FINRA Focus Areas: Communications, Reg BI and Complex Products

FINRA 2024 Annual Report

By Ed Wegener, Sarah Sutton, Dean Pelos and Casey Dougherty

Camera eye representing FINRA Focus areas

Each year in what is now called its Oversight Report, FINRA lets the industry know its areas of focus when it comes to compliance.  In this episode of the Oyster Stew podcast, Oyster Consulting’s compliance experts discuss areas where FINRA spends a lot of examination and enforcement resources – Communications and Sales. Listen as we share insights into challenges our clients are facing, FINRA’s common findings and best practices in the following areas:

  • Communications with the Public and Advertising
  • Reg BI and its focus on the Care Obligation
  • Complex Products, from variable annuities to private placements

The Compliance Partner You Need

Oyster Consulting’s experts stay current with regulatory and compliance issues and are ready to help you navigate the challenges that your firm faces. Our consultants have the regulatory and compliance experience you need to review your firm’s policies, procedures and controls testing around Reg BI, Communications with the Public, and supervision of variable annuities and private placement business.

Regulatory Background

Rule 2210 – Communications with the Public and Advertising

While Rule 2210 has always been a FINRA priority, the way people communicate and advertise, and the platforms they use have significantly changed over the years. FINRA requirements and recommendations are also becoming complex, including a focus on disclosures around crypto and ESG. 

Reg BI – The Care Obligation

In 2019 the Securities and Exchange Commission issued a new standard of conduct for broker-dealers under the Securities Exchange Act of 1934 (“Exchange Act”) when making a recommendation of any securities transaction or investment strategy involving securities to a retail customer.

Generally, under the Regulation Best Interest (Reg BI) Care Obligation, firms must exercise reasonable diligence, care, and skill when making a recommendation to a retail customer to:

  • understand potential risks, rewards, and costs associated with recommendation
  • have a reasonable basis to believe the recommendation is in the best interest of a particular retail customer based on that customer’s investment profile and the potential risks, rewards, and costs associated with the recommendation
  • have a reasonable basis to believe the recommendation does not place the interest of the broker-dealer ahead of the interest of the retail customer; and
  • have a reasonable basis to believe that a series of recommended transactions, even if in the retail customer’s best interest when viewed in isolation, is not excessive.

Complex Products – Rule 2330 – Variable Annuities Recommendations

Generally, Rule 2330 applies to recommended purchases or exchanges of deferred variable annuities. Under Rule 2330, when recommending a deferred variable annuity transaction, a registered representative must reasonably believe the customer has been informed of the various features of this type of annuity, such as a surrender charge, potential tax penalties, various fees and costs, and market risk.

Before making any variable annuity transaction recommendations, registered representatives must make reasonable efforts to determine the customer’s age, annual income, investment experience, investment objectives, investment time horizon, existing assets, and risk tolerance.

A registered representative must also have a reasonable basis to believe the customer would benefit from certain features of deferred variable annuities, such as tax-deferred growth, annuitization, or a death or living benefit.

Complex products – Rule 5123 – Private Placements

FINRA Rule 5123 (Private Placements of Securities) requires firms to file certain offering documents and information about the issuer, the offering terms, and the firms selling the private placement with FINRA. FINRA will examine firms’ private placement offerings to ascertain whether firms are conducting a reasonable inquiry of the issuer and offering.

FINRA published Regulatory Notice 23-08 which reminds members of their obligations when selling private placements outlining the regulator’s expectations of private placement business.


Transcript provided by TEMI

Bob Mooney:   Welcome to the Oyster Stew podcast. I’m Bob Mooney, General Counsel for Oyster Consulting. In today’s podcast, our experts will take a look at challenges our clients are facing and industry best practices when it comes to several topics that receive a considerable amount of attention from FINRA: Communications with the Public and Advertising, Reg BI and its focus on the Care Obligation, and complex products from variable annuities to investment decisions. With me today are some of Oyster’s Governance, Risk and Compliance experts Casey Dougherty, Dean Pelos, Sarah Sutton and Ed Wegener. Ed will be leading our discussion today, so let’s get started – Ed?

