State Regulator Opens Inquiry Into Products Sold to Older Investors

The top financial regulator in Massachusetts has subpoenaed 15 brokerage firms as part of a new investigation into the marketing of complicated financial investments to older people.

The Massachusetts secretary of the commonwealth, William F. Galvin, asked the firms - including Merrill Lynch, Morgan Stanley and LPL Financial - about the way they have sold “high-risk, esoteric products” to older citizens.

Several regulators have previously expressed concern about the rising number of opaque products that have been pitched to unsophisticated investors looking for higher returns in an era of low interest rates. Brokers like selling the products because they frequently offer higher commissions than traditional investments like mutual funds.

“These things are accidents waiting to happen when they are sold to inexperienced investors,” Mr. Galvin said on Wednesday.

Mr. Galvin recently collected $11 million in fines from five broker-dealers for selling illiquid real estate investment trusts, or REITs, to investors in his state. Unlike publicly traded REITs, the illiquid products are not easy to sell when a consumer wants to get out of the investment.

In the course of his office's investigation of those REITs, Mr. Galvin said that his staff noticed that many brokers were selling a number of other complex financial products that even they did not understand, with little oversight from their parent companies.

“It's the whole methodology by which these products are sold  - that's the bigger problem,” Mr. Galvin said.

In addition to the REITs, Mr. Galvin's office will be looking into the selling of structured products, oil and gas partnerships and private placement deals  - all of which disclose less public information than public stocks and bonds.

These investments used to be restricted only to sophisticated investors with a net worth of at least $1 million. Now, regulators say that they are being opened up to less wealthy investors, as well as a growing number of wealthy but less l sophisticated investors.

The sales of these products has become more prominent since the financial crisis, because many older Americans are trying to make up for losses they suffered in their retirement portfolios. The low yields on bank accounts and bonds in recent years has also made investors more willing to look at riskier products that promise better returns.

Richard G. Ketchum, the chief executive of the Financial Industry Regulatory Authority, the industry regulatory group, said in a recent speech that over the last two years his organization had noticed an uptick in “the sale of complex products and speculative products with low liquidity, to unsuitable customers by financial advisers who often don't fully understand the risks of the products.”

The Massachusetts investigation began on the same day that the Securities and Exchange Commission agreed to lift its ban on public advertisements for some of the same complex investments Mr. Galvin is examining. Mr. Galvin and other state securities regulators have criticized the S.E.C. decision, arguing that even with advertising banned, too many unsophisticated investors have ended up learning about and buying products that are unsuitable for their investment goals.

Mr. Galvin's office emphasized that the investigation was just beginning. He added that being on the list of banks and brokerages receiving subpoenas “is not an indication of wrongdoing at this time.”