GOP lawmakers warn FINRA against heightened ‘complex product’ regulation

GOP members of the House Financial Services Committee say heightened regulation of retail investors sale of “complex products” and options could raise costs and unfairly limit retail investors’ access to products and strategies that are readily available to other investors.

A notice posted recently by the Financial Industry Regulatory Authority (FINRA) about so-called “complex products,” hinted that tighter regulation may be on the way. Although no strict definition exists for complex products, they are typically notes with principal protection and high-yield bonds with lower credit ratings and higher risk of default, but with more attractive rates of return and include such things as futures, options, and complicated trading strategies.

FINRA said it is especially concerned that the complex products are being sold though self-directed platforms rather than through trained financial professionals.

“Important regulatory concerns arise when investors trade complex products without understanding their unique characteristics and risks,” FINRA said in soliciting comments. “The number of accounts trading in complex products and options has increased significantly in recent years.”

FINRA said the current regulatory framework for complex products was developed when most sales were conducted through financial professionals rather than the self-directed computer platforms in high use today. It said complex investment products can contain futures contracts and other derivatives, or may engage in short sales; structured products with embedded optionality; interval funds and non-traded REITs. Retail investors and customers may not fully understand the potential risks of such products, FINRA said.

Notice could lead to changes

But in a letter to FINRA’s president and CEO Robert W. Cook, Republican members of the House Financial Services Committee warned that FINRA’s Regulatory Notice could lead to changes that would prohibit retail investors from trading in certain products, including options on registered securities.

“In particular, we are concerned that FINRA is acting as a ‘merit’ regulator by considering prohibiting or unduly restricting the sale of registered securities to specific investors, even when these investors have access to full and fair disclosure,” said the letter signed by the 11 GOP committee members.

The committee members asked FINRA to supply answers to four questions that asked for, among other things, evidence that current regulations are insufficient; the impact proposed changes would have on retail investors; and whether FINRA is coordinating its effort with the Securities and Exchange Commission, which has also raised concerns about the retail sale of complex investment products.

“The Regulatory Notice fails to adequately justify why new regulations are needed, or why existing regulations are no longer sufficient, to oversee the options markets and protect retail investors,” the four-page committee letter said. “A general increase in retail trading volume is not enough to justify restricting such investors’ access to widely used and regulated financial products.”

“FINRA is continuing to review the responses to our request for comment, and we welcome inquiries from Congress,” said Ray Pellecchia, FINRA’s senior director of corporate communications. “Please note, there is no plan or proposal in that notice, just a series of questions. If FINRA should determine to proceed with rule-making, there would be a formal proposal and additional opportunities for comment.”

Nevertheless, the committee gave FINRA until Sept. 30 to respond.

Doug Bailey is a journalist and freelance writer who lives outside of Boston. He can be reached at [email protected].

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Doug Bailey is a journalist and freelance writer who lives outside of Boston. He can be reached at [email protected].