Ed Wegener:  Well, thank you so much. And hello everyone. I’m Ed Wegner. I’m the Practice Lead for Governance Risk and Compliance at Oyster Consulting. I want to welcome you to another installment of our discussions where we do a deep dive into specific areas that FINRA’s outlined in its 2024 regulatory oversight report. And today we want to discuss the areas where FINRA spends a good deal of its examination and enforcement resources. And that is in the communications and sales practice area. FINRA’s always been very focused on retail investors and these areas are of particular interest. I’m really fortunate today to be joined by three of Oyster’s, very experienced consultants, Sarah Sutton, Casey Dougherty, and Dean Pelos. In addition to being consultants with Oyster, all three are very experienced compliance professionals and CCOs, and they spent their careers dealing with the issues that we’re going to talk about today. So, welcome all.

Casey Dougherty:  Thanks, Ed.

Ed Wegener:  Why don’t we start with communications? FINRA’s Rule 2210 deals with communications with the public and advertising. And while this has always really been a priority for FINRA, the way people communicate and the platforms on which they communicate have significantly changed over the years, and it’s become increasingly complex with things like social media and texting and various technologies. And I was wondering if one of you could share what FINRA has identified as particular considerations that firms should have when dealing with communications, especially around these new communication channels.

Casey Dougherty:  Sure, Ed. FINRA changed the way that it approached communications some number of years ago. Now, I think, when firms are thinking of communications, the first thing they need to do is to sort between correspondence retail communications and institutional communications. And for most firms, that actually has some bearing on whether or not you are pre-reviewing or post-reviewing whatever it is you happen to be looking at. When I read this year’s notice, what I picked up on is FINRA emphasized the communication needs to be fair and balanced. You need to have a factual basis for any claims that you’re making within an advertisement or communication. There was also some discussion around mobile apps. As you alluded to Ed, there’s some changes that we’re seeing, making sure there’s appropriate disclosures, certainly if you’re using those apps, retaining copies of communications that are flowing through these new devices or apps.

We also saw some sensitivity around crypto advertising. I think we saw crypto last year, too. And then municipal advertising, specifically in regard to crypto. FINRA was reminding us that we should make sure that we’re talking about the risks associated with those assets. I think, also Munis. There’s this sense sometimes when people talk about municipal securities to say, oh, these things are tax free. They’re not really tax free. They’re tax free certainly at a federal level, but you need to consider also state level and local AMT taxes, things like that. And FINRA was reminding firms to make sure that you take a holistic view. Anyway, I think also what I picked up on is last year, I think, FINRA put a one of its little stars or asterisks next to a new item: ESG. This year that wasn’t new, but they certainly repeated it. So certainly, as a reminder to firms, you want to think about ESG and whether or not you have a factual basis before you talk about those items.

Ed Wegener:  You know, one of the things that you mentioned was digital apps, and that’s another area that has really sort of taken off in the last few years. The communications that you do on that, the digital apps, has made it rather challenging in dealing with. And I know Dean, you had worked with clients that have been in that space, and I’m wondering if you have any particular challenges or issues that you’ve seen in working with firms that use digital apps and communicate through digital apps?

Dean Pelos:  Yeah, thanks, Ed. There are a lot of issues with digital apps. Just from the standpoint of if you’ve been in the business for a very long period of time, this wasn’t a communication that was around 20 years ago and has sudden suddenly become a very popular area for a lot of business people that want to promote their product or their service to underlying clients. I had a client who had a mobile app that they marketed to potential clients and clients in general. And there were a lot of things there that FINRA was focused on, in terms of how things were properly disclosed: whether or not there were costs and benefits that were clearly explained on their apps, or links that could take you to their website where additional information could be disclosed and the product or the service could be properly explained. So potential clients had clarity of what that was, what was available to them. That’s a very difficult area, and FINRA has been clearly focused on explaining, making sure you have some clarity in terms of how those products or services are provided to people that want to better understand that service that’s being offered to them. It’s just looking for those things and making sure that you’re following the guidelines that FINRA has prescribed in terms of the types of things that should be available to people.

