On May 1, 2012, FINRA announced that it had sanctioned four member
firms a total of 9.1 million, including fines of $7.3 million and
restitution of $1.8 million, for selling leveraged and inverse
exchange-traded funds ("ETFs") without reasonable
supervision and without a reasonable basis for recommending the
securities. Each firm entered into an Acceptance, Waiver and
Consent ("AWC") resolving the FINRA investigation.
In settling the matters, the firms neither admitted nor denied the
charges, but consented to the entry of FINRA's findings.
Background. ETFs typically invest 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 performance that is the opposite of the
performance of the index or benchmark they track (e.g., by
using short positions in derivatives to profit from a falling
market). In FINRA Regulatory Notice http://www.finra.org/Industry/Regulation/Notices/2009/P118952,
published in June 2009, FINRA explained that most leveraged and
inverse ETFs reset daily, meaning that they are designed to achieve
their stated objectives on a daily basis. Firms are required
to perform a customer-specific suitability review before
recommending securities to customers and, in the view of FINRA,
inverse and leveraged ETFs typically are not suitable for retail
investors who plan to hold them for more than one trading session,
particularly in volatile markets.
Findings. 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 also found that the firms' registered
representatives made unsuitable recommendations of leveraged and
inverse ETFs to some customers with conservative investment
objectives or risk profiles. According to FINRA, each of the
firms sold billions of dollars of leveraged and inverse ETFs to
customers, some of whom held them for extended periods when the
markets were volatile.
FINRA'S findings covered sales during the period ending June
2009, when it first cautioned members in Regulatory Notice 09-31
with respect to leveraged and inverse ETFs. The penalties
levied by FINRA reflect a determination that the firms should have
known that the investments were unsuitable for some retail
customers even in the absence of notice by FINRA. FINRA has
more recently advised member firms about the obligation to provide
heightened supervision with respect to complex products generally,
in Regulatory Notice 12-03
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In this newsletter, we provide a snapshot of the principal European, US and global financial regulatory developments of interest to banks, investment firms, broker-dealers, market infrastructures, asset managers and corporates.
On July 30, 2014, The Financial Crimes Enforcement Network Issued A Notice Of Proposed Rulemaking To Clarify And Strengthen Customer Due Diligence Requirements As A Fifth Pillar Under The Bank Secrecy Act For Banks And Other Covered Financial Institutions.