Stifel, Nicolaus & Company and Century Securities Associates Fined by Regulator Over Leveraged ETFs

The Financial Industry Regulatory Authority (FINRA) ordered brokerage firms Stifel, Nicolaus & Company, Incorporated (Stifel Nicolaus) and Century Securities Associates, Inc. (Century Securities) to pay combined fines of $550,000 and nearly $475,000 in restitution to 65 customers concerning allegations of the improper sale of leveraged and inverse exchange-traded funds (ETFs).  Stifel Nicolaus and Century Securities are affiliates and are both owned by Stifel Financial Corporation.

A leveraged ETF employs debt or leverage in order to increase and magnify the returns of the underlying securities.  Leveraged ETFs are generally available for most investment indexes such as the S&P 500, the Dow Jones, commodities, or foreign exchanges.  Many leveraged ETFs carry leverage as high as 300% leverage and will typically return 3% if the underlying index returns 1%.  Leveraged ETFs can also be designed to return the inverse or opposite of the benchmark.

Leveraged ETFs are generally used and are only appropriate 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.  Thus, even if an index is relatively flat over a period of time, a leveraged ETF may still decline in value during the same period.

FINRA has previously stated that leveraged ETF carry significant risks and are inherent complexity of the products.  Accordingly, FINRA has advised brokerage firms that these nontraditional ETFs are typically not suitable for retail investors.  In FINRA’s press release Brad Bennett, FINRA Executive Vice President and Chief of Enforcement, reiterated the risks of leveraged ETFs stating that “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.”

FINRA found that between January 2009, and June 2013, Stifel Nicolaus and Century Securities made unsuitable recommendations of non-traditional ETFs to customers.  FINRA stated that some of the firm’s representatives did not fully understand the unique features and specific risks associated with leveraged and inverse ETFs and nonetheless the firm allowed the representatives to recommend leveraged ETFs to customers.  According to FINRA, some of the firm’s customers who bought one or more non-traditional ETFs had conservative investment objectives and held the ETFs for longer periods of time and experienced losses.

In addition, FINRA found that Stifel Nicolaus and Century Securities did not have a reasonable supervisory systems in place for sales of the leveraged and inverse ETFs. According to FINRA the firms only generally supervised transactions in nontraditional ETFs in the same manner that they supervised traditional ETFs.  FINRA alleged that both firms failed to have adequate formal training for leveraged ETFs for their registered representatives and supervisory personnel before allowing representatives to recommend them to customers.

The attorneys at Gana LLP are experienced in investigating claims concerning leveraged and inverse ETFs.  Our consultations are free of charge and we welcome all inquiries.