FINRA Issues Sanctions on Sellers of Leveraged and Inverse ETFs

Today FINRA issued sanctions on four firms for selling leveraged and inverse exchange-traded products. The story has also been picked up by the New York Times [UPDATE: the Wall Street Journal too]. The offending firms, with links to their respective Letters of Acceptance, Waiver, and Consent ('AWC's), were:

• Wells Fargo Advisors
• UBS Financial Services
• Morgan Stanley & Co.
• Citigroup Global Markets

These firms faced a total of $9.1 million in fines and restitution for sales occurring between January 2008 and June 2009. From the press release:

[T]he firms did not have adequate supervisory systems in place to monitor the sale of leveraged and inverse ETFs, and failed to conduct adequate due diligence regarding the risks and features of the ETFs. As a result, the firms did not have a reasonable basis to recommend the ETFs to their retail customers. The firms' registered representatives also made unsuitable recommendations of leveraged and inverse ETFs to some customers with conservative investment objectives and/or risk profiles. Each of the four firms sold billions of dollars of these ETFs to customers, some of whom held them for extended periods when the markets were volatile.

Our research on leveraged and inverse ETFs has shown that these products can deviate significantly from their stated objectives for holding periods longer than a single day, raising serious concerns about the suitability of these products for retail investors. Other firms have begun to acknowledge that these products are designed for traders, and that most investors do not have the sophistication to use them properly.

While this and other regulatory actions will go a long way in preventing the sale of unsuitable investments, it is still not clear that advisors and representatives fully understand the risks of these products. We have several ongoing research projects which we hope will help illuminate the complex features of these exotic investments. We will keep abreast of regulatory and industry actions in this space.