Some ETF industry veterans are expressing concern that a recent Finra regulatory notice on “complex products” is vague and overly broad, and may stifle product innovation and investor recommendations.
In the March notice, Finra said it was “reminding members of their sales practice obligations for complex products and options and [to] solicit comments on effective practices and rule enhancements.”
Finra said it is particularly concerned with the sale of options, leveraged and inverse ETFs, and crypto future funds. The regulator has also targeted retail platforms such as Robinhood and has suggested a test that retail investors could be required to take before they are able to invest in complex products, ETF Trends reported first.
But, in public comment letters on the Finra notice, some in the ETF industry expressed concern about future regulation and enforcement. “I’m a bit terrified by the scope the notice includes as a potential definition for what constitutes a ‘complex’ product,” Dave Nadig, financial futurist at ETF Trends and ETF Database, said in his comment letter.
Nadig said he worried that even “the simplest target-date funds” and structured notes with knock-out options would be “scooped up” in an effort to regulate complex products.
“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 proposal to crack down on complex products, Nadig wrote.
Finra said in its notice that it purposely did not define “complex products ... because new products and strategies are constantly introduced.”
"Finra has construed the term 'complex product' flexibly to avoid a static definition that may not address the evolution of financial products and technology," Finra said in its notice. "Specifically, Finra has described a complex product as a product with features that may make it difficult for a retail investor to understand the essential characteristics of the product and its risks (including the payout structure and how the product may perform in different market and economic conditions)."
Phil Bak, founder and CEO of atNav, an early stage capital markets technology company, said that while plain vanilla, cookie-cutter investment advice may be entirely appropriate for many, others’ “goals will best be attained through complex strategies. It is easy to dismiss those clients as overly aggressive gamblers, but in my experience the exact opposite is the case. Many retirees, in particular, are seeking downside protection strategies, or other investments that mitigate market risk. Others may need to hedge against certain assets or scenarios. It would be a shame if we were to limit product creators to using only the blandest of ingredients,” Bak said in his comment letter.
“A better framework might need to include ... personal responsibility placed on investors and their advisors to perform due diligence and to take responsibility for the risks that come along with the rewards of investing. Placing the onus of risk management entirely in the hands of product issuers and regulators will lead to even more investor complacency, which itself poses a far greater long-term risk to those same investors,” he added.