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SEC Staff Summary Report Reveals Weaknesses in Sale of Structured Products

Tuesday, August 2, 2011
The Securities and Exchange Commission’s Office of Compliance Inspections and Examinations (OCIE) issued a report summarizing the results of a sweep examination of 11 broker-dealers engaged in the retail structured securities products business (Structured Products). The report identified common weaknesses in sales of Structured Products and offered steps broker-dealers can take to better protect retail investors from fraud and abusive sales practices. Structured Products Structured Products are a pre-packaged investment strategy based on derivatives, such as a single security, a basket of securities, options, indices, commodities, debt issuance and/or foreign currencies, and swaps. Structured Products yield investor returns based on the performance of one or more underlying assets. According to the report, Structured Products have experienced an upward sales trend in recent years. For example, Structured Products sales to retail investors rose from $34 billion in 2009 to $45 billion in 2010. Despite this growth, Structured Products are complex investments and “present wide-ranging risks and regulatory issues.” OCIE Report Observations The OCIE's key observations indicate that broker-dealers recommended unsuitable Structured Products and omitted material facts about them to retail investors. In addition, broker-dealers engaged in questionable sales practices with customers, including trading at disadvantageous prices. The OCIE also observed supervisory deficiencies with respect to Structured Products sales. For example, according to the report, broker-dealers lacked training requirements for supervisors and registered representatives that marketed Structured Products to customers. Staff Report Recommendations The OCIE suggested areas of focus for broker-dealers selling retail Structured Products. For example, broker-dealers should maintain procedures and controls to prevent and detect possible abuses in Structured Products’ secondary markets. Broker-dealers also should disclose material facts about Structured Products and require registered representatives and their supervisors to complete specialized training in Structured Products. Finally, broker-dealers should put in place controls to (1) independently review desk prices, (2) adequately review suitability, and (3) review customer concentrations. The OCIE noted that it is continuing to monitor how Structured Products evolve and “considering additional steps in the near future relating to [Structured Products] that may further bolster investor protection.” Disclaimer This document and any discussions set forth herein are for informational purposes only, and should not be construed as legal advice, which has to be addressed to particular facts and circumstances involved in any given situation. Review or use of the document and any discussions does not create an attorney-client relationship with the author or publisher. To the extent that this document may contain suggested provisions, they will require modification to suit a particular transaction, jurisdiction or situation. Please consult with an attorney with the appropriate level of experience if you have any questions. Any tax information contained in the document or discussions is not intended to be used, and cannot be used, for purposes of avoiding penalties imposed under the United States Internal Revenue Code. Any opinions expressed are those of the author. The Bureau of National Affairs, Inc. and its affiliated entities do not take responsibility for the content in this document or discussions and do not make any representation or warranty as to their completeness or accuracy. ©2014 The Bureau of National Affairs, Inc. All rights reserved. Bloomberg Law Reports ® is a registered trademark and service mark of The Bureau of National Affairs, Inc.

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