Securities that offer exposure to commodities have become increasingly popular and accessible to retail investors, so FINRA thought it's a high time it reminded firms of their sales obligations when offering commodity futures-linked securities. 

    Commodity-Linked Securities ("CLS's") ...  often use futures contracts to track an underlying commodity or commodity index.  Commodity futures-linked securities ("CFLS's") can be an effective tool for gaining exposure to an asset class that in some cases can be difficult for retail investors to access.  However, the performance of the CFLS can sometimes deviate significantly from the performance of the referenced commodity, especially over longer periods.  Whether that deviation is positive or negative depends on market conditions and the product’s investment strategy.  In either case, they can produce unexpected results for investors who aren't familiar with futures markets, or who mistakenly believe that CFLS's securities are designed to track commodity spot prices.

    A Firm's Sales Obligations.   (i) Communications with the public about these securities must be fair and balanced.  (ii) Suitability is critical when recommending the securities to customers.  (iii) RR's have to understand what they're selling and they must be able to explain the securities to their customers.  To fulfill these obligations, firms must:

• Train registered personnel on the characteristics, risks, and rewards of each product before they go out and sell.  [i.e. - talking points and sales scripts just won't cut it.]
• Have adequate WSP's and supervisory controls to ensure compliance with federal securities laws and applicable FINRA rules.

For CFLS's, the RR and retail customer should discuss, among other things:

• the commodity, basket of commodities or commodities index that a given product tracks;
• the product’s goals, strategy and structure;
• that commodities prices, and the performance of CFLS's, can be volatile;
• that use of futures contracts can affect the performance of the product as compared to the performance of the underlying commodity or index;
• the product’s methodology, including its strategy, if any, for managing roll yield and other factors that may affect performance; and
• the product’s tax implications. (Commodity pools have different tax implications than mutual funds or ETNs.)

    About Futures Contracts and Futures-Linked Securities.   Standardized futures contracts are exchange-traded derivatives that guarantee delivery of a commodity on an agreed-upon date for an agreed-upon price.  CFLS's that seek to provide investors with continuous exposure to commodities typically avoid taking physical delivery of the commodity by selling their next-to-expire contracts prior to expiration, and purchasing new contracts with more distant delivery dates - "rolling the position."

In some cases a CFLS will have to roll its position into a more expensive contract, resulting in a loss, or negative roll yield.  This is typical of a futures market in contango, in which futures contracts with more distant delivery dates are more expensive.  In other cases, it may roll its position into a less expensive
contract - i.e., backwardation.  Due to these and other market forces, CFLS's can perform differently - either better or worse - than the spot price for the commodity itself.

Moreover, over time, any performance differential can be magnified if a specific condition persists in the market for a given commodity, such as contango or backwardation. This deviation is not tracking error, because the futures-linked products are designed to track futures.  However, it can lead to unexpected results for investors or RR's who don't understand the product, or who mistakenly believe that the product will replicate the performance of the commodity’s spot price.

For further details, click onto:  [ Regulatory Notice 10-51, October ]