Tuesday, February 8, 2011
Rick Ketchum, Chairman and CEO, FINRA, spoke today at the CCOutreach BD National Seminar on product concerns:
Private Placements & Private Self Offerings
First, we're looking at retail sales of private placement interests, including those issued by broker-dealers and control affiliates. Our examinations and investigations have identified significant failures in firms' compliance with suitability, supervision and advertising rules, as well as potential instances of fraud and participation in illegal distributions of unregistered securities. A number of these investigations have led to enforcement actions.
Last year, we reminded firms of their obligations to conduct reasonable investigations into "Reg D" offerings. And we highlighted a number of specific practices relating to these offerings that firms should consider. But the bottom line is that the responsibility and the commitment to know what you're selling—whether it is from a legal or reputational standpoint—is more important than ever. Recently, we have also proposed changes and are requesting comment on an expansion of the provisions of our private placements rule, to provide investors with additional protection from fraud and abuse.
Second, we want to ensure that firms meet their sales practice and due diligence obligations when selling municipal securities. Municipal securities dealers must understand what they're selling in order to meet their disclosure, suitability and pricing obligations—and their obligation to deal fairly with customers under MSRB rules and federal securities laws. Firms must also review their procedures for compliance with MSRB Rule G-32, which requires the delivery of an official statement, or a notice of its availability on the MSRB's EMMA system, to any customer purchasing a municipal security during the primary offering disclosure period.
In any transaction in a municipal security, a dealer must obtain, analyze and disclose to customers all known material facts about the transaction, as well as material facts that are reasonably accessible to the market through established industry sources.
Third, we are looking at firms that sell structured products and certain riskier asset-backed securities to retail investors. Recent enforcement cases highlight the importance of training brokers on products sold and reasonable supervision to ensure suitable recommendations. Brokers must understand the risks and costs associated with the products recommended and disclose them to customers. For instance, collateralized mortgage obligations present a variety of risks, including credit and default risk, interest-rate risk, prepayment risk and extension risk. CMOs are structured into different tranches, each with their own set of rules by which interest and principal get distributed. So it is important for brokers to understand the features of the tranche they are selling and the rules governing its income stream as these affect the product's risk.