Regulator Continues to Battle Unsuitable Leveraged ETFs

FINRA Focuses on Unsuitable Sales of Leveraged ETFs

The securities industry self-regulator, FINRA, has once again warned broker-dealers and investors over its unsuitable sales of leveraged and inverse ETFs. Over the past few years, ever since these sophisticated products rose to prominence, FINRA has repeatedly issued regulatory notices and investor alerts about the perils of investing in leveraged ETFs. The agency has also fined numerous broker-dealers and individual brokers for poor sales practices and supervision of leveraged ETFs.

What’s the problem with leveraged ETFs?

As FINRA has pointed out many times in the past, leveraged inverse exchanged-traded notes (ETNS) and exchange-traded funds (ETFs), present unique problems for broker-dealers and investors alike because they are strictly designed for one trading session only. In other words, they are completely unsuitable for financial advisors or investors who plan to hold them for any longer than a single day, particularly in volatile markets.

Often making the situation more complicated is the fact that leveraged ETFs are structured in such a way that they perform in multiples of a certain benchmark. Depending on whether they are 2x or 4x, positive or negative, they may respond with compounded gains or losses.

These unique features — trading for one session only and leveraged performance — have brought many an investment portfolio to grief. They have also invited a landslide of regulatory action by FINRA in the hopes of alerting broker-dealers to unsuitable and abuse sales practices of non-traditional ETFs.

Why sell an investor ETFs at all?

For a small (very small) number of investors, non-traditional ETFs can be used to fully diversify a portfolio. Of course, that assumes the ETFs are used as they were intended — for one trading session at a time. For the vast majority of investors who find ETFs in their accounts, however, there is really no good reason for them being there other than that a financial advisor may make a higher commission by selling you these products.

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