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Our law firm is investigating the trading practices and supervision by major retail brokerage firms in connection with their sales of leveraged and inverse exchange-traded funds (“ETFs”). In June of 2009, FINRA issued Regulatory Notice 09-31 on Non-Traditional ETFs, reminding firms of the sales practice obligations relating to leveraged and inverse ETFs. The Notice noted that these products are “highly complex financial instruments that are typically designed to achieve their stated objectives on a daily basis.” Because of the effects of compounding, the performance of these investments “over longer periods of time can differ significantly from the stated daily objective.” As a result, “inverse and leveraged ETFs that are reset daily typically are unsuitable for retail investors who plan to hold them for longer than one trading session, particularly in volatile markets.”
Because the objective of leveraged ETFs is to deliver a multiple of the underlying index’s daily performance, they should only be held on a short-term basis. For example, from November 28, 2008 through February 27, 2009, while the Russell 2000 gained 2.38%, the UltraShort Russell 2000 ProShares (NYSEArca: TWM) lost 25%. Similarly, from November 21, 2008 to March 3, 2009, the Russell MidCap experienced a gain of 2.77%, while the UltraShort Russell MidCap ProShares (NYSEArca: SDK) dropped 28%. Finally, The UltraShort Financials ProShares (NYSEArca: SKF) lost 46%, while, during the same time period, the iShares Dow Jones U.S. Financial Sector index broke even.