Financial Advisor (May 10, 2022) - The Financial Industry Regulatory Authority received more than 750 responses to its complex product request for comment by the time the comment period closed on Monday and one of them was from Ric Edelman, a financial planning magnate and founder of Digital Assets Council of Financial Professionals, who gave the self-regulatory organization’s idea to administer a competency exam to investors before they can invest in complex products a thumbs down.
The proposal, designed to curb registered reps’ push of exchange-traded products that invest in more exotic underlying investments, doesn’t define a “complex product.” Instead, it uses examples of leveraged and inverse products, defined-outcome ETFs and crypto futures funds as examples registered representatives should take greater care pitching.
Edelman admitted products are getting increasingly complex, but called the idea of testing investors before they can purchase complex products “fatally flawed.”
“Testing investors before they invest so they can prove they have the knowledge required to make informed investment decisions is completely unworkable. Any attempt to implement would create havoc in the marketplace, disrupt the entire asset management industry, and materially harm millions of Americans who are striving to save for retirement,” said Edelman, who is also the founder of Edelman Financial Engines, the largest independent financial planning and investment management firm in the nation, with $300 billion in assets under management.
Edelman asked who will write the exam questions or administer or grade such an exam, who will create the training materials and, what score will be required to be deemed to have passed the exam.
Finra asked if “after receiving additional education or training, should customers be required to demonstrate to the member the customer’s understanding about options? What form of demonstration would be most efficient and effective? Should the demonstration include answering questions or otherwise demonstrating understanding of options?”
Edelman wanted to know who will write the exam questions or administer or grade such an exam, “and, what score will be required to be deemed to have passed the exam?”
Finally, if testing were implemented, what would happen to an investor who fails the exam? Must they liquidate their current investments – and incur whatever taxes, penalties and surrender charges are incurred?” Edelman asked.
While America may have a financial illiteracy problem, “forcing investors to pass an exam in order to be permitted to invest is not the way to resolve it,” he said.
Instead, Finra should encourage investors to rely on the services of a professional financial advisor,” Edelman said, in a plug for the industry he has profited from for more than 30 years. “Advisors are already required to pass an extensive battery of exams, at both the federal and state levels, and are obligated to complete ongoing continuing education requirements to maintain their proficiency,” he noted.
But that doesn’t satisfy Public Investor Advocacy Bar Association (PIABA) President Michael Edmiston, who said in his letter to Finra that attorneys who represent wronged investors see a multitude of abuses from reps and even registered investment advisors (RIAs).
"Despite FINRA’s clear identification of the significant problem with investments in leveraged and inverse ETFs longer than a day and its clear warning to member firms, our members continue to see investors who have been victimized by inappropriate longer-term holding of positions in these complex products,” Edmiston said.
PIABA is also concerned with what Edmiston termed “the dramatic rise of options trading,” which poses serious risks for retail investors who do not understand the characteristics or risks related to the product. In April, FINRA censured and fined Berthel, Fisher & Co. Financial Services, Inc. $100,000 for failing to supervise unsuitable options trading activity for a senior citizen, he noted.
“Perhaps worse still, our members are seeing an uptick in small RIA firms using complex options strategies that the advisers themselves do not understand,” Edmiston said. “These RIA firms typically use FINRA member firms to execute their strategies. The brokerage firms disclaim any responsibility for the trading, placing that responsibility on the RIA. However, investors do not understand that they are dealing with two separate entities, each of which have limited responsibilities and obligations,” he added.
Listed options trading volume has jumped 30% since 2020 and almost 100% since 2019 to more than 38.6 million contracts a day, Finra noted.