Investments That Concern FINRA
The Financial Industry Regulatory Authorityrecently announced its 2012 regulatory and examination priorities. The regulator listed several types of investments with heightened conduct and suitability issues. Among those investments were:
- Complex Exchange-Traded Products—Exchange-traded funds ( and other products that rely on synthetic derivatives to achieve a certain return may exhibit significant tracking errors, especially during times of market stress.
- Micro-Cap Fraud—Micro-cap or penny stocks pitched via bulletin board postings, email spam, high-pressure sales tactics, or paid promoters are vulnerable to market manipulation and fraud. AAII’s Model Shadow Stock Portfolio requires that companies file regular regulatory filings (SEC forms 10-Q and 10-K) and meet minimum market capitalization and price requirements in order to be considered. The portfolio also does not invest in bulletin board or pink sheet stocks.
- Reverse Mergers—These transactions allow a private company to enter the U.S. capital markets without completing an initial public offering. FINRA is particularly concerned about Chinese companies that have used reverse mergers, given the significant allegations of fraud that have been made.
- Variable Annuities—Long holding periods and significant surrender fees make variable annuities unsuitable for investors who need portfolio cash flow now, as opposed to in the future. FINRA is also concerned that high commissions can entice advisers to pressure clients to switch products. The regulator acknowledges that the product does offer benefits to suitable investors.
- Church Bonds—Often sold on an affinity basis to religious groups, these securities commonly do not provide an adequate disclosure of the underlying issuer and its true financial condition. AAII members may be better served by making a direct charitable contribution to a congregation or religious institution than by buying church bonds or similar securities.
- Life Settlements—These products have very high commissions, and recent court rulings increase the risk that the validity of a life settlement contract may be challenged.
FINRA also warned that individual investors may be susceptible to “yield chasing.” The regulator is concerned that investors may be pitched higher-yield products that lack a full disclosure of their risks, liquidity (ability to easily buy or sell an investment), and cash flow characteristics (when payments are made and what the source of those payments is).
Your best defense is to ask as many questions as is necessary and never to invest in a product or security you do not fully understand. Furthermore, always be wary of high-pressure sales tactics—a reputable adviser, broker or agent will give you as much as time you need to make a decision.
Source: FINRA, January 31, 2012, letter to executive representative and chief compliance officers.