Regulators zero in on leveraged and inverse ETFs

Leveraged and inverse exchange traded funds are high on the state securities regulators' watch list of “investor traps.” “It is the first time we've included ETFs on our top-10 list. The concern is that they've become very mainstream,” said Keith Woodwell, director of the Utah Commerce Department Division of Securities. “It is specifically related to complaints about leveraged and inverse ETFs. We've had complaints in Utah, and I know of other states as well.” Mr. Woodwell, who spoke yesterday at the annual meeting of the North American Securities Administrators Association Inc., stressed that regulators were not concerned about ETFs that tracked mainstream stock indexes. Leveraged ETFs are designed to return a multiple of the daily performance of the stock index they track. Investors can get hammered by using a buy-and-hold strategy — in some cases even if the stock index rises over time. Inverse ETFs are built by using derivatives to construct a security that profits from a decline in the underlying index or benchmark. Leveraged and inverse exchange traded funds pose a suitability issue for long-term investors, he said. “The question is, is it being marketed to someone as a buy and hold kind of product,” Mr. Woodwell said. “It doesn't perform the way you might expect, and if that's not disclosed to the clients upfront, that's where the suitability issues come in.” “I don't think that brokers are pushing these particularly hard. Sometimes I think some of the agents themselves may not understand fully how the leveraged or inverse ETFs work,” Mr. Woodwell said. He added that improper marketing of the funds is not an overwhelming problem right now. “But we probably are on the cusp of seeing more of these issues because they are fairly new.” According to NASAA, other “investor traps” include foreign- exchange trading schemes, gold and precious metals, “green” or new energy investment schemes, and oil and gas schemes. Promoters of fraudulent investment schemes are also turning to social media and online communities, such as Facebook, Twitter, Craigslist and YouTube to solicit unsuspecting investors, NASAA officials said.