FINRA Encourages Firms to Notify FINRA if They Engage in Activities Related to Digital Assets
For the past two years, FINRA has encouraged firms to keep their Risk Monitoring Analyst (formerly known as a “Regulatory Coordinator”) informed if the firm, or its associated persons or affiliates, engaged, or intended to engage, in activities related to digital assets, including digital assets that are non-securities. FINRA appreciates members’ cooperation with this request and is encouraging firms to continue to keep their Risk Monitoring Analyst abreast of their activities related to digital assets until July 31, 2021.
• FINRA Regulatory Notice 20-23 (July 09, 2020): FINRA Encourages Firms to Notify FINRA if They Engage in Activities Related to Digital Assets
SEC, FINRA, and the NASAA investor alerts, bulletins and statements on initial coin offerings and cryptocurrency-related investments.
• SEC resources for investors considering digital assets: Spotlight on Initial Coin Offering and Digital Assets
• FINRA Investor Insights: Cryptocurrency Trading Platforms: Do Your Homework (April 18, 2019)
Securities Offering Reform for Closed-End Investment Companies
The SEC adopted rules that will modify the registration, communications, and offering processes for business development companies (“BDCs”) and other closed-end investment companies under the Securities Act of 1933. As directed by Congress, the SEC is adopted rules that will allow these investment companies to use the securities offering rules that are already available to operating companies. August 1, 2020 was the effective date for all aspects of the final rule, subject to the exceptions noted in the Release.
• SEC Release No. 34-88606 (April 8, 2020) 85 FR33290 (June 1, 2020): Securities Offering Reform for Closed-End Investment Companies (Final Rule)
Amendments to Nasdaq Rules 5705 and 5710 to Adopt a Disclosure Requirement for Certain Securities
The SEC approved a proposed rule change to amend Nasdaq Rule 5705(b)(1)(B) relating to Index Fund Shares and Nasdaq Rule 5710(d) relating to Linked Securities to require issuers of such Index Fund Shares or Linked Securities to include on each such product’s website a statement that the product seeks returns for a single day, and that, due to the compounding of returns, holding periods of longer than one day can result in investment returns that are significantly different than the product’s target returns. The disclosure would also direct investors to consult the prospectus for further information on the calculation of the returns and other risks associated with investing in this type of product.
• SEC Release No. 34-85362 (March 19, 2019), 84 FR 11148 (March 25, 2019): Order Granting Approval of a Proposed Rule Change, as Modified by Amendment No. 2, to Amend Nasdaq Rules 5705 and 5710 to Adopt a Disclosure Requirement for Certain Securities
Alternative Mutual Funds
The SEC’s Office of Investor Education and Advocacy issued an Investor Bulletin to inform investors about features, and some potential risks, of alternative mutual funds.
• SEC Investor Bulletin (February 3, 2017): Alternative Mutual Funds
Fund of Funds Arrangements
The SEC adopted a new rule under the Investment Company Act of 1940 to streamline and enhance the regulatory framework applicable to funds that invest in other funds (“fund of funds” arrangements). In connection with the new rule, the Commission rescinded rule 12d1-2 under the Act and certain exemptive relief that had been granted from sections 12(d)(1)(A), (B), (C), and (G) of the Act permitting certain fund of funds arrangements. Finally, the Commission adopted related amendments to rule 12d1-1 under the Act and to Form N-CEN. The rule became effective on January 19, 2021.
• SEC Press Release 2020-247 (October 7, 2020): SEC Updates Framework for Fund of Funds Arrangements
Sales Practice Obligations With Respect to Oil-Linked Exchange-Traded Products
Exchange-traded products (ETPs) provide different types of exposure to the oil market through several product structures, which some investors or investment professionals might not understand. Moreover, the performance of such products may be linked to unfamiliar indices or reference benchmarks, making them difficult for the average investor to comprehend. In particular, a number of these ETPs are designed to track daily price movements of specified crude oil futures contracts, such as those on West Texas Intermediate (WTI) light, sweet crude oil (referred to herein as “oil-linked ETPs”). Due to recent extraordinary conditions in crude oil markets, combined with the manner in which the products are structured, several oil-linked ETPs have experienced significant volatility and lost a substantial percentage of their value, with at least one ETP liquidating and another forced to halt the issuance of new shares and adjust its investment objective.
These concerns are not limited to oil-linked ETPs: some other commodity-linked products, such as natural gas ETPs, as well as volatility-linked ETPs, may share similar features and have been the subject of prior FINRA guidance and regulatory action. Based on FINRA’s experience with complex products broadly, some investors—as well as investment professionals recommending them—may not understand oil-linked ETPs’ investment objectives, how their performance relates to the “spot” (or cash) price of oil, or how the different product structures can impact their performance and the investor experience.
This Notice reminds firms of their sales practice obligations in connection with oil-linked ETPs, including that recommendations to customers must be based on a full understanding of the terms, features, and risks of the product recommended; communications with the public must be fair and accurate; firms must have reasonably designed supervisory procedures in place to ensure that these obligations are met; and firms that offer oil-linked ETPs must train registered representatives who sell these products about the terms, features and risks of these products.
• FINRA Regulatory Notice 20-14 (May 15, 2020): Oil-Linked Exchange-Traded Products.
Volatility-Linked Exchange-Traded Products
Volatility-linked exchange-traded products (ETPs) are designed to track Chicago Board Options Exchange Volatility Index (VIX) futures, rather than the VIX itself. For the reasons explained in the Notice, many volatility-linked ETPs are highly likely to lose value over time. Accordingly, volatility-linked ETPs may be unsuitable for certain retail investors, particularly those who plan to use them as traditional buy-and-hold investments. This Notice reminds firms of their sales practice obligations in connection with volatility-linked ETPs as discussed more generally in Regulatory Notice 12-03, including, without limitation, that recommendations to customers must be based on a full understanding of the terms, features and risks of the product recommended, sales materials must be fair and accurate, and firms must have reasonable supervisory procedures in place to ensure that these obligations are met.
• FINRA Regulatory Notice 17-32 (October, 2017): FINRA Reminds Firms of Sales Practice Obligations for Volatility-Linked Exchange-Traded Products
FINRA published guidance to firms about the supervision of complex products, which may include a security or investment strategy with novel, complicated or intricate derivative-like features, such as structured notes, inverse or leveraged exchange-traded funds, hedge funds and securitized products, such as asset-backed securities. These features may make it difficult for a retail investor to understand the essential characteristics of the product and its risks.
Regulatory Notice 12-03 identifies characteristics that may render a product “complex” for purposes of determining whether the product should be subject to heightened supervisory and compliance procedures and provides examples of heightened procedures that may be appropriate.
• FINRA Regulatory Notice 12-03 (January 2012): Heightened Supervision of Complex Products