Trading in options poses risks if investors don’t have the financial experience to understand options and options trading strategies. Since the number of accounts trading in complex products and options has increased significantly in recent years, it’s important that broker-dealers properly explain the benefits and risks of the securities and investment strategies that they recommend to their clients.
So, the Financial Industry Regulatory Authority has issued a regulatory note reminding its members of their current regulatory obligations, including applying the Regulation Best Interest when broker-dealers recommend securities and investment strategies to clients.
“The availability of complex products and options can potentially expand the investment opportunities for retail investors and, if properly understood, offer favorable investment outcomes,” the note says. “However, important regulatory concerns arise when investors trade complex products without understanding their unique characteristics and risks.”
Adopted in 2020, Regulation Best Interest (aka Reg BI) requires brokers to act in the best interest of clients when making investment recommendations. In other words, brokers must be able to explain the nature of the investment product they’re recommending and their potential risks and rewards.
“This is clearly a stalking horse for a new piece of rulemaking,” Dave Nadig, financial futurist at ETF Trends, told CNBC. “The SEC is concerned there is a new raft of retail investors who are under-educated about what they are doing.”
Added Nadig: “It is partly a reaction to retail investing in options, but it is even broader than that. They are proposing to create a class of new products called ‘complex’ that is basically everything besides plain vanilla stocks and bonds.”
Over the years, FINRA has taken such steps to address complex products and options, including publishing guidance regarding sales practice concerns raised by complex products and options, issuing investor-focused alerts to highlight the risks of these products, adopting rules with specific requirements for complex products and for options, and examining members for compliance with SEC and FINRA rules.
FINRA is asking members to offer comments on effective practices that they’ve developed for complex products and options, and whether the current regulatory framework is properly tailored to address current concerns raised by complex products and options. FINRA members have until May 9 to submit comments.
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