As a former complex product supervisor for one of the largest broker-dealers in the nation and which is probably the highest producing structured product firm, I would like to make some comments on the practices employed by them and in the industry by general. First of all the process in getting an account approved for structured notes and options is largely a joke. Anyone from an 18 year old fresh out of high school wanting to invest their graduation money to a 93 year senior citizen in a senior living facility gets approved. I am not aware of a single person who actually got rejected except for paperwork NIGOs. Secondly while I cannot speak to the use of options strategies by my former firm as I did not work in that area, I can say that there aren't any controls or specific guidelines employed to restrict or otherwise gauge best interest for the client in structured note trading. 99.9% of trades are ultimately approved with nothing more than an email acknowledgement from the registered representative guessing the client liquid net worth and stating the client likes structured notes and income. Third there was no distinguishment made between issues. A 5 year note tracking the ARKK (Cathie Wood) or XOP (oil) etf with 35% barrier was treated the exact same way as a 2 year note tracking the S&P 500 index and having a 50% barrier. All structured notes without principal protection were treated exactly the same. I would think there is a difference between blackjack and the big 6 wheel on the casino floor based on odds and risk but I guess naivete prevails. Fourth, the use of custom single stock notes were growing increasingly popular. Reps and the trading department can negotiate the terms from commissions earned by the rep, to the barrier levels and the stock. I believe even the BD traders get a cut for this, since they seem to highly tout their numbers each month. Reps to drive up yield were lead to use stocks like Peloton, Roku, Tesla and Docusign, which the recent volatility have devasted the stated values of such investments. And agreeing to purchase a minimum of 500k and 1 million for an issue leads reps to strongarm clients to meet their quota that they set for themselves often leading liquidating perfectly fine existing investments such as variable annuities and A share mutual funds, just so the rep can "hit their number". Also OSJ offices would get other reps to get with the program to hit the number for the branch. Using this strategy if you would call it was largely encouraged but is viewed by supervisors as unnecessarily risky and distasteful. Often with a trade deadline approaching we would be given a list of 50 clients and maybe 2 hours to review them. You kind of can figure out what would happen in that situation. Fifth, the firm would flag just about every trade that takes place, which makes it nearly impossible to review the universe of trades that could be viewed as questionable. When $25,000 trades made by a multimillion dollar account, and bizarrely advisory RIA accounts too gets flagged just the same as a $250,000 trade for a 75 year old IRA account worth $400,000. I can probably conclude this was done by design just create a huge workload forcing the supervisor to clear things out as quickly as possible. Sixth, there really should be some rule written by FINRA to steer the broker-dealers on the generalities of what would be acceptable practices for the purchase of these products and to which universe of investors. Representatives convincing clients that they can beat a 7% annual living benefit by investing in a 8% yielding structured note is certainly distasteful but a common practice. Allowing 80 year old clients without any investment experience to put most of their nest egg on a bet that the S&P 500 or Russell 2000 won't fall 35% in 4 years is a very dangerous risk in my opinion. Allowing representatives to sell existing notes to "lock in gains" and then swap it for a worse structured note to allow themselves to get paid more commissions or "limit losses" by selling the notes early and swapping it for a so called safer note would make someone want to take a shower. There should be a rule to limit the amount of commissions that can be earned by a rep for the same capital, otherwise reps often can earn double digit commissions for the same money in a year between early redemptions done by the issuer and possible selling on the market and swapping. These products should be held to maturity and only be sold early in exigent circumstances. Clients do not get a fair price from the issuer in early liquidation and reps have a serious conflict of interest when recommending early sales in a nonadvisory account. Just force broker-dealers to limit commissions and this practice will go away on its own without any further intervention. Lastly, with fixed income funds in doldrums and bonds being largely uninvestable in the era of double digit inflation these products are being touted as a panacea for disease of low to no yield. 7-8% annual yield unless something crazy happens, is too easy of a sell to make for a rep and clients would genuinely think it would have to be armageddon for them to lose money, and that's really false hope considering crashes were experienced as recently as 2020. These investments should be recommended only for sophisticated investors and not those cashing out their bank CDs and fixed annuities to chase yield. I really think these could be the next weapons of mass destruction in the financial market space and FINRA should step up and do something or you will end up with reacting to the same wrath faced in the nontraded reit space from 2006-2013. Thank you for your time.
