U.S. securities regulators have sanctioned four Wall Street firms for unsuitable sales of leveraged and inverse exchange-traded funds.
The Financial Industry Regulatory Authority announced that it has levied US$9.1 million in fines and restitution against four firms, Citigroup Global Markets, Inc.; Morgan Stanley & Co., LLC; UBS Financial Services; and Wells Fargo Advisors, LLC amid allegations that the firms sold leveraged and inverse ETFs without reasonable supervision, and did not have a reasonable basis for recommending the securities.
The firms were fined more than US$7.3 million and are required to pay a total of US$1.8 million in restitution to certain customers who made unsuitable leveraged and inverse ETF purchases. Wells Fargo received the largest fine of US$2.1 million, and US$641,489 in restitution. Citigroup got a US$2 million fine and US$146,431 in restitution; Morgan Stanley was hit with a US$1.75 million fine and US$604,584 in restitution, and UBS faces a US$1.5 million fine and US$431,488 in restitution.
The firms neither admitted nor denied the charges, but consented to FINRA’s findings.
Regulators have been concerned about the suitability of sales of complex leveraged and inverse ETFs to retail investors over the past couple of years, noting that they carry risks that are not found in traditional ETFs. Features such as daily resets, leverage and compounding can mean that the performance of these sorts of ETFs differs significantly from the performance of the underlying index or benchmark when held for longer periods of time, particularly during volatile markets, regulators have warned.
“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. Firms must conduct reasonable due diligence and ensure that their representatives have an understanding of these products,” said Brad Bennett, FINRA executive vice president and chief of enforcement.
In this case, 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, it says, the firms did not have a reasonable basis to recommend the ETFs to their retail customers. It also says that the firms’ registered reps made unsuitable recommendations of leveraged and inverse ETFs to some customers with conservative investment objectives. 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, it adds.