It's getting harder to make money on Wall Street these days -- at least according to Wall Street. The financial industry's grumbling about the new regulations it must now live with, including the 2,300-page Dodd-Frank Act. After the recent financial crisis, regulators are also keeping a closer eye on financial professionals -- particularly the proliferation of "structured products."
Financial advisors generally have a "fiduciary duty" to act in the best interest of their clients. While some critics wanted the Dodd-Frank Act to extend that responsibility to broker-dealers, that didn't happen. The law did give the SEC the power to do so, but until the SEC decides to implement that power, broker-dealers need only offer "suitable" investments to their customers.
However, regulators have grown concerned that broker-dealers and other financial companies are increasingly selling structured products to customers. The companies like them because they can generate more profits than simple stock and fund trades, whose profits have shrunk as rival brokerages steadily cut commission costs. E*TRADE
Structured products can be so complicated that even the salesperson offering them to a customer may not fully understand them -- thus making it hard to determine that investment's suitability. And many people buying them don't understand, either.
These products come in many shapes and sizes, with more than 8,000 sold last year. Some are structured as mutual funds, others as notes. They can employ a lot of leverage, upping the investor's risk. Many include commodities, options, and/or derivatives, tying returns to benchmarks such as currencies, interest rate spreads, or commodities. Some promise a degree of protection of your principal, but at a cost. (And that protection is often only as solid as the company offering it.) While limited downside risks might sound appealing, your gains might also be capped, limiting the value of the investment. Structured products can also be expensive and illiquid.
Investors in financial services companies may be pleased to see outfits such as US Bancorp
Financial Industry Regulatory Authority chief Richard Ketchum recently warned brokerages that, "It is a bit bizarre we have investments with embedded derivative capabilities as open and available as they are," noting that FINRA will look at traits like leverage and counterparty risk in assessing these investments.
If someone is trying to sell you on any structured products, make sure you learn as much as possible about them before you think about buying. You should also consider sticking with less expensive brokerages, which are less likely to tempt you with costly and potentially dangerous investments.
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Longtime Fool contributor Selena Maranjian holds no position in any company mentioned. Click here to see her holdings and a short bio. Motley Fool newsletter services have recommended buying shares of Charles Schwab. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.