Commentary May 06, 2022 at 07:44 AM Share & Print
What You Need to Know
- FINRA’s potential definition of complex products is broad enough to include even target date funds, Dave Nadig says.
- Ric Edelman says requiring investors to pass an exam, as FINRA has proposed, would be unworkable.
- Comments are due May 9.
The Financial Industry Regulatory Authority’s potential changes to regulation of complex products are “fatally flawed” and “completely unworkable,” according to RIA founder turned crypto evangelist Ric Edelman.
As set out in Regulatory Notice 22-08, FINRA could limit retail investor access to many mutual funds, ETFs and closed-end funds, according to Dave Nadig, financial futurist at ETF Trends.
“I’m a bit terrified by the scope the notice includes as a potential definition for what constitutes a ‘complex’ product,” Nadig told FINRA in his comment letter.
Comments continue to flood in to FINRA as the May 9 comment deadline nears.
As FINRA has stated, there is currently no standard definition of a “complex product.” But it names leveraged and inverse ETFs, Bitcoin futures funds and equity-indexed annuities as examples.
According to Debra Fuhr, managing partner, founder and owner of ETFGI, FINRA has said that complex products could include:
- Nontraditional index funds, including smart beta, quant, custom index and ESG funds
- Emerging market funds
- High-yield bond funds
- Target date funds
- Floating-rate loan funds
- Unconstrained bond funds
- Insurance-linked securities
In its request for comment, FINRA asked whether investors should be required to pass tests and get pre-approved to buy various types of mutual funds, ETFs and other investments.
FINRA also asked for feedback from broker-dealers on how they’re handling complex products as the regulator weighs the changes to its rules.
Robert Cook, FINRA’s CEO, said last October that FINRA is “looking closely at the offering of complex products by our member firms.”
FINRA said in its notice that the availability of complex products and options “can potentially expand the investment opportunities for retail investors and, if properly understood, offer favorable investment outcomes (e.g., enhancing returns, limiting losses or improving diversification).”
However, “important regulatory concerns arise when investors trade complex products without understanding their unique characteristics and risks,” FINRA said.
Nadig told FINRA in his comment letter that “If you chase all of the footnotes and referenced documentation (hand up!), it’s not hyperbole to suggest that every fund providing anything but plain vanilla beta exposure to stocks and bonds would be included” in FINRA’s list of complex products.
“In filings and commentary referenced, FINRA has suggested everything from structured notes with knock-out features all the way down to the simplest Target Date Fund would be scooped up,” Nadig continued.
“I agree that some products are complex, however modern markets are complex,” he added.
“The role of the SEC is to determine what products are available to investors under what rules. Just a few years ago, after 20 years, they finally codified what is and isn’t an ETF under rule 6C11. I believe the SEC is the appropriate jurisdiction to continue to define and maintain any kind of classification of products by type or structure.”
Encourage Investors to Rely on Advisors
Edelman, founder of Edelman Financial Engines who now leads the Digital Assets Council of Financial Professionals, or DACFP, told FINRA in his letter that while the regulator is “correct to acknowledge that investment-product complexity has exceeded the knowledge base for most investors, and that efforts are indeed needed to reduce this gap,” requiring investors to pass a competency exam is “fatally flawed.”
Said Edelman: “Testing investors before they invest so they can prove they have the knowledge required to make informed investment decisions is completely unworkable. Any attempt to implement would create havoc in the marketplace, disrupt the entire asset management industry, and materially harm millions of Americans who are striving to save for retirement.”
The better, easier way: “FINRA should encourage investors to rely on the services of a professional financial advisor,” Edelman said. “Advisors are already required to pass an extensive battery of exams, at both the federal and state levels, and are obligated to complete ongoing continuing education requirements to maintain their proficiency.”