A leveraged Exchange Traded Fund (non-traditional or leveraged ETFs) is a security that employs debt, or leverage, in order to amplify the returns of an underlying stock position. Leveraged ETFs are generally available for most security indexes such as the S&P 500 and Nasdaq 100. A leveraged ETF with 300% leverage will return 3% if the underlying index returns 1%. Nontraditional ETFs can also be designed to return the inverse of the benchmark.
Leveraged ETFs are generally used only for short term trading. The Securities Exchange Commission (SEC) has warned that most leveraged ETFs reset daily, meaning that they are designed to achieve their stated objectives on a daily basis. As a result, the performance of nontraditional ETFs held over the long term can differ significantly from the performance of their underlying index or benchmark during the same period. The Financial Industry Regulatory Authority (FINRA) has acknowledged that leveraged ETF carry significant risks and are inherent complexity of the products. Accordingly, FINRA advises brokers that nontraditional ETFs are typically not suitable for retail investors.
Recently, FINRA sanctioned and suspended broker Michael E. French (French) over allegations that the broker recommended unsuitable transactions in leveraged and inverse ETFs in the accounts of elderly customers. FINRA also alleged that French held the leveraged ETFs in his customers’ accounts for extended periods contrary to Wells Fargo Advisor’s (Wells Fargo) written supervisory procedures.
From August 5, 2000, through August 26, 2011, French was registered representative with Wells Fargo. On August 26, 2011, Wells Fargo filed a termination notice for (Form U5) stating that French was terminated for violating the firm’s policy by failing to report multiple complaints by the same client and attempting to personally resolve the complaints.
FINRA alleged that from January 2010, to May 2011, French recommended and traded non-traditional ETFs in the accounts of his Wells Fargo customers. Wells Fargo’s supervisory procedures warned that “non-traditional ETFs are speculative trading vehicles.” In addition, the client in question relied upon French to achieve the objective of devising suitable investments for their retirement. According to FINRA, French recommended non-traditional ETFs to the client based on French’s belief that global equity markets would decline and the securities would increase dramatically in value. FINRA also alleged that French was also attempting to recoup money that the client had previously lost through a transaction that French recommended.
The prospectuses for the non-traditional ETFs and Wells Fargo’s supervisory procedures advised that the securities should not be held for more than one trading session or as long-term investments but, according to FINRA, French held those products in his customers’ accounts as long as nine months. FINRA found that French recommended non-traditional ETFs in violation of his suitability obligation by failing to have reasonable grounds for believing that the securities were suitable for the customers given their financial situation, investment objectives and needs. The customers lost at least $29,000 of their principal because of their investments in non-traditional ETFs. By recommending unsuitable transactions, FINRA found that French violated NASD Rules 2310 and IM- 2310-2 and FINRA Rule 2010.
FINRA suspended French for three months and fined the broker $25,000. The attorneys at Gana LLP are experienced in investigating claims concerning the sale of securities, including leverage or nontraditional ETFs. Our attorneys can help you detect and uncover suspicious activity in your accounts. Our consultations are free of charge and the firm is only compensated if you recover.