Massachusetts Securities Regulators Fine RBC for Selling Unsuitable Leveraged and Inverse ETFs

RBC Capital Markets has agreed to pay $2.9 million in restitution to Massachusetts investors related to the sale of unsuitable leveraged, inverse, and inverse-leveraged ETFs. Secretary of the Commonwealth of Massachusetts William Galvin, who has previously investigated Bank of America over warehousing of CLO assets, issued the complaint in July 2011, accusing RBC and its registered representative Michael D. Zukowski of selling these products "to clients who did not understand what these products were, the risks associated with the products or, how these products were to be properly used in an investment portfolio." The complaint also documents RBC's failure to appropriately supervise and adequately train representatives who sold these products to investors.

This settlement comes on the heels of FINRA's recent sanctions onfour major sellers of leveraged and inverse ETFs, which received considerable media attention. Interestingly, the FINRA complaint only covered the period from January 2008 through June 2009, leading one commentator to suggest that unsuitable sales of exotic ETFs was limited to "a brief and well-publicized episode of cowboy capitalism," and was a "tempest in a teapot" rather than a systematic problem in the industry. However, the Massachusetts action against RBC covers a much larger time period -- January 1, 2006 to December 22, 2009 -- suggesting that the sale of unsuitable ETFs has been a much bigger problem than the latest FINRA action alone would suggest.

Our research has confirmed that leveraged and inverse ETFs are extremely complex investment products. Because of daily rebalancing, these products can deviate substantially from stated returns over periods longer than a single day, and are therefore more suitable for traders than buy-and-hold investors. The continuing regulatory actions against firms who sell leveraged and inverse ETFs suggests that these risks may not be accurately communicated to potential investors.