Ed Wegener:  You know, one of the challenges too in that space is oftentimes the firms that come in and start doing securities related business on these types of applications and through new technologies, the FinTech firms are often run by people who have technology backgrounds versus financial backgrounds and having worked in very regulated environments. So a big part of dealing with those types of situations is making sure that you are sensitizing the senior leadership about the things that they have to be concerned about when advertising through these mobile apps, because they might not be used to the dos and don’ts that us who have been working in this industry have become very accustomed to through things like examinations and examination findings in this area. Which is a good way to turn over to the next question, which FINRA outlined not only considerations with respect to communications, but also outlined some of the things that they’re seeing in the common findings. I wonder if someone can talk about some of the common findings that FINRA has had when examining for advertising and communications with the public?

Dean Pelos:  I can take that Ed. False, misleading and inaccurate information on mobile apps has been an area that FINRA has been finding are reasons for improvement. Failing to disclose information about the risk of loss that’s associated with certain transactions that might take place on a mobile app – let’s say, willing to fully explain or clearly and prominently disclose risks where they’re required to do that. Deficient communications, promoting crypto assets – that’s another area that has been an issue and a finding for FINRA. So, failing to appropriately and accurately address relevant risks, disseminating promotional materials that contain material misstatements, these are things that they found when you’re promoting crypto assets, or any kind of mobile app for that matter. And failing to differentiate communications with mobile apps between crypto assets and mobile apps offered through an affiliate. The other thing too that’s happening here is you’re promoting a product or a service and you’re explaining the benefits that are available, but you’re not clearly focusing on the potential pitfalls that may exist for a client to understand what the risks are. And you’re misleading your clients as a result of this.

Ed Wegener:  Exactly. Well, a lot of people that create marketing material are marketing people, right? And marketing people are designed to try to sell benefits of things, right? And so, I think it’s incumbent then on Compliance to make sure that you’re tempering that need to want to sell things with also, some of the issues that investors need to be aware of and making sure that they’re not exaggerating the benefits while diminishing the potential drawbacks and risks that are associated with the products and services that they’re offering.

Casey Dougherty:  Yep. I like that, Ed; I like data to echo that. I think, in ESG, I think there’s a problem. And we’re seeing with artificial intelligence and ESG as well, that this idea that somebody might exaggerate what the benefits are and also minimize the risks. I think we’re seeing that as a common theme across these FINRA findings.

Ed Wegener:  You know, it’s one of the things that I think we’ve seen regulators talking about throughout. I’m not sure it was in FINRA’s priorities, but it’s something to think of into the future when you’re talking about communications with the public. The more the prominence of generative AI is starting to develop and people’s use of that to create text and content and making sure that to the extent that you use artificial intelligence to create any type of content, making sure that you review it for the content standards, but also making sure that you have as a firm assessed acceptable use of tools like AI and generative AI. It’s really important to make sure that you have policies and procedures around that, and you’re training people on what it’s okay to use and how to use those types of tools. And another thing that was really, I think, effective in FINRA’s report is, in addition to identifying considerations and examination findings, they talk about some effective practices that firms can employ in order to supervise the areas. And they did that as well with communications with the public. So, I wonder if somebody can talk about some of the effective practices that FINRA identified.

Dean Pelos:  I can address that, Ed, from the standpoint of trying to supervise these activities. First of all, number one would probably be to maintain and implement procedures, have proper policies and procedures in place for how you supervise mobile apps, to be cognizant of all the digital communication channels that you and your reps use, properly train these employees on how these tools should be used to be able to archive that content, and make sure that your written policies and procedures define all of this in a very concise way. If you’re advertising crypto, you’ve got to make sure that it’s fair and balanced, and you’ve got to explain that in your policies and procedures and how that gets supervised, right? So that you can properly understand that you need to communicate to your clients that these are volatile issues and there are no guarantees here, and it has to be expressed properly. So, I think having the proper process in place, being able to communicate that to your registered individuals to be able to understand what they can and cannot do, how they need to properly disclose this information on their sites, and be able to point out all the risks that are involved with using these products and services available to potential clients.

