FSC Securities Corp., headquartered in Atlanta, GA, has agreed to a letter of acceptance, waiver and consent (“AWC”) with FINRA dated August 10,2017. The agreement in Enforce,ment Action AWC 2010024620303 involves the sale to customers of non-traditional Exchange Traded Funds (“ETFs”).
FSC operates a general securities business utilizing an independent contractor model. It has approximately 1,300 registered representatives and 650 branch offices.
This investigation centered on the sale of non-traditional ETFs. Traditional ETFs are currently popular investment vehicles. Similar to a mutual fund, an ETF is comprised of a “basket” or index of underlying securities, commodities, etc. However, unlike a mutual fund, the price of ETFs fluctuates daily; ETFs trade like a common stock.
Several years ago, Wall Street firms created leveraged and inverse ETFs, referred to as non-traditional ETFs. Inverse ETFs, through the use of derivative products, are structured to provide returns that are the inverse of the performance of the underlying basket or index of securities. Leveraged ETFs borrow against the basket of securities to increase the size of the basket, thereby increasing the rate of return (or, of course, the possible negative return). There are even leveraged inverse ETFs.
These products are meant to be held short term and are viewed as trading vehicles.
In short, these are particularly complex products, not suitable for many retail investors. Indeed, as noted in the AWC, FINRA issued a Regulatory Notice in June 2009 that given the complex nature of these products and their short term trading characteristics, these products were typically not suitable for retail customers who intend to hold them longer than one trading session.
Nevertheless, FINRA found that FSC failed to properly supervise the sale of non-traditional ETFs by FSC sales representatives to their customers. For the period in question (January 2009 to September 2014) there were 6,500 purchases of non-traditional ETFs in 1,400 FSC customer accounts. $92 million of the products were purchased, resulting in $603,000 in commissions charged to clients.
The AWC states that from January 2009 until November 2009 FSC did not have a supervisory process in place to monitor the sale of non-traditional ETFs to its customers. In November 2009, FSC did install procedures to monitor the sale of some non-traditional ETFs, but not all. Specifically, supervisory procedures were implemented regarding the sale of non-traditional ETFs that were greater than 2 times leveraged and/or inverse of the performance of the underlying index. Therefore, FSC allowed its brokers to recommend non-traditional ETFs that sought to deliver two times or less the leveraged and/or inverse daily performance of the underlying index without any supervision or monitoring.
FINRA found that FSC failed to establish and maintain reasonable supervisory systems regarding the non-traditional ETFs, failed to monitor holding periods and that its sales representatives made unsuitable recommendations to customers.
FSC agreed to a censure, a fine of $100,000 and to pay restitution to certain identified customers in the amount of $492,485.
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