It is widely acknowledged that inverse and leveraged ETFs are highly risky, and that in connection with the recommendation and sale of inverse or leveraged ETFs, many brokers did not, and do not, fully understand the risks and characteristics of these securities.
"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); See also, "Are complex ETFs suitable investments?," Investment News, February 10, 2011.
As early as January 2009, financial publications began to warn investors of these risks. According to Morninstar,® the UltraShort S&P 500 ProShares SDS is an "expensive and extremely risky fund." Morninstar® also warns investors that using this fund as a hedge the funds leverage vastly increases risk and volatility, and accordingly these funds may not be appropriate for all investors.
Indeed, in January 2009, Morgan Stanley’s own analyst, Dominic Maister, warned investors that they "probably don’t want to hold leveraged and inverse ETFs more than a few days.". 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). Similarly, on 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.
Many brokerage firms were also 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. Many brokerage firms also told investors and regulators that: "Unsolicited purchases in these accounts will be permitted only subject to enhanced oversight and review."
Many brokerage firms also required its brokers to complete a "Single ETF training module" and reiterated that these products were only suitable for customers with either aggressive or speculative investment objectives.
If you have suffered losses a the result of the recommendation of inverse and leveraged ETFs by your stockbroker or investment professional and were unaware of the risk associated with these securities, you should consult with an attorney to determine whether your losses may be recoverable through FINRA securities arbitration.
Nicholas J. Guiliano, Esquire, Guiliano Law Firm, P.C. Practice limited to the representation of investors in arbitration claims against stockbrokers for fraud, the sale of unsuitable investments, breach of fiduciary duty, failure to supervise. National Practice. Contingent Fee. Free Consultation. (877) SEC-ATTY.