The following story appeard on Reuters on April 18, 2012:
The Financial Industry Regulatory Authority will bring enforcement cases against certain brokerages for selling exchange-traded funds that were not appropriate for their customers, the Wall Street regulator’s enforcement chief said Wednesday.
FINRA enforcement chief Bradley Bennett told Reuters that the cases will be related to unsuitable sales of leveraged and inverse exchange-traded funds. The cases will also involve allegations of improper or inadequate training for brokers who sell ETFs, he said.
Bennett declined to name the firms involved.
Leveraged and inverse ETFs are designed to amplify short-term returns by using debt and derivatives and are more suitable for professional traders than for long-term retail investors. They make up only $29.3 billion of the $1.15 trillion U.S. ETF market, according to Lipper.
But FINRA is concerned that brokers are selling these products to long-term retail investors, despite the dangers with holding on to these products for more than a day.
“We don’t have a qualm with the product,” Bennett told Reuters. “We just want to make sure that people who are selling them understand them.”
On Wednesday, Bennett told lawyers who attended a presentation at the New York-based Practising Law Institute, a training organization for lawyers, that the cases would “make statements” about what brokerages should do to ensure their brokers are trained properly and sell the securities to appropriate customers.
FINRA, along with state regulators and the Securities and Exchange Commission, have been investigating leveraged and inverse ETFs for years, but enforcement action has been few and far between.
In July 2011, Massachusetts’ top securities regulator sued RBC Capital Markets LLC and one of its brokers over selling leveraged ETFs to clients who did not understand them.
In March, FINRA barred a former broker for Morgan Keegan & Co. for making excessive and inappropriate trades in a group of leveraged and inverse ETFs for clients.
FINRA also is looking into how firms market and sell exchange-traded notes, after the Credit Suisse-managed VelocityShares Daily 2x Short-Term exchange-traded note, or ETN, lost half its value in just two days earlier last month.
While no other exchange-traded products have “collapsed” in the way that the Credit Suisse product did, the agency is “getting ahead of the curve” before that happens, Bennett told Reuters.
Increased enforcement action around these risky ETFs may cause regulators to make it more difficult for retail investors to buy these products, experts said.
BlackRock Inc, which is the biggest manager of ETFs, has called on regulators and legislators to take steps to require investment firms to clearly explain to investors the risks involving complex ETFs and ETNs.
Morningstar Inc advocates the idea that retail investors would have to sign a form stating they acknowledge the risks before investing in these products, said Paul Justice, an ETF analyst at Morningstar.
“Most people agree certain investor protections are required,” he said.