The Financial Industry Regulatory Authority (FINRA) sanctioned (Case No. 2014038906201) brokerage firm BestVest Investments, Ltd. (BestVest) concerning allegations that from January 2012, through August 2014, BestVest failed to establish and maintain a supervisory system reasonably designed to monitor transactions in leveraged, inverse, and inverse leveraged exchange traded funds (Non-Traditional ETFs).
As a background, Non-Traditional ETFs behave drastically different and have different risk qualities from traditional ETFs. While traditional ETFs seek to mirror an index or benchmark, Non-Traditional ETFs use a combination of derivatives instruments and debt to multiply returns on underlining assets, often attempting to generate 2 to 3 times the return of the underlining asset class. Non-Traditional ETFs are also used to earn the inverse result of the return of the benchmark.
However, the risks of holding Non-Traditional ETFs go beyond merely multiplying the return on the index. Instead, Non-Traditional ETFs are generally designed to be used only for short term trading as opposed to traditional ETFs. The use of leverage employed by these funds causes their long-term values to be dramatically different than the underlying benchmark over long periods of time. For example, between December 1, 2008, and April 30, 2009, the Dow Jones U.S. Oil & Gas Index gained two percent while the ProShares Ultra Oil and Gas, a fund seeking to deliver twice the index’s daily return fell six percent. In another example, the ProShares UltraShort Oil and Gas, seeks to deliver twice the inverse of the index’s daily return fell by 26 percent over the same period.