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Regulators Zoom in on Leveraged, Inverse ETFs

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The biggest problem with leveraged and inverse ETFs isn’t how they’re sold, but how their labeled. Yet, financial regulators like the Securities and Exchange Commission (SEC) and Financial Industry Regulatory Authority (FINRA) don’t see it that way.

In its latest victory lap, FINRA announced nearly $1.03 million in fines against two St.Louis-based brokerages related to their marketing of leveraged and inverse ETFs to customers.

FINRA ordered Stifel, Nicolaus & Co. (SF) and Century Securities Associates to pay combined fines of $550,000 and a total of nearly $475,000 in restitution to 65 customers in connection with sales of leveraged and inverse ETFs.

According to the regulatory group, from January 2009 to June 2013, Stifel and Century made “unsuitable recommendations” of non-traditional ETFs to some clients, “because some representatives did not fully understand the unique features and specific risks associated with leveraged and inverse ETFs.”

These clients included those with conservative investment objectives “who bought one or more non-traditional ETFs based on recommendations made by the firms’ representatives, and who held those investments for longer periods of time, experienced net losses,” FINRA says.

Much of the confusion surrounding leveraged and inverse ETFs can be blamed – not on Wall Street’s brokerage community – but directly on regulators. Why?

Poor Labeling?

Regulators have permissively allowed a lack of uniformity in how ETF providers are permitted to label their products. The final result is confusion – and lots of it.    

ProShares, for example, uses the word “Ultra” to describe its two-times(2x) daily leveraged ETFs and “UltraShort” to describe its two-times daily inverse ETFs. The “UltraPro” lineup is three-times (3x) daily leveraged ETFs, meaning these ETFs aim for 300% daily magnification to the underlying index.

Meanwhile, other firms with leveraged and inverse ETPs, like Direxion and VelocityShares, label their products very differently.

Both firms, in the official names of the leveraged and inverse products they offer, include the amount of leverage (2x or 3x) used and the word “daily” to indicate the length of the fund’s performance goal.

Why is ProShares naming its daily leveraged ETFs “Ultra” and “UltraPro,” whereas other providers use 2x or 3x daily in their names? Which of these labeling methods is in the best interests of the investing public? 

When it comes to the 101 of investment product naming, shouldn’t accuracy and precise labeling always come first? Furthermore, that accuracy and precise labeling among investment products should be uniform across all categories without exception.

Why haven’t regulators applied this high but necessary standard in the leveraged and inverse ETF marketplace?  

Shouldn’t the amount of leverage (2x or 3x) be a mandatory item in the ETF’s name? And shouldn’t the length of the performance goal (daily or monthly) be specifically stated in the fund’s name too?

When will regulators have enough sense to enact these strict but necessary changes in the ETF and ETN market? What’s taken so long?  

“The complexity of leveraged and inverse exchange-traded products makes it essential for securities firms and their representatives to understand these products before recommending them to their customers. Firms must also conduct reasonable due diligence on these and other complex products, said Brad Bennett, FINRA executive vice president and chief of enforcement, in a press release.

Now, if FINRA and other regulators would only follow their own good advice.


Ron DeLegge is editor of the ETF Profit Strategy Newsletter which uses technical and fundamental analysis along with market history and common sense to keep advisors on the right side of the market. In 2013, 70% of ETFguide’s weekly ETF picks were winners.


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