The Securities Litigation Expert Blog

Independent Valuations of Structured Products from EDI

Posted by Jack Duval

Mar 6, 2013 1:36:00 AM

This blog post continues our expert analysis of complex investments and their regulation.

Here's an overdue idea: independent valuations of structured products.  Exchange Data International and Derivative Partners are teaming up to do just that.  (EDI) Here's the press release:

Exchange Data International (EDI), a well-established provider of Security Reference and Corporate Actions data, today announced its partnership with Derivative Partners, a leading provider of independent risk management and valuation services of structured products, to provide valuations for a wide range of structured products and complex derivative instruments.

The current service covers result sets combining various asset classes including equity, indices, FX and commodities, payoffs and pricing models.

Derivative Partners operates a scalable architecture for providing daily independent valuations, currently calculating over 200,000 instruments using an independent database and proprietary state-of-the-art valuation models. In combination with a flexible approach for integrating new payoffs and pricing models this allows to meet the intensified regulatory demands for transparency that clients are faced with.

Jonathan Bloch, CEO at EDI says: "We have noticed an increased demand from our clients for independent portfolio valuations and more especially for complex financial derivatives and structured products over the last years. We are very pleased to have partnered with Derivative Partners and provide our clients with a reliable and impartial valuation solution that will help them meet the transparency standards."

Andreas Kropf, Managing Director of Derivative Partners Research, adds: "We have been continuously developing and enhancing our coverage of complex derivative instruments. The partnership with EDI allows us to bring our valuation capabilities to a larger audience."  (Emphasis added.)

 See our previous coverage of structured products here, here, and here.
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Topics: Exchange Data International, valuation, complex products, investments, Structured Products, fixed income, Derivative Partners, regulation., Complexity

Yield Chasing in Complex Products will End Badly

Posted by Jack Duval

Feb 13, 2013 2:42:00 AM

This blog post continues our expert analysis of complex investments and their regulation.

Retail investors are reaching for yield in complex products, a New York Times article reports. (NYT) The result has been a wave of litigation and regulatory concern.

Regulators across the country are confronting a wave of investor fraud that is saddling retirement savers with steep losses on complex products that until a few years ago were pitched only to the most sophisticated investors.

The victims are among the millions of Americans whose mutual funds and stock portfolios plummeted in the wake of the financial crisis, and who started searching for ways to make better returns than those being offered by bank deposits and government bonds with minuscule interest rates.

Tens of thousands of them put money into speculative bets promoted by aggressive financial advisers. The investments include private loans to young companies like television production firms and shares in bundles of commercial real estate properties.


See our previous coverage of complex products here, here, and here.


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Topics: Master Limited Partnerships, FINRA, yield chasing, fraud, Investment Advisors, litigation, complex products, investments, SEC, fixed income, Compliance, regulation., Complexity

IOSCO Issues Toothless Final Report on Suitability of Complex Products

Posted by Jack Duval

Jan 28, 2013 5:13:00 AM

This blog post continues our expert analysis of complex investments and their regulation.

IOSCO has issued an essentially toothless final report on suitability requirements for the distribution of complex financial products.  (IOSCO)  In the executive summary, the authors spell out a number of principles that should be followed.  While certainly true, they merely restate what is already in place in Finra and other rules.

Also, some of the issues contemplated are nonsensical, such as the occurrence of unsolicited trades in complex financial products.  As anyone in the industry could attest, these types of products (hedge funds, private equity funds, structured products, etc.) are virtually never advertised and almost always sold on a new issue basis, so it is virtually impossible for a retail client to be aware of them (and thus to call their broker to initiate an unsolicited trade).

Nevertheless, the report is interesting in some respects, especially to see how IOSCO has addressed complex products over time.

Our previous coverage of complex products can be found here and here.

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Topics: FINRA, complex products, investments, Structured Products, Compliance, IOSCO, regulation., Complexity

Finra Annual Conference May 20-22 | Washington, D.C.

Posted by Jack Duval

Jan 13, 2013 5:16:16 AM

Finra has announced it's annual conference topics.  (Finra)  FYI, if you can't make it down to Washington, you can live stream it for $700 (for non-members).  (I have used the Finra streaming software before and it works well.)

Topics will include:

  • Anti-Money Laundering

  • Branch Office Inspections

  • Business Continuity Planning

  • Consolidated Audit Trail (CAT) and Large Trader Reporting

  • Cyber Security

  • Enforcement Developments

  • Ethics for Securities Attorneys

  • Examinations

  • Financial and Operational Considerations

  • Fraud Prevention

  • JOBS Act

  • Municipal Securities

  • Outside Business Activities

  • Private Placements

  • Retail Sales of Complex Products

  • Small Firm Compliance Practices

  • Social Media and Communications With the Public

  • Suitability

  • Supervision

  • Technology Priorities for Broker-Dealers


Detailed session descriptions can be found here.



