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Complex Investment Products Are In The SEC’s Crosshairs

April 23, 2015 Blog

Financial advisors have been pushing complex investment products to their yield-starved retail investors. Such opaque and complex products have names like structured products, equity-indexed annuities, leveraged and inverse exchange-traded funds and alternative mutual funds.

Notice the abundance of hyphens in such investments. Maybe a good rule of thumb for Mom and Pop investors is, if a broker is selling you an investment product with a hyphen in it, buyer beware!

Perhaps your financial advisor has tried to sell you such a product. Indeed, the market for complex products is booming. According to a report by Mark Schoeff of industry newspaper InvestmentNews, the amount of assets in alternative mutual funds has grown from $76 billion at the end of 2009 to more than $311 billion at the end of 2014.

Unfortunately, most investors don’t understand what they are buying and the associated risks. This is clearly on the radar of the Securities and Exchange Commission. Part of the SEC’s examination process of investment firms this year will focus on firms that create new structured products and sell them to retail investors.

It’s common knowledge in the securities industry that many financial advisors are not properly trained to sell such products and often fail to properly disclose to investors the liquidity risk and high fees that come with such products.

SEC Commissioner Luis Aguilar last week at a speech to the North American Securities Administrators Association (NASAA), a group of state securities regulators, announced that the SEC would likely bring future enforcement actions over the fraudulent sale of complex structured products to retail investors.

Aguilar singled out complex securities, such as those that involve embedded derivatives, including leveraged and inverse exchange-traded funds, equity-indexed annuities and principal protected notes.

“Alternatives generally have high fees and low liquidity,” Schoeff reported. “Mr. Aguilar said investor advocates have questioned whether there’s enough disclosure about risks associated with alts. These concerns are valid and deeply troubling.”

According to Schoeff’s article, Aguilar called for the SEC to extend to all complex securities the agency’s initiative to strengthen disclosures about structured notes. He also said the SEC should partner with state regulators and the Financial Industry Regulatory Authority (FINRA) in a crackdown.

Schoeff also reported that the securities industry, which likes the fat fees that come from selling high risk products, is pushing back. Schoeff quotes an industry source that said that the “emphasis seems to be too much on the risk side” and that “investor education” is needed, rather than regulatory action.

Here’s the rub. The investor education that the securities industry now trumpets has been sorely missing. There is simply no plain English explanation given to investors when these complex and opaque products are sold.

A perfect example is the sale of Puerto Rico Closed-End Bond funds by UBS and others to retail investors. Investment fraud attorneys have filed almost 1000 claims on behalf of investors who weren’t informed of the risks and liquidity issues before their purchase. When the market for those bonds fell over 50% in the fall of 2013, investors were blindsided and suffered tremendous losses.

The SEC needs to step up and take action to prevent another meltdown for investors in these high risk products which are not widely understood. Commissioner Aguilar’s recent words make it sound like that the SEC is attempting to warn investors of the risks associated with such products. We would like to see bolder action from the SEC in the months ahead when it comes to policing complex investment products. Stay tuned.

Zamansky LLC are investment and stock fraud attorneys representing investors in federal and state litigation and arbitration against financial institutions.

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