FINRA Launches Sweep of Worst-of Structured Note Sales Practices
The Financial Industry Regulatory Authority has launched a targeted review of member firm practices involving higher-risk structured products, specifically non-principal-protected “worst-of” structured notes, the regulator announced Tuesday.
The notes represent a growing segment of the $194 billion structured products market.
The review will examine how firms supervise client concentration in these products and whether registered representatives comply with Regulation Best Interest and FINRA conduct rules when recommending them. FINRA said it has identified multiple instances where firm representatives concentrated client assets in structured products carrying compounded complexity risks — including absence of principal protection and worst-of payoff features.
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, like a bond, with a derivative component.
Worst-of structured notes are a subset of structured products whose returns depend on the worst-performing reference asset in a pre-specified group. Unlike mutual funds or ETFs, a structured note does not hold an underlying portfolio; the issuer promises to pay a return based on a formula tied to one or more reference assets. FINRA said some investors have lost significant portions of their portfolios through concentrated positions in such products.
“Highly concentrated investments can pose risk, and that risk is heightened when the concentrated investment is a complex product,” the regulator said in its announcement.
The review will affect only a subset of FINRA member firms, but the regulator said it is encouraging all firms that recommend these products to assess their practices against the questions outlined in the sweep letter, including training programs, compensation structures, product classification frameworks, suitability controls, and supervisory procedures for professionals making recommendations. The regulator is also seeking data on customer demographics, holdings, and performance for the products.
The sweep letter continues FINRA’s broader scrutiny of how firms implement Reg BI in the context of complex and high-risk products.
The regulator has increasingly focused on concentration risk as a distinct supervisory failure mode — separate from suitability of individual recommendations — particularly where complex products amplify portfolio-level exposure. Last month, it fined J.P. Morgan Securities $3.25 million for failing to supervise a registered representative who recommended and implemented a high-risk complex strategy involving concentrated positions in high-yield securities financed through margin and other forms of leverage. The strategy exposed customers, including seniors and those with moderate risk tolerances, to substantial losses during market volatility.
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