SEC’s amped-up oversight of complex financial products expected to continue under Biden

Over the last several weeks, the Securities and Exchange Commission has stepped up its oversight of risky, complex financial products, a trend that experts say likely will continue and intensify in a new presidential administration.

On Nov. 13, the SEC announced a $3 million settlement with three investment advisory firms and two dually registered firms for unsuitable sales of exchange-traded products linked to market volatility.

A few days later, the Office of Compliance Inspections and Examinations warned firms to shore up their policies and procedures for selling complex financial products and to ensure that their advisers understand how they work and whether they’re a good idea for clients.

This sequence of events followed SEC approval of a derivatives rule that removed a sales practice provision that would have required due diligence by brokers and advisers selling leveraged and inverse exchange-traded funds. Instead, SEC officials sought public comment on the need for additional protections related to customer purchases of complex products through self-directed accounts.

“I consider them financial weapons of mass destruction.”

Jim Stewart, owner of Carmichael Hill & Associates

The SEC’s concerns about complex products won’t wane in the Biden administration.

“Expect the focus on complex ETPs to survive the transition to new leadership at the SEC — these products, and other products with similar features, will continue to be in the crosshairs, along with the firms that sell them,” said Kurt Wolfe, a securities compliance attorney at Troutman Pepper.

“What the SEC sees is a bunch of registered reps and investment advisers who may not understand the products selling them to clients who don’t understand the products and for whom they may be unsuitable,” Wolfe added.

In fact, the SEC may become more intense about complex products next year.

“I believe we’ll see, especially with the administration change, an increased focus on complex financial instruments that are offered to retail investors,” said Valerie Dahiya, a partner at Perkins Coie. “You’ll see more enforcement actions related to sales practice obligations.”


Last month’s enforcement action was initiated before Regulation Best Interest, the new broker advice standard, was implemented in June. In its follow-up statement, OCIE used Reg BI and fiduciary duty, which governs investment advisers, to make its point that advisers need to be cautious with investments that are volatile and opaque.

“Under these standards, a financial professional recommending a complex or risky product should apply heightened scrutiny to understand the terms, features and risks of the product and whether such product fits within the client or customer’s risk tolerance and specific-trading objective, and whether it would require daily monitoring by the investor or the financial professional,” OCIE said.

The Financial Industry Regulatory Authority Inc., the broker-dealer regulator, also has been sending warnings. It released a regulatory notice in May warning brokerages to tighten up their policies and procedures for selling exchange-traded products linked to oil.

“Anything that happens after June 30, the SEC and Finra have a more blunt instrument to after BDS who fail to make adequate disclosures and put the best interests of their clients first,” Dahiya said in reference to Reg BI.  

Most advisers who recommend complex products probably understand them, but that doesn’t mean they can translate them to clients, said Matt Bacon, an adviser at Carmichael Hill & Associates. Even if they can, that doesn’t mean the client will retain the knowledge.

“If you ask them in a month how [complex products] work, my guess is they would struggle to explain it,” Bacon said.

Traditional ETFs are linked to indexes such as the S&P 500 and rise or fall as the index does. But when they move in an opposite direction and use debt to amplify those swings or when they are linked to market volatility, the dangers for investors increase exponentially.


The message the SEC is sending is “there’s not just elevated reward with these products, there’s elevated risk,” said Todd Rosenbluth, director of mutual funds and ETF research at CFRA. “The fund that is at the top of the ladder could become the fund at the bottom of the ladder very quickly and vice versa.”

Those swings can decimate portfolios, especially if a client buys and holds a complex financial product that is meant to be traded on a daily basis.

“I consider them financial weapons of mass destruction,” said Jim Stewart, owner of Carmichael Hill & Associates.

Complex financial products likely will continue to proliferate as investors chase higher returns, and regulators won’t ban them outright. But caution will be the watchword for using them.

Financial professionals must “do a significant amount of assessment and due diligence before offering products and determining whether the products are suitable or appropriate for any retail investors,” Dahiya said.

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