FINRA Compliance When Customers are Hunting for Yield

Today, December 1, 2014, a quick check of the web shows that the national average rate for a one year FDIC insured certificate of deposit is 0.27% APY. The rate on savings accounts is 0.09%. And taxable money market mutual funds are averaging a yield of about 0.02%. When faced with rates like these, bank customers often turn to broker-dealers for higher yields. This is particularly the case when bank broker-dealers have referral relationships with bank tellers, or when they operate in the bank lobby.

There are also plenty of non-bank customers out there who are frustrated with their traditionally “safe” short-term municipal, corporate or government bond fund yields. In this low interest rate environment, yields on these products, which have traditionally been a safe haven for brokerage customers, are disappointing to say the least. And broker-dealers are working hard to find alternatives that do not surpass the risk tolerance of customers.

And as the old adage goes, with risk comes reward – or at least the opportunity for reward. Broker-dealers are looking more and more to alternative investments to satisfy the demands of customers for higher yielding products. And one only need to turn to the FINRA Disciplinary Actions page to find those broker-dealers who have struggled making this approach work effectively. FINRA has long advised broker-dealers, both in Regulatory Notices and in its annual Exam Priority Letters, that the search for higher yielding products presents compliance issues for broker-dealers. Simply put, a client who wants the safety of a CD or money market fund, or even a short term bond fund should rarely be placed in alternative investments.

Broker-dealers seeking to add higher yielding products, including alternative investments, to their platform should employ a comprehensive due-diligence process that includes a reasonable basis suitability analysis. Firms should determine whether the products they are considering are appropriate for their customer base, and if so, which customers. Upon approval of a product for sale to customers, a broker-dealer should update its written supervisory procedures to address the unique features of that product, and should implement training for representatives selling the product as well as the principals who review and approve the product. Often alternative investments are more complex than traditional investment products. So determining investor suitability is critically important. There have been more than a few FINRA enforcement cases involving unsuitable sales of complex products and alternative investments.

Broker-dealers with strong compliance programs have effective due diligence, training and suitability review processes. They often limit the percentage of client liquid net worth which may be placed in any particular product or class of products. Further, their client suitability forms clearly define the terms used by the firm in the suitability analysis.

Mitch Atkins, FINRA’s former SVP and Regional Director has extensive experience developing procedures and review processes for alternative investment products. Contact him at FirstMark Regulatory Solutions in Fort Lauderdale, Florida at 561-948-6511.



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