2005 NASD Regulatory Notice 05-59 - Structured Products
    This Regulatory Notice discusses providing balanced disclosure in promotion efforts; ascertaining accounts eligible to purchase structured products; dealing fairly with customers and performing suitability determinations; and supervisory control systems and training.
  • 4/2005 NASD Regulatory Notice 05-26 - New Products
    NASD Regulatory Notice 05-26 discusses written formal procedures for vetting new products; and a survey of best practices.
  • 10/2002 NTM 02-69 - Brokered Certificates of Deposit
    This notice provides guidance about brokered CDs (which include structured certificates of deposit), including sales practices and disclosures on customer account statements.

FINRA Enforcement Actions Relating to Structured Products

  • 10/2017 Wells Fargo Clearing Services, LLC
    A broker-dealer settled charges with the SEC relating to improper sales of structured CDs and notes. The broker-dealer had generated large fees by encouraging retail customers to trade structured products prior to their maturity and replace them with similar securities. The broker-dealer’s supervisory procedures were insufficient to prohibit these short-term trading activities.
  • 8/2015 Wells Fargo Advisors LLC
    This consent agreement addresses internal brokerage communications and training as to relevant transaction terms and risk factors in connection with complex products.
  • 3/2014 LPL Financial 
    This action does not arise out of structured products, but from the sale of other non-traditional investments. FINRA’s findings provide a useful “case study” as to the types of issues that a firm should consider in evaluating its own processes for sales of complex products.
  • 12/15/2011 FINRA Enforcement Actions: Wells Fargo Investments, LLC
    FINRA fined Wells Fargo Investments, LLC for unsuitable sales of reverse convertible securities through one broker to 21 customers, and for failing to provide sales charge discounts on UIT transactions to eligible customers. The firm was required to pay restitution to customers who did not receive UIT sales charge discounts and to provide restitution to certain customers found to have unsuitable reverse convertible transactions. FINRA also filed a complaint against Alfred Chi Chen, the former firm registered representative who recommended and sold the unsuitable reverse convertibles and made unauthorized trades in several customer accounts, including accounts of deceased customers.
  • 4/12/2011 FINRA Enforcement Actions: Santander Securities Corporation
    FINRA fined Santander Securities of Puerto Rico for deficiencies in its structured product business, including unsuitable sales of reverse convertible securities to retail customers, inadequate supervision of sales of structured products, inadequate supervision of accounts funded with loans from its affiliated bank, and other violations related to the offering and sale of structured products. The firm reimbursed more than $7 million for reverse convertible losses.
  • 4/11/2011 FINRA Enforcement Actions: UBS Financial Services, Inc.
    FINRA fined UBS Financial Services, Inc., and required UBS to pay restitution for omissions and statements made that effectively misled some investors regarding the "principal protection" feature of 100% Principal-Protection Notes Lehman Brothers Holdings Inc. issued prior to its September 2008 bankruptcy filing.
  • 10/20/2010 FINRA Enforcement Actions: Ferris, Baker Watts LLC
    FINRA fined the former Ferris, Baker Watts LLC for inadequate supervision of sales of reverse convertible notes to retail customers, as well as unsuitable sales of reverse convertibles to 57 accounts held by elderly customers who were at least 85 years old and customers with a modest net worth.
  • 2/16/2010 FINRA Enforcement Actions: H&R Block Financial Advisors, Inc.
    FINRA fined H&R Block Financial Advisors for failing to establish adequate supervisory systems and procedures for supervising sales of reverse convertible notes to retail customers. FINRA also fined and suspended an H&R Block broker for making unsuitable sales of reverse convertible notes to a retired couple. The firm was ordered to pay restitution to the couple for losses they incurred. FINRA issued guidance for firms and for retail investors regarding risks, potential rewards and complexity of this popular structured product.

