The Financial Industry Regulatory Authority announced that it will conduct a review of firm practices involving higher-risk structured products.
The move, which FINRA said is part of of its mission of protecting investors, specifically pertains to non-principal protected “worst-of” structured notes. These notes refer to principal-at-risk structured notes that may result in a reduction or cessation in interest payments, and/or a reduced return of principal at maturity, based on the worst-performing asset in a group of two or more reference assets.
The review will examine how firms supervise concentrations in these products, including how they comply with Regulation Best Interest and FINRA rules when their registered representatives recommend these products to investors.
FINRA notes that structured products are designed to meet specific investment objectives for retail investors, such as growth, income or risk management. They typically combine a traditional security, such as a bond, with a derivative component. But unlike a mutual fund or exchange-traded fund, a structured note does not hold an actual underlying portfolio of investments. Instead, the note issuer promises to pay a return based on a formula that incorporates the performance of one or more reference assets.
“While structured products may have the potential for higher returns than their reference assets, they also have unique risks,” FINRA states. “Their terms and features can be different and significantly more complex, which may warrant heightened supervisory scrutiny. Certain structured products, such as structured notes that provide payoffs that depend upon the worst performing reference asset in a pre-specified group (commonly referred to as “worst-of” notes), present particularly complex features.”
FINRA said that it has identified multiple instances where firm representatives concentrated their customers’ assets in more complex and higher risk structured products that include a lack of principal protection and “worst-of” features. This can expose investors to losses that are not correlated with overall market conditions. Some investors lost signifcant portiona of their portfolios through such concentrated investments, which can pose a higher risk particularly when the investment is a complex product.
As part of its review, FINRA is seeking information from January 2022 to December 2025 and asks for firms to detail training and supervisory controls around structured product sales.
This request specifically focuses on how firms define and monitor concentration thresholds, what surveillance alerts they use, whether supervisors review customer data before approving recommendations and whether brokers receive higher payouts for selling certain notes.
FINRA’s review of firm supervision for concentration in higher-risk structured products will only affect a subset of member firms. But all firms who recomend these products were encouraged to review the questions in the letter and evaluate their practices. This includes firms’ training, guidance, controls and supervisory structure for professionals making these product recommendations to clients.
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