Securities Lawyers Blog
The Financial Industry Regulatory Authority (FINRA) has sanctioned brokerage firm Huntleigh Securities Corporation (Huntleigh) concerning allegations that the firm failed to establish and maintain a supervisory system regarding the sale of leveraged as well as inverse leveraged exchange traded funds (Non-Traditional ETFs) reasonably designed to achieve compliance with applicable securities laws.
Huntleigh is a FINRA member firm since 1977 and has headquarter offices in St. Louis, Missouri. Huntleigh engages in general securities business and employs approximately 53 registered representatives across its five branch offices.
Non-Traditional ETFs contain drastically different risk qualities from traditional ETFs. While traditional ETFs simply 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 can also be used to return the inverse or the opposite result of the return of the benchmark.
In addition, regular ETFs can be held for long term trading, but Non-Traditional ETFs are generally designed to be used only for short term trading because the use of leverage effects funds’ returns dramatically over longer periods of time. If Non-Traditional ETFs are held for longer periods, the results can vary drastically from the underlining index. 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. The inverse ETF Fund, 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.
Because of these risks, The Securities Exchange Commission (SEC) has warned that most Non-Traditional ETFs reset daily and FINRA has stated that Non-Traditional ETFs are typically not suitable for most retail investors. Consequently these funds typically have very limited uses and in many cases are completely inappropriate for retail investors. Increasingly, brokerage firms are prohibiting the solicitation of these investments to its customers due to suitability concerns.
In this case, FINRA alleged that Huntleigh allowed its representatives to recommend and sell Non-Traditional ETFs to customers from January 2011, through May 2013 while the firm’s written supervisory procedures did not address the sale or supervision of these products. FINRA also found that Huntleigh did not conduct due diligence of Non-Traditional ETFs before recommending the products to customers. FINRA found that despite the unique features and risks as discussed above, Huntteigh did not provide its representatives or supervisors with any training or guidance on when Non-Traditional ETFs might be appropriate for their customers nor did the firm use or make available tools to monitor either the length of time that customers held open positions in Non-Traditional ETFs or any losses.
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