Many issuers and their affiliated broker-dealers have an elaborate new product approval process, but may focus less time on the post-approval review. FINRA has regularly commented on its expectations regarding the need for member firms to have in place a similarly robust post-sale review process. The post-sale review may be conducted by a broker-dealer's "new product committee." FINRA Notice 05-26 states that broker-dealers should:
- track and monitor customer complaints and grievances relating to new products;
- reassess the firm's training needs regarding a product on a continuing basis;
- establish procedures to monitor, on an ongoing basis, firm-wide compliance with any terms or conditions that have been placed on the sale of the product;
- periodically reassess the suitability of the product; and
- review any product before lifting any restrictions or conditions on the sale of the product.
Similarly, FINRA Notice 12-03 states that a "well-designed system of internal controls should include a process to periodically reassess complex products a firm offers to determine whether their performance and risk profile remain consistent with the manner in which the firm is selling them." FINRA Notice 12-03 notes that, as to complex products, member firms should implement a post-approval review process:
- periodically reassess the complex products a firm offers to determine whether their performance and risk profile remain consistent with the manner in which the firm is selling them;
- consider developing procedures to monitor how the products performed after the firm approved them; and
- conduct periodic reviews to ensure that only associated persons who are authorized to recommend complex products to retail customers are doing so.
In its Report on Conflicts of Interest, FINRA stated, "effective practice for product manufacturing firms is to implement post-launch reviews to identify potential issues with a product that may not have been apparent during the initial review process, which could lead to conflicts of interest or reputational risk. Such issues could include unexpected product performance, subsequent activity by the manufacturer that may specifically influence the performance of the product, use by investors for whom the product was not intended, or use that is inappropriate or unanticipated."
With these principles in mind, we provide a framework and checklist for conducting a post-approval review. Each broker-dealer will need to consider its processes in light of its own business model, including the nature of its investor base, the types of products that it sells, and the channels through which it offers its products. Moreover, if a broker-dealer sells any of its products outside of the United States, the laws and practices of the relevant jurisdictions may need to be considered as well in formulating an appropriate post-sale review process.
SELECTION PROCESS FOR REVIEW
The broker-dealer may consider selecting notes for review:
- by underyling reference asset in order to ensure a variety of reference asset exposures are considered;
- by date (i.e., some issued in the first quarter of the most recent year, some issued in the third quarter, or through some other random or non-randomized sampling);
- by pay-off feature (principal-protected, buffered, etc.) with an emphasis on the most complex structures;
- by distribution channel;
- based on sales volumes, retail focus of distribution or other relevant criteria; or
- any other reasonable sampling basis.
PROCEDURES FOR POST-APPROVAL REVIEW
The new product committee should be provided with data, including:
- amounts offered;
- distribution channel;
- types of investors;
- products of performance;
- actual performance versus product performance anticipated when the product was introduced;
- any inquiries received from regulators on the product type, marketing material used, offering documents used and initial new product committee approval submissions.
The committee also may wish to consider the extent to which:
- the product is described appropriately in marketing and disclosure documents, particularly as to the disclosure of the relevant risk factors, as well as in internal training materials;
- the product description in the original new product committee submission remains accurate;
- the product has performed as contemplated at the time of approval;
- additional training of the representatives or distributors is advisable;
- the performance is consistent with any relevant hypothetical back-tested data and/or any sensitivity or similar tests;
- the objective of the product remains valid or continues to address a market need;
- investors have attempted to liquidate the product prior to maturity to a greater extent than other products;
- any operational issues have arisen in relation to the issuance, hedging or trading of the product;
- any compliance issues have arisen, including any unexpected conflicts of interest;
- peer firms are offering similar products;
- any other products are offered that are advantageous as compared to the relevant product, for example, with fewer fees, greater liquidity, etc.; and
- the distribution channel should be changed, minimum purchase amount required or other precautions taken.
In addition to assessing the adequacy of a firm's internal controls with regard to a firm's post-approval review process, when dealing with complex products FINRA encourages firms to:
- thoroughly train registered representatives to understand the features and risks associated with the product;
- consider the customer's financial sophistication when making product suitability determinations;
- discuss with retail customers the features of the product, how it is expected to perform under different market conditions, the risks and possible benefits, and the costs of the product;
- consider whether less complex or costly products could achieve the same objectives for the customer; and
- be cognizant that the broker-dealer suitability obligation extends from the product design and product approval process to post-approval review.
Last, FINRA notes that even the most elaborate procedures will not be effective unless they are rigorously implemented, something that ultimately depends on the firm's culture and the level of commitment on the part of the firm's leadership.
Originally published in REVERSEinquiries, Volume 2, Issue 1.
Originally published 22 January 2019
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