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SEC Commissioner Announces Increased Regulatory Focus on Complex Securities

On April 14, 2015, in a speech to the North American Securities Administrators Association (“NASAA”), Luis Aguilar, Commissioner to the Securities and Exchange Commission (“SEC”), stated that the SEC is looking closer at sales practices with respect complex securities.  The term, “complex securities” while difficult to define in a vacuum, refers to securities that often involve imbedded derivatives.  Complex securities include, but are not limited to; equity-indexed annuities, leveraged and inverse-leveraged exchange traded funds, reverse convertibles, alternative mutual funds, exchange traded products, and structured notes.  For example, structured notes, contain characteristics of both bonds and derivatives and complex pay-off structured and opaque pricing features that may not be easily understood or suitable for mom-and-pop investors.

Many of the recent SEC enforcement actions alleging sales practices violations with respect to complex securities are prosecuted by the Complex Financial Instruments Unit of the SEC.  The Complex Financial Instruments Unit was created in 2010 and was formerly known as the Structured and New Products Unit.  The Complex Financial Instruments Unit’s enforcement actions have recently targeted big banks that were alleged to have misled sophisticated investors with respect to complex structured products, such as collateralized debt obligations.  However, in his speech, Commissioner Aguilar noted that the Complex Financial Instruments Unit is devoting more resources to complex products that are being marketed to unsophisticated, retail investors and that “[t]he Commission expects future enforcement cases in this space.”

According to Commissioner Aguilar: “The growth of [the complex securities market] was fueled by the growing interest in the retail market…[and] [a]n investor’s constant quest for the next big thing plays right into the hands of fraudsters, who often use the complexity of new products to hide their schemes.”  While difficult to define, Commissioner Aguilar stated that the growth of the complex securities market is evidenced by the facts that: 1) the total asset growth of exchange traded products in the U.S. rose to more than $2 trillion in March 2015 and retail investors and their advisers hold an estimated 50% of ETP assets in the U.S; 2) the alternative mutual fund market grew from about $76 billion in assets at the end of 2009 to over $311 billion in assets at the end of 2014; and 3) the structured note market has increased from $34 billion in 2009 to approximately $45 billion in 2014.  Commissioner Aguilar stated that he expects these markets will continue to grow.

Because these products may be difficult to understand and can pose great risks to retail investors, investor advocates have questioned whether the Commission has done enough to disclose the risks of these products.  These questions include, whether the current disclosure required by the SEC is enough the address the risks associated with complex investment products.  According to Commissioner Aguilar, the SEC has increased its focus on improving disclosure with respect to structured notes by requiring enhanced disclosures of pricing and valuation at the time of issuance of structured notes.  However, he noted that there still may be more to do, such as: expand its focus on disclosures to include all complex securities sold to retail investors and work to include the NASAA and the Financial Industry Regulatory Authority in this effort.

The securities fraud attorneys at Lax & Neville LLP understand the intricate structures of complex securities and represent high net-worth individuals, and entities in both litigation and arbitration regarding these products.  If you have suffered damages stemming from the recommendation to purchase complex securities, contact Lax & Neville LLP today at 212-696-1999.