Ed Wegener:  Anytime you’re talking about advertising with respect to FINRA, if you’re a broker dealer, always considering when it is that you’re required to file advertising with FINRA’s advertising department for review and the timeframes around when you need to really appreciate that. So why don’t we turn to a somewhat related topic, and that’s Reg BI. Reg BI has been in place for a number of years now; though, since its effective dates, examinations have evolved from doing good faith efforts type reviews to then focusing on things like disclosures and conflicts. But they’re now looking more closely at the care obligation, and while in the report FINRA identified effective practices, considerations, findings around each of the different obligations in Reg BI, given this current focus on the care obligation what has FINRA identified as important considerations with regards to this specific obligation?

Sarah Sutton:  Hey, Ed. It’s Sarah. I’ll jump in on that one. So I think one of the key takeaways when it comes to care obligation is, do you have a documented basis for your recommendation? So, it’s not a black and white type scenario in most instances. You’ve got several layers of items that you need to look at and discuss with your clients, and disclose them as well when you’re looking at the different options. If you’re working for a clearing firm that’s both a broker dealer and an RIA, that’s a layer that is, should this transaction be on the broker dealer side, in a broker dealer account, or should it be on the RIA side where it’s a fee based account for the type of security or investment that you’re recommending? That could make a difference in the amount of commissions or expenses that the client ends up being charged, or fees that they are paying for a specific investment that could very well likely cost less on a different platform.

So, it’s definitely something that you need to have just your documentation and your proof that you looked at it and really made the determination that either, again, from the broker dealer standpoint is a one-time recommendation that it’s the right one, or from a fiduciary standpoint, if it’s an ongoing fee based on the RIA side. It’s also something that they will want to hold for a while and keep as an investment. The amount of information that an individual who is making these recommendations and how they keep that information, I think is very important as well. I think that that’s something that the regulators are also looking at. They want to, again, make sure that you remember why you made the recommendation when you made it and it’s always a good idea to make sure that firms have a minimum standard as to how this information is kept, where it’s kept, what information they’re looking for, making sure that they have a basis for what they’re offering and what they’re telling clients to invest in.

Ed Wegener:  A lot of those areas that you talked about are really critical. And the way I’ve heard it explained by the SEC is they really look at the approach as a funnel; starting from the top of the funnel, the account type, like you had mentioned, what’s the appropriate account type based on the accounts features and risks and costs relative to the client’s profile and investment objective? And then down to the account type that the different asset classes. And then, once you’ve identified an asset class identifying which particular products within that asset class and at all of those different levels, assessing the reasonably available alternatives, the reasonably available alternative account types asset classes, product types. To your point about documentation, while they said in the adopting release that they don’t necessarily require documentation in every case, they did say that they would expect it in certain cases, and they gave some examples like complex products and certain situations, but as you’ve seen more recent guidance come out, they’ve indicated that they’re expecting to see documentation quite frequently in order for firms to be able to assess whether they’re implementing an effective program as well as for regulators to come in and assess whether you’re following your procedures. So that’s one of the things that you really need to take a look at is when and how to document the basis for your recommendations. Because if you’re not going to do it all the time, it’s important that you really clearly identify when you’re going to do it and make sure you’re training your people on when they need to and how they need to do that.

Dean Pelos:  Right. I was just going to say, one of the other areas too, that I want to add to this conversation is that when there are products that are complex and, these are considerations that have to be made, how many different options are you considering here in terms of evaluating those products? Let’s say you have a series of five different complex products that you want to offer to your client, and you want to be able to evaluate the costs and benefits associated with the product. How many of these products are you going to look at and make comparisons on? And are you going to document that information so you have that in your files so that you can prove that you took that time to make that evaluation for the best interest of your client in order to give them the best investment available to them based upon the suitability that you’ve identified within your client’s profile to be able to make those decisions?

I think that’s a, a very important point to be able to document that. FINRA really hasn’t come out and said, you need to look at X-amount of complex products before you offer one of these complex products to your client. They have not given you that number. I think that you have to take a reasonable approach to this and be able to make a determination and say, in this area I need to look at five products, or I need to look at two products because there aren’t too many of these products that are available, but I know that it fits my client’s profile, therefore I’ve got to be able to properly document how many of these I’m looking at and what evaluations were being made in order to make that proper determination.

