Investors suffering losses in Inverse and Leveraged Exchange Traded Funds may have claims against their stockbrokers or financial advisors for failure to disclose risk or perform due diligence.
An Exchange-Traded Fund (ETF) is an investment fund traded on stock exchanges, much like stocks. An ETF holds assets such as stocks or bonds and trades at approximately the same price as the net asset value of its underlying assets over the course of the trading day. Most ETFs track an index, such as the S&P 500. ETFs may be attractive as investments because of their low costs, tax efficiency, and stock-like features. However, “Ultra” funds are highly leveraged funds, and are different from most ETFs in that it seeks leveraged returns and only on a daily basis. Accordingly, these Ultra Funds are also riskier than similarly benchmarked exchange-traded funds that do not use leverage.
Leveraged ETFs
Leveraged ETFs are one of the most controversial trading instruments to be introduced in recent years. Leveraged ETFs are meant to double, or in some cases triple, the daily performance of a particular index.
Because leveraged ETFs are bundles of derivatives, investors cannot buy and hold them the way they do similarly benchmarked ETFs. Derivatives have a time value portion that decays as each day goes by. And because the leveraged ETF portfolio needs to be constantly rebalanced, expenses consume any potential returns. In fact, as set forth herein, the SEC finds that certain leveraged ETFs produced negative returns even when the index it tracks moved up and that leveraged ETFs are too complicated and too risky for most retail investors.
“Non-traditional ETFs may not be suitable for retail investors” and “inverse and leveraged ETFs typically are not suitable for retail investors who plan to hold them for more than one trading session, particularly in volatile markets.” See, D. Franceski, & Z. Knepper, Practical Compliance & Risk Management For The Securities Industry, Non-Traditional Exchange Traded Funds at 8 citing Regulatory Notice 09-31)(February 2010)
Inverse ETFs
Inverse or leveraged ETFs include a high degree of risk, and are not appropriate for all investors.
In May 2009, FINRA’s Enforcement Department’s Strategic Programs Group conducted an inquiry regarding the sale of inverse, leveraged, and inverse-leveraged Exchange Traded Funds, and subsequently in June 2009, FINRA issued Notice to Members 99-31, reminding firms of: their sales practice obligations in connection with leveraged and inverse ETFs. In particular, recommendations to customers must be suitable and based on a full understanding of the terms and features of the product recommended; sales materials related to leveraged and inverse ETFs must be fair and accurate; and firms must have adequate supervisory procedures in place to ensure that these obligations are met.
FINRA Notice to Members 99-31 (June 2009) (emphasis added).
In this Notice to Members, FINRA also warned members that: “Firms must train registered persons about the terms, features and risks of all ETFs that they sell, as well as the factors that would make such products either suitable or unsuitable for certain investors.” Id. at 4 (emphasis added).
In August 18, 2009, the SEC staff and FINRA issued an Investors Alert, with respect to Leveraged and Inverse ETFs: Specialized Products with Extra Risks for Buy-and-Hold Investors, and warned that: before purchasing an inverse or leveraged ETF, investors should also consider seeking the advice of an investment professional. Be sure to work with someone who understands your investment objectives and tolerance for risk. Your investment professional should understand these complex products, be able to explain whether or how they fit with your objectives, and be willing to monitor your investment.
FINRA Investor Alert, August 19, 2009.
Most major brokerage firms aware of the risks associated with the purchase of leveraged or inverse ETFs, and in August 2009, stopped permitting solicited purchases of these ETFs in traditional brokerage accounts also told investors and regulators that: “Unsolicited purchases will be permitted only subject to enhanced oversight and review.”
Guiliano Law Group
The practice of Nicholas J. Guiliano, Esq., and The Guiliano Law Group, P.C., is limited to the representation of investors in claims for fraud in connection with the sale of securities, the sale or recommendation of excessively risky or unsuitable securities, breach of fiduciary duty, and the failure to supervise. We accept representation on a contingent fee basis, meaning there is no cost to unless we make a recovery for you, and there is never any charge for a consultation or an evaluation of your claim. For more information contact us at (877) SEC-ATTY.