Anonymous Comment On Regulatory Notice 22-08
As a former complex product supervisor for one of the largest broker-dealers in the nation and which is probably the highest producing structured product firm, I would like to make some comments on the practices employed by them and in the industry by general. First of all the process in getting an account approved for structured notes and options is largely a joke. Anyone from an 18 year old fresh out of high school wanting to invest their graduation money to a 93 year senior citizen in a senior living facility gets approved. I am not aware of a single person who actually got rejected except for paperwork NIGOs. Secondly while I cannot speak to the use of options strategies by my former firm as I did not work in that area, I can say that there aren't any controls or specific guidelines employed to restrict or otherwise gauge best interest for the client in structured note trading. 99.9% of trades are ultimately approved with nothing more than an email acknowledgement from the registered representative guessing the client liquid net worth and stating the client likes structured notes and income. Third there was no distinguishment made between issues. A 5 year note tracking the ARKK (Cathie Wood) or XOP (oil) etf with 35% barrier was treated the exact same way as a 2 year note tracking the S&P 500 index and having a 50% barrier. All structured notes without principal protection were treated exactly the same. I would think there is a difference between blackjack and the big 6 wheel on the casino floor based on odds and risk but I guess naivete prevails. Fourth, the use of custom single stock notes were growing increasingly popular. Reps and the trading department can negotiate the terms from commissions earned by the rep, to the barrier levels and the stock. I believe even the BD traders get a cut for this, since they seem to highly tout their numbers each month. Reps to drive up yield were lead to use stocks like Peloton, Roku, Tesla and Docusign, which the recent volatility have devasted the stated values of such investments. And agreeing to purchase a minimum of 500k and 1 million for an issue leads reps to strongarm clients to meet their quota that they set for themselves often leading liquidating perfectly fine existing investments such as variable annuities and A share mutual funds, just so the rep can "hit their number". Also OSJ offices would get other reps to get with the program to hit the number for the branch. Using this strategy if you would call it was largely encouraged but is viewed by supervisors as unnecessarily risky and distasteful. Often with a trade deadline approaching we would be given a list of 50 clients and maybe 2 hours to review them. You kind of can figure out what would happen in that situation. Fifth, the firm would flag just about every trade that takes place, which makes it nearly impossible to review the universe of trades that could be viewed as questionable. When $25,000 trades made by a multimillion dollar account, and bizarrely advisory RIA accounts too gets flagged just the same as a $250,000 trade for a 75 year old IRA account worth $400,000. I can probably conclude this was done by design just create a huge workload forcing the supervisor to clear things out as quickly as possible. Sixth, there really should be some rule written by FINRA to steer the broker-dealers on the generalities of what would be acceptable practices for the purchase of these products and to which universe of investors. Representatives convincing clients that they can beat a 7% annual living benefit by investing in a 8% yielding structured note is certainly distasteful but a common practice. Allowing 80 year old clients without any investment experience to put most of their nest egg on a bet that the S&P 500 or Russell 2000 won't fall 35% in 4 years is a very dangerous risk in my opinion. Allowing representatives to sell existing notes to "lock in gains" and then swap it for a worse structured note to allow themselves to get paid more commissions or "limit losses" by selling the notes early and swapping it for a so called safer note would make someone want to take a shower. There should be a rule to limit the amount of commissions that can be earned by a rep for the same capital, otherwise reps often can earn double digit commissions for the same money in a year between early redemptions done by the issuer and possible selling on the market and swapping. These products should be held to maturity and only be sold early in exigent circumstances. Clients do not get a fair price from the issuer in early liquidation and reps have a serious conflict of interest when recommending early sales in a nonadvisory account. Just force broker-dealers to limit commissions and this practice will go away on its own without any further intervention. Lastly, with fixed income funds in doldrums and bonds being largely uninvestable in the era of double digit inflation these products are being touted as a panacea for disease of low to no yield. 7-8% annual yield unless something crazy happens, is too easy of a sell to make for a rep and clients would genuinely think it would have to be armageddon for them to lose money, and that's really false hope considering crashes were experienced as recently as 2020. These investments should be recommended only for sophisticated investors and not those cashing out their bank CDs and fixed annuities to chase yield. I really think these could be the next weapons of mass destruction in the financial market space and FINRA should step up and do something or you will end up with reacting to the same wrath faced in the nontraded reit space from 2006-2013. Thank you for your time.