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Wall St Regulator Questions Sales of Complex Securities

The Financial Industry Regulatory Authority is looking at potential conflicts of interest and financial incentives stemming from sales of complex securities by major brokerages, the head of the Wall Street regulator said on Thursday.

The Financial Industry Regulatory Authority is looking at potential conflicts of interest and financial incentives stemming from sales of complex securities by major brokerages, the head of the Wall Street regulator said on Thursday.

FINRA is looking "very closely" at the effects of incentive compensation, such as commissions, that might motivate brokers to sell certain complex securities, said FINRA Chief Executive Officer Richard Ketchum.

The regulator is also looking at conflicts and incentives at broker-dealers that both develop and sell certain complex products, Ketchum said during remarks at an industry conference in New York.

He did not name the brokerages that the regulator is questioning.

The industry-funded watchdog has been clamping down on sales practices involving a range of complex securities, including leveraged and inverse exchange-traded funds. Many investors are often drawn to the securities because of the promise of high returns, but are not fully aware of the risks, Ketchum said.

Leveraged and inverse ETFs, for example, are designed to amplify short-term returns by using debt and derivatives and are more suitable for professional traders than for long-term retail investors.

In May, Citigroup Inc Morgan Stanley, UBS AG and Wells Fargo & Co agreed to pay FINRA more than $9.1 million in fines and restitution for selling leveraged and inverse exchange-traded funds "without reasonable supervision."

In June, the regulator barred a small brokerage from the industry, saying its sales practices for complex securities tied to risky mortgage-backed holdings violated industry rules.

U.S. regulators require brokerages to disclose the risks and supervise sales of risky and complex securities, but do not keep retail investors from buying them, Ketchum said during a conference hosted by the Securities Industry and Financial Markets Association.

But that could change.

"If the industry and regulators can't demonstrate their ability to control sales practice abuses, then, in my opinion, some (restrictions) may become inevitable," Ketchum said. Certain controls are already in place in some overseas markets, he said.

FINRA is also asking brokerages about their training practices to ensure that brokers and other sales staff fully understand the risks of complex securities before recommending them to investors, Ketchum said.

"If firms are going to have account executives selling products that have leverage and a variety of credit issues that may not be immediately apparent in a product that may look and feel like a fixed income product, they need to understand (them)," Ketchum told reporters after his remarks. "How they do that training is up to them."

Copyright 2010 by Reuters. All rights reserved.

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