As more cutting-edge investment products make their way onto the market, there is growing fear among retail investors and even professional brokers.
Former SEC attorney David Gorman, who is now a partner at Dorsey & Whitney, says complex products designed for profit create unprecedented risks and that US regulators are taking notice.
“It’s just starting to emerge in their application business,” Gorman told CNBC’s “ETF Edge” this week. “These products are incredibly complicated.”
The Financial Industry Regulatory Authority, or FINRA, considers leveraged and inverse ETFs, equity-linked annuities, and inverse convertibles to be complex products.
It may not even be enough to have a doctorate. in economics to understand sophisticated instruments, according to Gorman.
“It’s classic Warren Buffett”
“It’s classic Warren Buffett. If you don’t understand it, you can’t invest in it. And that’s what’s happening here,” he said. “The first line of defense here is the broker. The broker is supposed to have policies and procedures in place that say that’s how you teach people this stuff. That’s what it is. And in the cases, the SEC brought, these were not followed.”
Senior Branch CEO Kim Arthur points out that the wide availability of alternative investments on trading platforms is problematic. His firm caters to institutional clients and wealthy individuals.
“We use complex products, mostly options. And it’s mostly covered call options. So the big difference with that is that you use it to smooth out volatility. Create another income stream or hedge against larger swings,” Arthur said in the same segment.
He thinks it’s essential that regulators enforce information in products.
“In the meantime, you’re just continuing to do increased education alongside regulation,” Arthur noted. “You don’t need a complex product to bust day trading Robin Hood.”
If there is a broad federal crackdown, Dave Nadig, CIO and director of research at ETF Trends, warns it could have serious consequences for the industry.
“[It] could have quite a chilling effect on sales of these products and investors‘ portfolios,” Nadig said in the same segment. “These are really powerful tools that investors rely on.”