Money hazards: 'Structured product' investment sales under regulatory review

Sometimes financial advisors recommend investment products that are hard to understand. When hearing their pitch, I'm not sure that they know how these "black box" investments really work.

One such investment is the "structured product." These big-commission investments can carry upfront fees of up to 5%, which are often hidden.

FINRA, the regulatory agency overseeing brokerage firms, is conducting an official review of how these complicated investments are being sold. It is specifically looking into non-principal protected structured notes.

The agency wants to ensure that brokerage firms appropriately supervise registered representatives when they pitch such investments, including the duty to disclose any conflicts of interest. 

In other words, is the financial advisor's recommendation to buy such an investment clouded by that big, upfront commission?

Buried in the fine print of some of these structured notes is the risk that the principal (your original investment) may not be returned. Some structured products can reduce or stop interest payments altogether.  

Many of these investments are pitched as suitable for income investors, especially retirees seeking a steady stream of cash.

"They typically combine a traditional security, like a bond, with a derivative component," FINRA said. "Unlike a mutual fund or exchange-traded fund (ETF), a structured note does not hold an actual underlying portfolio of investments. Instead, the note issuer promises to pay a return based on a formula that incorporates the performance of one or more reference assets."

See? Complicated stuff. 

Structured products also have unique risks, FINRA noted. 

"Their terms and features can be different and significantly more complex. FINRA has identified multiple instances where firm representatives have concentrated their customers’ assets in structured products that increase complexity and risk. Highly concentrated investments can pose risk, and that risk is heightened when the concentrated investment is a complex product. Structured notes can expose investors to losses not correlated with overall market conditions. Some investors have lost significant portions of their portfolios through such concentrated positions," the agency added.

Avoiding a money hazard: If a financial advisor pitches you a structured product, ask about the fees —exactly what they are and how much commission they are earning.  

And do they own it?