Ed Wegener:  And you can’t cherry pick because you don’t want to be in a situation where the only products that you’re picking to compare against it are ones that are always going to be more costly and more risky. So that you can make sure that you justify why you recommended the one that you did, you need to do a fair and reasonable basis, making sure that the products that you’re assessing against are products that were available to your client. And then just to verify that the product that you’re recommending is the appropriate one. Casey, you were going to say something.

Casey Dougherty:  Yeah. To piggyback on what Sarah, Dean, and you Ed, were talking about here. First, reference was related to documentation. It reminds me of an argument I lost with a regulator once, which was where the regulator said if it’s not documented, it didn’t happen. And I think I responded with no, if it’s not documented, it’s not documented. But again, I preface that I lost. So, I recommend to our clients, document everything. It’s just easier than trying to say, look, it happened, trust me. The other thing is, it is related to this number of reasonable available alternatives. Ed, I think you formally were a FINRA regulator – so if I was to compare, let’s say, investing in a variable annuity versus putting money into a mattress, would you think that that’s an appropriate number of reasonable available alternatives, or do you think it should be something greater than that?

Ed Wegener:  Well, if, if those are both alternatives at the top of that funnel, I would say they would be included. But that shouldn’t be all that you’re assessing.

Casey Dougherty:  Got it, yeah. It is a bit of a rhetorical question, but yes, thank you. Yeah, it’s something that’s come up a lot with my clients is how many reasonably available alternatives do you need to have? I picked up on that with Dean’s comments as well. And Sarah, you talking about the different layers, this is a complex issue for all firms.

Ed Wegener:  You know, I think we hit on a lot of this in talking about the considerations. But, just in thinking about what FINRA had identified in terms of their common findings and maybe some of the effective practices to address those common findings, is there anything that you think would be helpful to add?

Casey Dougherty:  You know, I, I think to add on my last comment, anecdotally, the reasonably available alternatives under the care obligation is something that’s important. As we talked, there’s no industry consensus on how many. Make sure you have good documentation. Make sure you know your customer. Look at each layer, as Sarah referenced. If you’re going to use complex products that might be more expensive or more commission generating, you probably better have good documentation as to why you’re using those, as opposed to a less expensive alternative.

Ed Wegener:  I think, as with any area in compliance and probably more pronounced when you’re talking about Reg BI, one of the key considerations is to make sure that you have a well-defined process in place so that people aren’t guessing at what it is they’re supposed to be doing. But in addition to that well-defined process, and importantly, because we’ve seen this is where some firms have fallen down, is that you’re training your people on what that process is. You’re training them how to do that, and you’re giving them the tools to effectively be able to do that. So, if you’re going to say to your advisors, go out and compare this against four products, how are they getting the information? What products should they be considering? How are they supposed to document all of this kind of stuff? So, you need to think through those and give your advisors the training and the tools to help them do that.

Well, we talked about complex products, and it’s not a very well-defined term, but one product that continues to get called a complex product by the regulators are variable annuities. And variable annuities are another area that FINRA continually has identified as an area of focus. Now, variable annuities, you don’t only need to comply with the requirements under Reg BI, but FINRA has specific policies, or I’m sorry, specific rules with respect to variable annuities suitability under Rule 2330. So, it’s important that you make sure that when making recommendations and variable annuities that you’re considering not only Reg BI, but also the specific requirements under 2330. I wonder if one of you can talk a little bit about the types of things that FINRA identified as being something to consider when making recommendations of variable annuities and supervising that activity.

Sarah Sutton:  I’ll take this one. So first I would like to say thank you to FINRA for reminding us about this specific rule, which they tend to. I think annuities, variable annuities specifically, have been on their radar for, gosh, honestly, on an annual basis. I think it’s probably been on the list for a very long time, and I don’t say that sarcastically. I think it’s a good reminder because the variable annuity space has gotten very complex, and I think one of the things that we can do, firms can do from a supervision or supervisory standpoint is basically, the person supervising or the team supervising needs to understand the product just as much as the advisor that’s selling it to the client. And a lot of the time, you have a sales rep come in and they give the highlights, and it sounds like it’s this new whizzbang awesome thing, and it’s got some index that’s got a floor and a ceiling, and everybody thinks they understand it, then they leave, and they try to go sell it or they try to go to explain this type of product to a client.

