By Anne Sherry, J.D.
A joint statement from SEC Chairman Jay Clayton and the directors of the Divisions of Investment Management, Corporation Finance, and Trading and Markets outlined some of the issues underlying complex investment products available to retail investors. These products, notably including those that have a leveraged or inverse component, may raise investor protection concerns for investors who do not fully understand the risks to their investment goals. The staff in the three divisions will be reviewing whether existing regulations are sufficient to protect investors and may recommend new rulemaking, guidance, or other policy actions based on the review and public comments.
Chairman Clayton and Directors Dalia Blass, William Hinman, and Brett Redfearn observed in the statement that the current regulatory landscape treats different products differently in ways retail investors may not fully understand. For example, exchange-traded funds are subject to the Investment Company Act, unlike exchange-traded notes, commodity pools, and structured pools. The latter products are governed by regulations that require robust disclosure but do not include the Investment Company Act’s fund-based protections.
The SEC officials said that retail investors and even financial professionals may not fully appreciate how complex products operate or the risks they present. Periods of market volatility also have an outsized effect on complex products that seek to provide leveraged or inverse exposure to an underlying index by a specified multiple ("leveraged/inverse products") and other products that use certain financial instruments. The statement notes that during the pandemic-related volatility in the spring of 2020, investors in leveraged products experienced significant losses in ways that, according to complaints received by the Office of Investor Education and Advocacy, were inconsistent with investor expectations. As another example, a large exchange-traded product that invested in crude oil futures lost 41 percent of its value in one week in late April and was unable to issue new shares.
Technology has also made leveraged/inverse products more widely available to retail investors, who can trade without the aid of a broker or adviser, the officials note. This era of self-directed investment has improved access and lowered costs, but those investors do not have the protections they would if they received recommendations or advice from a broker or adviser. "Regulation Best Interest and an investment adviser’s fiduciary duty do not apply where a retail investor invests on his or her own accord in complex products through a self-directed account," the statement warns.
Review and comments. Recognizing their responsibility to consider whether existing protections can be improved, the chairman and directors announced that Investment Management, CorpFin, and Trading and Markets will review the existing regulations’ effectiveness in protecting investors—especially self-directed investors—in complex products. The staff will, accordingly, as mentioned, make recommendations to the SEC for potential new rulemakings, guidance, or other policy actions. The review will include consideration of whether any such new requirements for complex products may help promote retail investor understanding of the products’ unique characteristics and risks. Staff may consider requirements that add new obligations for broker-dealers and investment advisers as well as point-of-sale disclosures or policies and procedures tailored to the risks of complex products.
The SEC established a new email address to receive public comments on the issues laid out in the statement. All market participants and members of the public are invited to communicate their views to complexproductsreview@sec.gov. Submissions will be made publicly available without redaction, even of personal identifying information. The statement does not provide a deadline for comments.