 

SEC Materials

  • 2/2018 Speech – Increasing Product Complexity: What’s at Stake?
    Comments of Commissioner Kara M. Stein
  • 2/2018  OCIE Examination Priorities
    The 2018 OCIE examination priorities are broken down into five categories:  (1) compliance and risks in critical market infrastructure; (2) matters of importance to retail investors, including seniors and those saving for retirement; (3) FINRA and MSRB; (4) cybersecurity; and (5) anti-money laundering programs.
  • 1/2017  OCIE Examination Priorities
    The 2017 OCIE examination priorities focus on electronic investment advice, money market funds and financial exploitation of senior investors.  The priorities also reflect a continuing focus on protecting retail investors, including individuals investing for their retirement, and assessing market-wide risks.
  • 9/2016 SEC Order Relating to Broker-Dealer Training Materials
    In this order, the SEC challenged a broker-dealer’s internal training materials relating to sales of reverse convertible notes due to the absence of certain information relating to volatility of the underlying assets and the option-like features of the reverse convertible notes.
  • 12/2015 SEC Investor Bulletin: Exchange Traded Notes (ETNs)
    The SEC’s Office of Investor Education and Advocacy issued this investor bulletin to educate investors about exchange-traded notes in particular, how they differ from exchange-traded funds, the difference between an ETN’s indicative value and trading price, and to highlight certain risk factors that are associated with an investment in ETNs.
  • 10/2015 SEC Cease and Desist Order
    SEC Cease and Desist Order relating to alleged misstatements and omissions in offering documents for notes linked to a proprietary index tracking G10 currency foreign exchange forward rates.  The issuer was alleged to have taken unjustified markups, engaged in hedging trades with non-systematic spreads and trading in advance of certain hedging transactions.
  • 8/2015 OCIE – Broker-Dealer Controls Regarding Retail Sales of Structured Securities Products
    Report by the SEC Office of Compliance Inspections and Examinations, focusing on branch offices, and assessing these firms’ compliance with suitability and supervision requirements in the Exchange Act and evaluating whether the firms effectively supervised and monitored activities and risks associated with sales of structured products to retail investors.
  • 5/2015 Speech: Structured Products – Complexity and Disclosure – Do Retail Investors Really Understand What They Are Buying and What the Risks Are?
    Comments of Amy M. Starr, Chief, Office of Capital Market Trends.
  • 1/2015 Office of Investor Education and Advocacy – Investor Bulletin Relating to Structured Notes
    Designed to explain key features and risk factors of structured notes to retail investors.
  • 2/21/2013 SEC Follow-up Letter to Sweep Letter Recipients re Estimated Initial Values Letter contains the SEC’s updated guidance to issuers relating to the disclosure of estimated value of structured notes, including the discussion of the bond component and derivative component, secondary market values, disclosure of certain costs built into the price of the notes, related risk factors, repurchase prices by the issuer in the secondary market, and timing of conveyance of information. (Text of letter adapted from the SEC EDGAR website.)
  • 8/2012 SEC Investor Bulletin: Exchange-Traded Funds
    This investor bulletin discusses various types of ETFs, factors to consider before investing in an ETF, the differences between ETFs and mutual funds, certain regulatory requirements, NAV and intraday value, premiums and discounts, arbitrage and the difference between index-based ETFs and actively managed ETFs.
  • 4/13/2012 SEC Sweep Letter re Structured Products
    The SEC sent this letter to certain financial institutions regarding their structured note offering disclosures in their prospectus supplements and Exchange Act reports. It addresses certain issues with products names, products pricing and value (estimated initial value – see the SEC follow-up letter of 2/21/13 above), use of proceeds and reasons for offerings, plans of distribution, liquidity, issuer credit risk, tax consequences, referenced asset/index disclosures, disclosure formats, and exhibits.
  • 7/27/2011 OCIE Report: Staff Summary Report on Issues Identified in Examinations of Certain Structured Securities Products Sold to Retail Investors
    This report looked at retail structured securities products business of 11 broker-dealers, covering a cross-section of the industry, for the time period 2008 – 2009, and found that firms (1) recommended unsuitable structured securities products to retail investors; (2) traded at prices disadvantageous to retail investors; (3) omitted material facts about structured securities products offered to retail investors; (4) engaged in questionable sales practices with customers. In response, it recommends larger broker-dealers focus on: (1) having adequate procedures and controls to prevent and detect possible abuses in the secondary market; (2) disclosing material facts; (3) requiring registered representatives and their supervisors to complete specialized training before selling these products; (4) accurately listing structured securities products on customer statements; (5) having controls to independently review their desk prices of structured securities products in the secondary market; (6) having controls to adequately review suitability and customer concentrations.
  • 6/1/2011 SEC/FINRA Investor Education Alert: Structured Notes with Principal Protection: Note the Terms of Your Investment
    This investor education alert discusses the unique features of structured notes with "principal-protection," how these notes may protect investments, an analysis of a “shark fin” payout structure, explanations of various terms used to define features of structured notes and questions a potential investor should ask before investing.
  • 8/1/2009 SEC/FINRA Investor Education Alert: Leveraged and Inverse ETFs - Specialized Products with Extra Risks for Buy-and-Hold Investors
    This alert discusses the unique features of leveraged and inverse ETFs, addresses investor’s concerns and confusion regarding the performance objectives of leveraged/inverse ETFs, explains concerns about daily reset features and recommends research investors should conduct prior to purchasing these instruments. The alert has a particular emphasis on not treating these types of ETFs as buy and hold investments.
  • 10/12/2007 SEC Letters re Exchange-Traded Note Programs and Regulation M
    These SEC no-action letters address registered exchange-traded note (“ETN”) programs with continuous distribution periods, and the circumstances under which relief from Regulation M restrictions may be provided for market-making and repurchase/redemption transactions. Relief was also granted under Section 11(d)(1) of the Exchange Act, Rule 10a-1 thereunder, and Rule 200(g) of Regulation SHO.
  • 10/12/2006 SEC on Equity-Linked CDs
    This report discusses equity-linked certificates of deposit and advises investors to understand the specific terms and features of these products before making investment decisions. The report also highlights risks associated with equity-linked CDs.
  • 5/21/1996 SEC “Morgan Stanley” Letter re Abbreviated Underlying Issuer Disclosures This SEC no-action letter applies to registered offerings of securities exchangeable for underlying common equity securities. It addresses the need for disclosures about the issuer of such underlying securities and the circumstances in which these disclosures can be abbreviated.