And I don’t know if they do a very good job of it and disclosing the risks and the limitations on the amount that you can earn on an investment or that you can lose is very important. So, I think disclosures are also another item that the folks that are supervising need to make sure, and the firm needs to make sure, that they have procedures in place and disclosures that the clients are signing off on, the advisors are reviewing with their clients, just to make sure that they’re all on the same page. It’s definitely one of those areas where I don’t think variable annuities will be going away anytime soon. I think they’ll continue to get more and more complicated, but firms, if they can limit or just make sure that they are only allowing the vendors and the annuity companies that are coming in and discussing these different complex products with their advisors, just make sure that they truly understand it. I think there are some out there that may be better than the others, but they probably have a cost associated with it, or they have so much additional risk that is definitely a consideration for you to take into consideration.

Ed Wegener:  You know, one of the areas too that consistently gets identified, and I know that FINRA scrutinized very closely when reviewing variable annuity activity, are exchange transactions where you’re exchanging one annuity for another. Typically, they look at annuities as being long-term investments. And so, they are going to question when you sell one annuity and roll that into a new annuity, and whether there might be different features or things that benefit the client. They just want to make sure that an assessment was done to make sure that exchange was in the client’s best interest, make sure it justifies the costs involved, the liquidity issues that come from new surrender periods, identifying whether surrender charges were paid for getting rid of the old annuity. And then looking at the pace of annuity exchanges both, at a customer level, how frequently has this customer exchanged annuities or recommendations been made to this customer to change annuities. But also looking at your advisors and looking for patterns where you have advisors doing a significant number of exchanges, that should be an area that raises some red flags that you want to follow up on.

Dean Pelos:  Yeah, you took the words right out of my mouth that I, as a former supervisor looking over my reps and making sure that they were selling the products that we had on the board, obviously. But understanding that the frequency of these exchanges that take place is a huge red flag, right? I mean, these are things that you can notice as a supervisor and say, yeah, we need to really look into these events that are taking place with this individual and make sure that because of the frequency of what’s happening here, we need to be able to identify or perhaps put more scrutiny on what’s happening here so that we’ve identified the costs and benefits associated with these exchanges and understand that these are reasonable in nature that are taking place. I think that we need to be able to focus on that as well.

Ed Wegener:  Absolutely. And Sarah, you mentioned the disclosures and the assessments that you do. And, in 23-30 FINRA was clear that it’s important that not only the rep, but the client understand the different features, the costs, the risks associated with it and if you’re going to be selling things like death benefits and living benefits and other riders to make sure they’re suitable and make sure that the cost associated with those various features are worth those features and the client understands the cost associated with those features.

Casey Dougherty:  Yeah, it’s one thing that jumped out to me in the FINRA notice Ed, is that we know there’s a lot of good automation out there to be able to monitor exchange rates, things like that. And since you know that FINRA is going to be looking at that when they come in, if your firm hasn’t already considered investing in some sort of automation to look at rates of exchanges or help you with some data points, certainly consider it. Obviously there’s lots of companies that can help you with that. Oyster is one of them. We’d be happy to help implement some sort of automated system for you if you need it.

Ed Wegener:  Absolutely. And the regulators are using data much more effectively as part of their examination programs, and they’re asking you to send a bunch of data before the examinations, and they’re doing some complex analytics to look for where there might be problems. So, in the old days when examiners came out, you just put boxes in a conference room and let them try to find the needle on the haystack. They’re getting much better at showing up already knowing where those needles might be and really focusing in. So, it’s really important that on the firm side, that you’re doing your own data analytics to tease out those issues before the regulators come out and do that.

Casey Dougherty:  Agreed.

Ed Wegener:  Moving on to another complex product, and again, this is a perennial priority area for FINRA, and that’s private placements. Private placements are considered to be risky, you know, because there’s limited information about them. They’re not registered. But also, I think FINRA has seen that the incidents of fraud that have happened with private placements tend to be elevated, just given all of those factors. We’ve recently seen a few private placements that have blown up and FINRA and the SEC have looked at the due diligence that firms have done in advance of those offerings to make sure that the due diligence that they did was reasonable. All of which is to say, this continues to be an area of priority for FINRA. I was wondering if somebody can talk about, what are the things that FINRA highlighted in this particular report in terms of things you should be considering, what they’re finding on exams and maybe some effective practices in terms of how to control this area. 

