Financial Planning (May 16, 2022) – Add SEC Chair Gary Gensler to the growing chorus of regulators and critics calling for tougher rules over complex products, despite accompanying cries of protest from the industry.

Gensler’s agency has “an opportunity to update our capital markets” and “can’t take anything for granted” in light of the impact of new technology enabling quicker trade execution as well as the collection and sale of data to financial firms, he said in a session with FINRA CEO Robert Cook at FINRA’s conference on May 16. While he didn’t reveal any new rule proposals, Gensler expressed continued concern about alternative products such as leveraged or inverse ETFs and other complex exchange-traded investments, as well as practices surrounding options trading.

His remarks followed a wave of letters to FINRA from member firms, registered representatives and other wealth management stakeholders opposing potential new regulations defining and codifying procedures governing sales of complex products and options. They also come after state regulators — who have already warned that the SEC’s Regulation Best Interest hasn’t altered the industry’s practices in terms of sales of complex, costly and risky products — and attorneys for harmed clients each sent letters to FINRA endorsing the idea of new rules.

Gensler said any proposals could affect both retail and institutional clients. He asked the Commission’s staff to consider “sales-practice appropriateness,” the functioning of capital markets in light of asset valuations and what the fiduciary duty and Reg BI mean for leveraged or inverse ETFs, options and the use of derivatives inside vehicles structured as funds, exchange-traded notes and exchange-traded products, he told Cook.

“Investors get to choose what risks they take,” Gensler said. “They’re supposed to get full and fair disclosure and not be lied to. But there’s also a concept of making sure that when a broker-dealer, an investment advisor is making recommendations or giving advice or steering or nudging through the digital engagement practices in all of that, that it’s risk-appropriate for the investors.”

As examples of the reasons for concern, he cited last year’s Archegos Capital Management case and so-called delta hedging that “accelerated some problems inside of the market and the market functioning” during the “Volmageddon” of February 2018.

Despite signs that volatility-linked products similar to those wiped out four years earlier are now returning to the marketplace, industry commenters responding to FINRA’s request for public discussion about complex products are warning of possible overreach with any new rule.

“We are concerned that various points FINRA is inquiring about, such as an enhanced account approval process before an account may trade in complex products, requiring a customer to complete training or a learning course before being approved to trade in certain complex products, requiring customer attestations regarding knowledge and experience or restricting or limiting access by retail customers to complex products based on their net worth or other categories would, if required to be implemented, unduly restrict investor access to publicly offered securities and run contrary to the disclosure-based system that underpins our securities laws,” Van Eck Securities, an affiliate of a group of fund companies managing $82 billion across a range of products, wrote in an April 21 comment to FINRA.

On the other hand, state regulators represented by the North American Securities Administrators Association and client attorneys who are part of the Public Investors Advocate Bar Association back new rules that would, if anything, go further than FINRA’s proposals. The regulator should focus on training any reps selling the products or pushing options, and especially their supervisors and compliance officers, PIABA President Michael Edmiston said.

“I hope they continue to take very stern action on firms that fail to adequately address and manage the risks in a customer’s account presented by these products,” he said. “They don’t understand the degree of losses they can suffer if the market goes against them.”

Former SEC Chair Jay Clayton, who served under the Trump administration, had also raised questions about complex products, Gensler pointed out in his remarks at FINRA’s conference. Those queries came alongside moves by the SEC that would have boosted access to certain alternative products as well, though.

Cook sought clarification from Gensler on whether the areas he had discussed represented topics he asked the SEC’s staff “to look at for further potential action.” Gensler answered in the affirmative, noting that he views the new investing technologies as “every bit as transformative as the internet” was upon its introduction. He then asked Cook whether he wears a Fitbit, drives a car and charges his phone regularly. Cook said he has an Apple Watch and answered “yes” to the two other questions as well.

“So that Apple Watch, that driving of your car and, yes, even whether you charge your phone every night, that provides data on you, my friend, to some data aggregator who can then sell it to some financial firm and sort of assess whether you’re a better risk or worse risk as to how you drive your car, how you walk and exercise and, yes, even whether you charge your phone,” Gensler said. “And so then it raises the questions about, well, how are you marketing, how’s a platform marketing? Are they doing it for your best interest, your best execution of a trade, or is it about their revenues? And therein lies the challenges of our times.”