The Financial Industry Regulatory Authority (FINRA) ordered J.P. Turner & Company, L.L.C. (JP Turner) to pay $707,559 in restitution to 84 customers for sales of unsuitable leveraged and inverse exchange-traded funds (Non-Traditional ETFs) and for excessive mutual fund switches. The current fine and is just one of several sanctions that regulators have brought against JP Turner brokers concerning the firms sales and supervisory practices.
Brad Bennett, FINRA Executive Vice President and Chief of Enforcement, was quoted in the settlement stating that “Securities firms and their registered reps must understand the complex products they are selling and the risks inherent to the products, and be able to determine if they are suitable for investors before recommending them to retail customers.”
As a background, Non-Traditional ETFs are novel products that have grown significantly in popularity since 2006. By 2009, over 100 Non-Traditional ETFs existed in the market place with total assets of approximately $22 billion. A leveraged ETF seeks to deliver two or three times an index or benchmark return the ETF tracks. Non-Traditional ETFs can also be “inverse” or “short” meaning that the investment returns the opposite of the performance the index or benchmark. While both ETFs and Non-Traditional ETFs track indexes, Non-Traditional ETFs contain significant risks that are not associated with traditional ETFs. Non-Traditional ETFs have additional risks of daily reset, use of leverage, and compounding.
In addition, the performance of Non-Traditional ETFs tend to differ significantly from the performance of the underlying index or benchmark the fund tracks over longer periods of time. For example, between December 2008, and April 2009, the Dow Jones U.S. Oil & Gas Index gained two percent while a leveraged ETF that tracked the index’s daily return fell six percent. Another related leveraged ETF seeking to deliver twice the inverse of the index’s daily return fell by 26 percent. FINRA published a Notice to Members to notify brokerage firms of these additional risks and clarify a brokerage firm’s obligation when selling Non-Traditional ETFs to customers.
FINRA found that JP Turner failed to establish and maintain a reasonable supervisory system to supervise the sale of leveraged and inverse ETFs. Instead, FINRA found that JP Turner sold the Non-Traditional ETFs in the same manner that it supervised traditional ETFs. FINRA also found that the firm failed to provide adequate training regarding the sale of ETFs. In addition, FINRA alleged that JP Turner allowed its registered representatives to recommend ETFs without performing reasonable diligence to understand the risks and features associated with the products.
As a result, FINRA found that many JP Turner customers held leveraged and inverse ETFs for periods of several months. FINRA’s findings concluded that JP Turner failed to determine whether the ETFs were suitable for at least 27 customers, including retirees and conservative customers, who suffered losses of more than $200,000.
Finally, FINRA found that JP Turner engaged in a pattern of unsuitable mutual fund switching. Mutual fund shares are not the proper vehicles for short-term trading because of the transaction fees and commissions incurred from buying and selling shares. FINRA found that JP Turner failed to establish and maintain a reasonable supervisory system designed to prevent unsuitable mutual fund switching. FINRA found that despite the presence of several red flags, JP Turner failed to reject any of the more than 2,800 mutual fund switches that appeared on the firm’s switch exception reports and that as a result, 66 customers paid commissions and sales charges of more than $500,000 in unsuitable mutual fund switches.
The attorneys at Gana LLP are experienced in handling claims concerning the sale of unsuitable securities including Non-Traditional ETs. We welcome all inquiries concerning our services.