Dean Pelos:  Yeah, Ed, private placements obviously are, I guess, we’re talking about complex products. That’s obviously a very complex product. There’s a lot of things associated with being able to evaluate whether or not it’s a reasonable investment for your client and so on. But in addition to that, we have now in place a proposal, not a proposal, but a rule that’s been enacted regarding private funds and how those private funds are being monitored. Obviously, private placements come into play in this area as well, and how you’re putting together information that’s associated with a private placement and whether or not you are having that particular product audited so that, you know, there’s more information out there that’s available to an advisor that wants to recommend this product, let’s say to an individual.

But the things that we should look for here first of all, we have to be able to communicate that most of these products are liquid in nature. The fact that you have a valuation that’s being determined by the advisor and perhaps their administrator or custodian, and how that gets evaluated is another important area. And there’s an absence of operating history for a lot of these PPMs that come out. And now, we’re communicating that you have to have an independently audited firm, a public accounting firm that’s out there that is auditing these products now, so that you’re able to have more information that’s available to an advisor that’s evaluating this product on behalf of their client. The things that FINRA looks at for firms to have in place are private placement checklists that talk about the review of related documentation.

Who’s responsible for performing the functions and tasks and the evidence of supervisory or principal approval taking place? You should have some bad actor questionnaires at the issuer or the placement agent levels. You should conduct and document independent research on the material aspects of the offering. You should be able to identify conflicts of interest between firms and affiliates for people who control or control persons that are perhaps employed by the firm. You want to make sure that you’re identifying those conflicts that might exist and be able to perhaps disclose that information as well, if that’s fitting the bill here. The other thing is who’s responsible for conducting the reasonable investigation for properly filing and training your representatives here on this type of product? Those are the things that I think about, and I think FINRA’s making those guidance recommendations as well.

Ed Wegener:  Yeah, in addition to that, one of the things, it’s a foundational thing, but making sure that the offering meets the claimed exemption from registration, if they’re claiming Reg D or one of the other exemptions, making sure that they’re complying with that as part of your due diligence, assessing whether the recommendations that you’re making are to the appropriate types of investors. And that could be accredited investors in some cases, or there might be limits to the number of non-accredited investors, or if you’re making recommendations to not accredited investors, there are certain qualifying factors that you have to look at when making those recommendations. All things that the firm should be aware of. And to your point around just understanding the products, making sure you had mentioned the checklists, making sure that your due diligence checklists talk about things like the issuer and their management, the business and the business prospects history, including litigation, and then also making sure, and this is where I think a lot of the current issues have happened, continuing to do ongoing due diligence, not from the standpoint of needing to due diligence after you’ve made a sale for a particular investor, but if you’re continuing to make offerings in a private placement, you need to make sure that you’re not relying on stale information, that if the business is operating and things are developing, that you’re aware of those developments as you’re making new recommendations. That’s critical.

And that’s where some firms have fallen down in the past. So that all being said, I’m curious Casey and Sarah, about things that you may have seen in this space.

Sarah Sutton:

So, Ed one of the things that kind of pops in my mind, and should be top of mind is, going back to our conversation just a few minutes ago about Rig BI, is looking at what alternatives does the advisor have? Again, when you’re looking at the very complex products, the lack of liquidity, the limitation on who can invest, there are lots of these products out there, but choosing which one is the best for the investor, for the client at the time and the overall market, what we’re looking at from a fiscal and economic outlook looking ahead. It’s just that there’s so many different factors. So, how do you choose? And there are certain platforms that offer different alternative investments or private placements that they’ve done a lot of the digital design, that firms are starting to start to utilize.

