The Financial Industry Regulatory Authority (FINRA) announced today that it will review firm practices regarding higher-risk structured products, specifically non-principal protected “worst-of” structured notes.

The review will examine how firms supervise concentrations in these products, including how they comply with Regulation Best Interest and FINRA rules when their registered representatives recommend these products to investors.

Structured products are designed to meet specific investment objectives for retail investors, such as growth, income or risk management. They typically combine a traditional security, like a bond, with a derivative component.

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.

While structured products may have the potential for higher returns than their reference assets, they also have unique risks. Their terms and features can be different and significantly more complex, which may warrant heightened supervisory scrutiny. Certain structured products, such as structured notes that provide payoffs that depend upon the worst performing reference asset in a pre-specified group (commonly referred to as “worst-of” notes), present particularly complex features.

FINRA has identified multiple instances where firm representatives have concentrated their customers’ assets in structured products that increase complexity and risk. This includes characteristics such as a lack of principal protection and “worst-of” features, among others. 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.

FINRA’s review of firm supervision for concentration in higher-risk structured products will only affect a subset of member firms.

However, the organization encourages all firms that recommend these products to review the questions in the letter and evaluate their practices. This includes firms’ training, guidance, controls and supervisory structure for professionals making these product recommendations to clients.