FINRA Launches Review of Higher-Risk Structured Products
The Financial Industry Regulatory Authority is launching a review of how firms handle higher-risk structured products, including “worst-of” structured notes that can threaten principal investments.
According to a notice released Tuesday, FINRA’s review will examine firm conduct from January 2022 through the end of last year, focusing on how companies supervise the oversight of structured notes—particularly their compliance with Regulation Best Interest and FINRA rules.
Structured products typically combine traditional securities with a derivative component that doesn’t include an underlying portfolio of investments (unlike a mutual fund or exchange traded fund). Instead, the issuer promises to pay returns based on formulas incorporating how certain reference assets perform.
These products can be designed for growth, income or risk management and could generate higher returns, but are often significantly more complex than a typical mutual fund.
According to a report from the Financial Planning Association with market data from Structured Retail Products, the U.S. structured note market stood at $149.5 billion in 2024, a 50% jump from the prior year.
Particularly, the “worst-of” notes are typically tied to the worst-performing reference asset in a select group; according to FINRA, the notes can put the principal at risk of being reduced on maturity, and can also risk “a reduction or cessation in interest payments.” FINRA claimed it had found “multiple instances” in which firms concentrated clients’ assets in these products.
“Structured notes can expose investors to losses not correlated with overall market conditions,” the statement read. “Some investors have lost significant portions of their portfolios through such concentrated positions.”
FINRA accompanied the statement with questions it will ask select firms about their supervision of “worst-of” structured notes, including the limitations it places on recommendations for such notes (such as concentration limits) and the supervisory alerts/exceptions the company has in place.
Regulators also want to know how firms train reps in structured products, how they compensate those who sell structured notes, and how the company “identifies and mitigates product-related conflicts of interest” associated with recommending the products.
While FINRA acknowledged its review would only impact “a subset” of member firms, it encouraged all firms recommending the products to review the questions and reassess their training, guidance, controls and supervisory structure when making recommendations.