Materials Relating to Structured Certificates of Deposit

  • 2/9/2016 Investor Alert—High-Yield CD Offers Can Be Bait for High-Commission Investments
    FINRA warns investors that advertisements promoting CDs with high rates may be a bait and switch tactic used to interest investors in completely different investments with high commission structures, such as fixed or equity-indexed annuities. The alert resulted from calls made to FINRA’s helpline for senior investors.
  • 5/17/2012 FDIC Warning on Market-Linked CDs
    This warning addresses questions potential investors should ask before investing in market-linked CDs, such as principal guarantee, CD maturity, consequences of early withdrawals, return calculations, and CD redemption.  The warning notes that these products are being marketed aggressively, including to seniors.
  • 4/23/2012 FDIC on Certificates of Deposit
    This report discusses essential information on CDs and offers tips to potential investors who are considering investing in a CD.
  • 12/3/2008 SEC on High-Yield Certificates of Deposit
    This report discusses issues relating to certificates of deposit that are important for potential investors to consider before making any investment decisions, such as maturity, call features, early withdrawal penalties, and various special considerations for brokered CDs.
  • 10/12/2006 SEC on Equity-Linked CDs
    This report discusses equity-linked certificates of deposit and advises investors to understand the specific terms and features of these products before making investment decisions.  The report highlights risks associated with these products, such as liquidity risk, call risk, FDIC insurance limits, caps and tax treatment.
  • 3/17/2006 NYSE Statement re Structured CDs
    This statement issued by the NYSE addresses sales practice reviews that have raised regulatory concerns relating to the marketing of CDs that are linked to market indices, including the adequacy of disclosure materials used in connection with the sale of these instruments to customers and whether registered representatives and customers fully understand the product and how it differs from conventional CDs.

State and Other Materials

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