More On Legal & Compliancefrom The Advisor's Professional Library
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- Risk-Based Oversight of Investment Advisors Even if the SEC had a larger budget and more resources, it is doubtful that the Commission would have the resources to regularly examine all RIAs. Therefore, the SEC is likely to continue relying on risk-based oversight to fulfill its mission of protecting investors.
The Financial Industry Regulatory Authority (FINRA) announced Tuesday that it has sanctioned Citigroup Global Markets Inc, Morgan Stanley & Co., UBS Financial Services and Wells Fargo Advisors a total of more than $9.1 million for selling leveraged and inverse exchange-traded funds (ETFs) without reasonable supervision and for not having a reasonable basis for recommending the securities.
The firms were fined more than $7.3 million and are required to pay a total of $1.8 million in restitution to certain customers who made unsuitable leveraged and inverse ETF purchases, FINRA said.
The breakdown of the FINRA sanctions are as follows:
- Wells Fargo– $2.1 million fine and $641,489 in restitution
- Citigroup– $2 million fine and $146,431 in restitution
- Morgan Stanley– $1.75 million fine and $604,584 in restitution
- UBS– $1.5 million fine and $431,488 in restitution
The firms neither admitted nor denied the charges, but consented to the entry of FINRA’s findings.
“The added complexity of leveraged and inverse exchange-traded products makes it essential that brokerage firms have an adequate understanding of the products and sufficiently train their sales force before the products are offered to retail customers,” said Brad Bennett, FINRA’s executive vice president and chief of enforcement, in a statement. “Firms must conduct reasonable due diligence and ensure that their representatives have an understanding of these products.”
ETFs are typically registered unit investment trusts (UITs) or open-end investment companies whose shares represent an interest in a portfolio of securities that track an underlying benchmark or index.
Leveraged ETFs seek to deliver multiples of the performance of the index or benchmark they track. Inverse ETFs seek to deliver the opposite of the performance of the index or benchmark they track, profiting from short positions in derivatives in a falling market.
FINRA found that from January 2008 through June 2009, the 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, FINRA said.
“The firms’ registered representatives also made unsuitable recommendations of leveraged and inverse ETFs to some customers with conservative investment objectives and/or risk profiles," the broker-dealer regulator said. "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.”
As FINRA explained, leveraged and inverse ETFs have certain risks not found in traditional ETFs, such as the risks associated with a daily reset, leverage and compounding. “Accordingly, investors were subjected to the risk that the performance of their investments in leveraged and inverse ETFs could differ significantly from the performance of the underlying index or benchmark when held for longer periods of time, particularly in the volatile markets that existed during January 2008 through June 2009. Despite the risks associated with holding leveraged and inverse ETFs for longer periods in volatile markets, certain customers of these firms held leveraged and inverse ETFs for extended time periods during January 2008 through June 2009,” FINRA said.