ATR Comments on FINRA Regulatory Notice on Complex Products 

On May 6^th, Americans for Tax Reform submitted comments to the Financial Industry Regulatory Authority’s (FINRA) notice on the availability of certain publicly traded securities to individual investors. ATR is concerned that FINRA’s proposal risks eliminating trillions of dollars of affordable and accessible investment options for individual investors.

The letter opens by taking a firm stance against what it names as the “paternalistic” regulatory framework of the notice:

Subsequent rules that are issued as a result of the Notice could increase the cost of offering ‘complex products’ to a point where these investments may offer lower returns than before, or retail investors may lose access to these services altogether. Future regulation of complex products and options as proposed in the Notice will undermine the innovation retail investors have experienced over the past several years. […] Implementation of strict prerequisites—as proposed in the Notice—for investing in complex products (e.g., knowledge tests, account opening requirements, proof of high-net worth, and learning courses) risks ruining this cost-cutting trend and eliminating the opportunity for the development of new cost-effective investment products. Firms may stop offering certain products because of the ambiguity and subjectivity of the definition of complex products, and the overall costs of compliance.

The letter suggests that the notice wants to place investment decision-making into the hands of bureaucrats: 

FINRA should… focus on ensuring that investors receive the information they need to make informed investment decisions. Arbitrarily delineating the level of risk between complex and simple products fails to inform investors and could raise the cost of offering certain products to a point where many could be removed from the market entirely. This limits options for investors and certainly is not in their best interests. By publishing the Notice, FINRA has made it clear that it intends to shift to merit-based regulation, instead of the traditional disclosure-based regime.

The notice also has the capacity to reduce investor returns and be influenced by SEC politics:

Although adequate transparency is necessary to keep investors informed and ensure that broker-dealers have a ‘reasonable basis’ for suggesting certain investment options, obtrusive regulatory requirements will increase costs for brokerage firms and ETF managers, thus reducing returns to investors. This would stymie the accessibility of a wave of new innovative investment products on trading platforms available to investors of all socioeconomic backgrounds… Defining a complex product or option also exposes publicly traded securities to politicization. Since the SEC oversees FINRA, the current leadership at the SEC has influence over decisions made at the self-regulatory organization… This benefits certain special interest groups and the Biden administration.

FINRA also circumvents its statutory authority: 

FINRA has also violated its authority under Section 15A(b)(6) of the Securities Exchange Act. Under the statute, FINRA is required to (1) ‘to promote just and equitable principles of trade,’ (2) ‘perfect the mechanism of a free and open market,’ and (3) prohibit ‘unfair discrimination between customers, issuers, brokers, or dealers,’ among other requirements. […] Embedded in the list of questions about complex products, the Notice asks whether members should “implement an account approval process” or require retail investors to complete a “knowledge check” or “learning course” in order to prove they have the aptitude to invest in complex products. Tests and subjective qualification requirements can be unintentionally biased – resulting in unfair discrimination between customers in violation of FINRA’s governing statute. Imposing these requirements on investors would deepen the divide between institutional and retail investors—allowing greater access to a wider variety of securities for the former but limiting choices for the latter. 

The letter closes by reiterating the importance of considering the notice’s unequal economic impact on investors of different means, and the value of cost–benefit analysis in evaluating future regulation:

Ensuring that retail investors have access to innovative financial products that offer a multitude of options is the key to thriving capital markets. Unfortunately, the provisions of the Notice threaten to impose a new layer of regulation that will impede investors’ access to complex products. Instead of imposing a paternalistic regulatory framework for retail investors, FINRA should stick to principles-based regulation that ensures clear lines of communication between fund managers and investors. Checking a box by requiring knowledge tests, prior account opening approval, and superfluous disclosures will surely increase the costs of these investment products or eliminate their availability to non-institutional investors… Any future rules published by FINRA should carefully take into consideration the negative repercussions of restricting certain investment products to a select few… If further justification for the proposed changes is not enumerated, future rules will likely fail to pass muster and be deemed arbitrary and capricious.

Click here to read the full letter.