But the main thing to just remember – there is the initial review and due diligence. You can’t rely on somebody else. The firm itself still has to rely on the information that they’ve gotten and reviewed, and they need to keep that and document that. And Ed, you mentioned the ongoing due diligence, looking at the quarterly information, looking at the annual information, what types of red flags are being thrown out from a valuation standpoint. Are you able to get valuation information in a timely manner? I know that’s one kind of sensitive piece of information that’s important to everyone. Just taking all those things into consideration. I would say, when looking at these type of products, that’s not for everybody. So, knowing your client base and who you’re talking to clients about, some may never want to even look at this. Some advisors want to have this in their back pocket. They feel like this is something that they need to have to separate themselves and stand out from other advisors that clients may be working with. And I get that, but again, we just have to make sure that you would sell it to your grandmother. That’s why I always say, everybody loves their grandmother, or I hope everyone does. So, would you sell that to your grandmother if she was the appropriate type of investor? If you wouldn’t, then don’t sell it.

Casey Dougherty:  Absolutely. So sorry. Okay. Yeah, sorry to interrupt you. And Sarah, those are great comments. What I was thinking about Sarah, as you were mentioning that, and Dean was really emphasizing the due diligence that needs to go into these things. And that you really carry that burden on your firm when you start working these products is how do our reps know? Do I sell this complex product where I get a 7% commission, it’s a liquid, but gosh darn the thing’s really cool. Or do I go and sell a publicly available traded, open-ended mutual fund or ETF maybe only get 4% commission on that? I think it becomes really incumbent on the firm to provide that training to the advisors, to the reps to say, how do we compare those reasonably available alternatives and make a distinction? When is that extra potential return or a little lack, a little less correlation with the overall market worth, that additional lack of liquidity for the clients and how do you compare that to the compensation? I think firms really need to be giving that thought. And when I read this FINRA letter, I think FINRA’s also picking up on that too, this idea that you really need to provide reps some training around how to approach this distinction between different options.

Sarah Sutton:  I completely agree with you, Casey. One of the things too is some firms limit the percentage that a rep can earn on some of these investments, not just from private placements, but on the annuity space. And kudos to them because it helps kind of take that one piece that might be conflicting someone as to, should I recommend this or not? Well, if you take out the fact that you’re not going to earn more than a set percentage, well that conflict is not there. Or it’s one thing that’s not going to stick out like a sore thumb.

Ed Wegener:  And you both mentioned compensation, which is one form of conflict, but that’s another thing to be looking at as well. Oftentimes the firm that’s selling or recommending a private placement may have other types of conflicts or affiliations with the issuer of the security. And all of that is not only something that you need to take into consideration when assessing, is this conflict impairing my ability to make a disinterested recommendation to the client, but also definitely something that you need to disclose to the clients and make sure that any of those conflicts are mitigated. Well, I really appreciate all your insights in, into these particular areas. That was a lot of information to digest, but we really appreciate your expertise and advice in these areas, and we look forward to talking to you all again.

Bob Mooney:  Again, thanks everyone for listening.  if you’d like to learn more about our experts and how Oyster can help your firm, visit our website If you like what you heard today, follow us on whatever platform you listen to and give us a review. Reviews make it easier for people to find us. Have a great day.

About The Authors
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Ed Wegener

Ed Wegener is an innovative compliance, risk management and supervisory controls expert with deep understanding of Federal Securities Laws and the rules of self-regulatory organizations, as well as technology optimization and risk mitigation. Prior to joining Oyster, Ed held several posts in FINRA, most recently as  Senior VP and Midwest Regional Director.

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Sarah Sutton

Sarah Sutton has over 20 years of experience in the financial services industry on both the revenue and compliance sides of the business. Her expertise includes compliance supervision, leading firm and regulatory examinations, regional and retail branch management, brokerage and clearing operations, developing and implementing advisor best practices along with technology training, financial planning delivery and implementation, advisor and firm transition management to new firms and channels, and project management for advisor and client solutions.

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Dean Pelos

With over 30 years of experience as a financial services professional, Dean Pelos has extensive experience helping firms maintain regulatory compliance, grow sales, and control costs. Dean has a strong background in compliance for investment advisers and broker-dealers and additional experience specializing in regulatory compliance for investment companies.

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Casey Dougherty

Casey Dougherty’s 20 years of experience includes expertise in Compliance and Legal supervision in a shared-services environment, executing broker-dealer to broker-dealer joint work and succession arrangements, and other marketing arrangements covering private placement life insurance, VUL and annuity sales.