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Topics: FINRA, streaming, private placements, litigation, arbitration, suitability, complex products, investments, supervision, Annual Meeting, Complex Investments, Compliance, Dodd-Frank Act, regulation., Complexity, education

Finra Focus Areas

Posted by Jack Duval

Jan 10, 2013 4:04:00 AM

This blog post continues our expert analysis of complex investments and their regulation.

In an interview with The New York Times, Finra CEO Richard G. Ketchum gave insights into the regulators areas of focus.  (NYT)  These include:

    • High Frequency Trading

    • Complex Products

    • Leveraged Loans

    • Collateralized Loan Obligations

    • Brokerage Conflicts with Proprietary Products

You can find our previous coverage of Richard G. Ketchum here and here.
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Topics: collateralized loan obligations, FINRA, complex, high frequency trading, Richard G. Ketchum, complex products, leveraged loans, investments, Compliance, regulation., Complexity

Finra EVP Susan Axelrod on Complex Products and Suitability

Posted by Jack Duval

Oct 31, 2012 3:18:00 AM

This blog post continues our expert analysis of complex investments and their regulation.

Speaking at a PLI Seminar on Broker-Dealer Regulation and Enforcement on October 24, 2012, Finra EVP Susan F. Axelrod had some interesting comments on Complex Investments, the new Suitability Rule 2111, and Know Your Customer Rule 2090.  (Axelrod)  You can also see our previous coverage on Complex Products here.  Below are some extracts.

Finra has noticed the hunt for yield that we have been observing in junk bonds here and MLPs here:

Let me now turn to complex products. This is an area that warrants our attention because of the continuous and rapid evolution of these types of products, and more importantly, because these products are now more frequently being offered to retail investors. There is no doubt that customers are seeking higher returns. The industry has responded by creating products that offer the potential for greater yields. But the greater yields provided through complex products can expose customers to increased risk. Firms and registered representatives must ensure that these products are only sold after a careful evaluation, through which all parties fully understand the intricacies of each product. Effective product vetting is critical if your firm is going to sell complex products.

The reasonable basis suitability requirement gets a lot of attention as well, including comprehensive due diligence, written supervisory procedures, and training:
FINRA examiners have been focused on several product types, including principal-protected notes, non-traded REITs, reverse-convertible notes, structured notes, and leveraged and inverse ETFs. FINRA recently issued Regulatory Notice 12-03 highlighting our concerns about complex products and offering guidance to firms on developing adequate supervisory systems for these products. In that guidance, FINRA notes that complex products often necessitate more scrutiny and supervision by a firm. More specifically, the guidance calls for a comprehensive process that includes due diligence prior to approval of the product for sale to clients. Also, this due diligence process must inform the firm's written supervisory procedures and training programs. Brokers should be trained on the features of the product as well as the firm's own suitability guidelines for that product. And these guidelines should be specific enough to identify those to whom the product should and should not be offered. The decision to offer complex products to retail investors is one that should be carefully considered and made only after a thorough assessment of a product's features, a comprehensive training effort and a full evaluation of firm supervisory systems related to that product.

The recent AWC and fine of David Lerner Associates was cited as an example of improper due diligence:
Earlier this week, FINRA announced a significant action involving David Lerner Associates wherein the firm agreed to pay approximately $11.7 million in restitution to customers who purchased Apple REIT Ten, a publicly registered, non-traded REIT. The sanctions, which also include a suspension of the firm's President, David Lerner, as well as a $250,000 fine, stem from the firm's recommendations and sales of Apple REIT Ten without performing adequate due diligence in violation of its suitability obligations. Also, the firm marketed the product using misleading marketing materials, including the presentation of performance results for closed Apple REIT issues, which did not disclose that income from those REITs was insufficient to support the distributions. David Lerner consented to findings that he made false, exaggerated and misleading claims regarding the investment returns, market values, prospects and performance of the closed Apple REIT issues through investment seminars and in letters to customers. As FINRA has repeatedly stated, inadequate due diligence in the complex product space is a recipe for significant problems. FINRA will take appropriate action when it finds that a firm has failed to take reasonable steps in this area.

Finally, Axelrod highlighted how some firms are now documenting hold recommendations:
In addition to understanding the products they sell, every firm must take steps to ensure that the products they sell are suitable for the specific customer. FINRA Rule 2111 (the Suitability Rule) and FINRA Rule 2090 (Know Your Customer Rule) became effective in July. The results of the examinations of this area, while preliminary at this stage, are very encouraging. With very few exceptions, FINRA examiners have observed that firms are demonstrating awareness of the requirements of the rules and have updated their supervisory procedures accordingly. Firms have updated their new account forms to include questions about the information that is required in the new know your customer rule. Although not a specific requirement of the rule, some firms have implemented a process whereby they create a "hold" ticket when brokers make an explicit hold recommendation. Others prefer to document the recommendation in customer relationship management systems. As we have said previously, not a one-size-fits-all approach to compliance with these rule changes.



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Topics: reasonable basis suitability, Rule 2111, FINRA, complex, Susan Axelrod, hold recommendations, complex products, investments, Rule 2090, Complex Investments, Compliance, David Lerner, regulation.

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