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FINRA Identifies Areas of Concern for Investors

The Doss Firm

Each year, the Financial Industry Regulatory Authority (FINRA) publishes a letter to the financial services industry identifying its regulatory and examination priorities. FINRA is the industry’s “self-regulatory organization,” which is charged with policing sales practice violations by its member broker-dealer firms, among other things. According to FINRA, its letter highlights important risks and problem areas in the industry that “could adversely affect investors.” While there may be some differences from year to year, the major risks and problems that impact the most investors seem to persist.

The two major categories of violations that concern FINRA are unsuitable recommendations and misrepresentation of the material facts about recommended investments. In general, the suitability rule requires selling firms to have (and be able to demonstrate) a reasonable basis for believing that a recommended investment is both (1) suitable for at least some investors based upon the nature of the investment and its potential risks and rewards, and (2) that the investment is suitable for the particular customer to whom it is being recommended based on that customer’s investment profile (e.g., age, investment experience, time horizon, liquidity needs, and risk tolerance).

FINRA has long been, and remains, concerned about sales practices related to a group of investments that share the characteristics of being illiquid, not transparent and hard to understand, and that are extraordinarily costly in that they pay outsized commissions to the agents that sell them to investors. In this regard, FINRA’s list includes the following categories of investments: Complex Structured Products, Private Real Estate Investment Trusts (also known as non-traded REITs), Frontier Funds and a group of interest rate-sensitive securities like Mortgage-Backed Securities, Long Duration Bond Funds, Long Duration Bond ETFs, and so on.

These products are typically sold to income-oriented investors, who are often retired people trying to live on a fixed income that consists of social security payments and investment income. Such investors typically have high liquidity needs and low risk tolerance. The low interest rate environment has sharply reduced their income. While these income-oriented investments promise more income, they are largely illiquid, higher-risk investments. For example, a number of non-traded REITs reduced or eliminated distributions in the wake of the real estate market crash, but they cannot be sold like a stock – i.e., they are illiquid, and investors were left holding a non-producing asset that was worth far less than what they paid for it.

FINRA is concerned that the selling brokers neither fully understand nor explain the risks and problems associated with these investments.

According to its letter, FINRA is also concerned about the disproportionate effect that chronic bad brokers, which it calls “recidivist brokers,” have on investors. However, if FINRA truly wanted to protect investors from recidivist brokers, it would take action to prevent brokers from expunging or whitewashing their customer complaint histories from the records it makes available to investors (and urges them to check out before investing) known as BrokerCheck. PIABA (the Public Investors Arbitration Bar Association), under the leadership of its President, Jason Doss, has launched a campaign aimed at improving disclosures of brokers’ histories to potential investors by placing more appropriate restrictions on brokers’ ability to expunge their records posted on FINRA’s BrokerCheck. We will keep you posted on those efforts. FINRA’s priorities letter can be viewed here.

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