Approved Product List

A firm's product committee approves a new alternative investment for the general approved product list after reviewing its risk and suitability characteristics for typical retail brokerage accounts. The product is subsequently sold into retirement accounts as well, without the committee having separately considered whether the product's characteristics raise different or additional concerns in that context. What should the committee have done?

1. A.Nothing further, since a product approved for general retail sale is automatically appropriate for any account type a customer happens to hold, including retirement accounts.Wrong. General retail approval does not automatically extend to every account type without considering its distinct characteristics.
2. B.The committee should have restricted the product entirely from ever being sold into any retirement account, regardless of the product's specific characteristics.Wrong. This overcorrects into a blanket restriction rather than requiring the committee to actually evaluate the account-type-specific considerations.
3. C.The committee should have considered whether the product's characteristics raise distinct concerns for account types with different considerations, such as retirement accounts, as part of its due diligence, rather than assuming an approval based on typical brokerage account characteristics automatically extends to every account type the product might later be sold into.Correct. The committee needs to actually evaluate account-type-specific considerations, not assume general approval covers every context.
4. D.The committee should have required a separate signed disclosure from customers using retirement accounts, without any additional analysis of the product's suitability for that context.Wrong. A disclosure requirement does not substitute for the committee's own analysis of account-type-specific suitability considerations.

Why: The committee should have considered whether the product's characteristics raise distinct concerns for account types with different considerations, such as retirement accounts, as part of its due diligence, rather than assuming an approval based on typical brokerage account characteristics automatically extends to every account type the product might later be sold into.

A firm is deciding whether to add a new non-traded REIT to its approved product list. Which of the following is a necessary part of the principal's due diligence before approval?

1. A.Confirming the product sponsor has been in business for at least one yearWrong. Sponsor tenure alone does not substitute for substantive due diligence on the product's own risk characteristics.
2. B.Reviewing only the sponsor's projected future return figuresWrong. Projected returns alone omit the risk characteristics -- like liquidity and fees -- that are central to due diligence.
3. C.Understanding the product's risk characteristics, such as liquidity, valuation, and fees, and identifying appropriate customer typesCorrect. Due diligence must cover risk characteristics and the appropriate customer profile, not just projected returns.
4. D.Confirming the product has FDIC insurance coverageWrong. A non-traded REIT is not an FDIC-insured product; this is not a relevant or accurate due diligence step here.

Why: Due diligence for a new product must include understanding its risk characteristics -- including factors like illiquidity, valuation methodology, and fee structure for a non-traded REIT -- and identifying the type of account and customer for which it may be appropriate.

A principal notices that several of a representative's customers, across otherwise unrelated accounts, have each independently mentioned making an investment in the same specific private company that is not on the firm's approved product list and does not appear on any of their firm account statements. What should the principal recognize about this pattern?

1. A.This pattern is a recognized red flag for potential selling away, where a representative may be involved in selling unapproved investments to customers outside the firm's books and records, and it warrants further inquiry rather than being treated as coincidental.Correct. A pattern of unrelated customers independently mentioning the same unapproved outside investment is a recognized selling-away red flag.
2. B.The pattern is not a concern, since the investment does not appear on any firm account statement and is therefore outside the firm's supervisory responsibility.Wrong. The absence from firm records is exactly why this pattern is a red flag for undisclosed activity, not a reason to disregard it.
3. C.The pattern only becomes a concern if one of the affected customers files a formal written complaint about the investment.Wrong. The pattern itself, not a complaint, should trigger further inquiry.
4. D.The concern is limited to verifying that each customer signed a risk acknowledgment for outside investments, which is available from the firm's back office.Wrong. No such acknowledgment resolves the actual concern about unapproved outside activity occurring without the firm's knowledge.

Why: This pattern is a recognized red flag for potential selling away, where a representative may be involved in selling unapproved investments to customers outside the firm's books and records, and it warrants further inquiry rather than being treated as coincidental.