Four brokerage giants were fined a total of $9.1 million for selling complex exchange-traded-fund investments to customers who should not have been buying something so risky. Together the firms sold $27 billion of the non-traditional ETFs in an 18-month period.
Citigroup Global Markets Inc., Morgan Stanley,
UBS Financial Services Inc. and
Wells Fargo Advisors LLC were also cited for supervisory failures, regulators said.
The brokerages were fined about $7.3 million by the
Financial Industry Regulatory Authority Inc. and agreed to pay about $1.8 million back to some customers who purchased the leveraged and inverse ETF investments.
Leveraged and inverse ETFs carry certain risks above those of a traditional ETF. Shares of both represent an interest in a portfolio of securities that track an underlying index or benchmark, but the more-exotic ETFs are made more volatile by the effect of a daily reset, and the use of leverage and compounding, Finra said. The results of leveraged and inverse ETFs can differ significantly from the performance of the underlying index when held for long periods of time, especially during volatile market periods.
Finra alleges that during the volatile market period of January 2008 through June 2009, the firms had inadequate supervisory systems for monitoring sales of these complicated ETFs and failed to research the investments enough to know the risks and features. Therefore, the firms did not have a “reasonable basis” to recommend the investments to their retail clients and, in some cases, the products were recommended to customers with conservative risk profiles, Finra said.
“The added complexity of leveraged and inverse exchange-traded products makes it essential that brokerage firms have an adequate understanding of the products and sufficiently train their sales force before the products are offered to retail customers,” said Finra enforcement chief Brad Bennett. “Firms must conduct reasonable due diligence and ensure that their representatives have an understanding of these products.”
Finra and the Securities and Exchange Commission published notices in 2009 warning investors about leveraged and inverse ETFs. In March 2010, the SEC stopped approving new applications for ETFs that use derivatives and indicated that it wanted to see if additional investor protections were warranted, particularly for leveraged and inverse ETFs.
The largest fine, $2.1 million, was levied on
Wells Fargo, which also agreed to pay $641,489 in restitution to customers.
“The issues underlying the settlement affected certain investors at many firms as nontraditional ETFs became increasingly popular with a wider range of retail investors during a relatively short period of time that coincided with a very volatile period in the market,” said
Wells Fargo spokesman Tony Mattera. “
Wells Fargo Advisors has enhanced its policies and procedures and is confident that it has appropriate supervisory processes and training to meet our regulatory responsibilities and clients' investment needs.”
Wells Fargo customers bought and sold more than $9.9 billion in nontraditional ETFs during the relevant period. One 65-year-old customer, with a stated net worth of $50,000, lost $25,000 in the 43 days he held a nontraditional ETF, Finra said. A 92-year-old client held a nontraditional ETF for 135 days and lost $2,000, regulators said.
All four brokerage firms settled the Finra allegations without admitting to or denying them.
Citigroup was fined $2 million and agreed to pay $146,431 in restitution. That firm's clients bought and sold more than $7.9 billion of nontraditional ETFs during the 18-month period, Finra said.
“We are pleased to have this matter resolved,” said
Citigroup spokeswoman Liz Fogarty.
Morgan Stanley agreed to pay a $1.75 million fine and $604,584 in restitution. Its customers bought and sold more than $4.78 billion of nontraditional ETFs during the 18-month period, according to Finra.
“Morgan Stanley strives for high standards of supervision and is pleased to settle this matter, which pertains to investments sold three to four years ago,” said Morgan Stanley spokeswoman Christine Pollak. “Since 2009, we substantially limited our sale of these specific types of investments and enhanced our tools to supervise them.”
UBS agreed to pay a $1.5 million fine and $431,488 in restitution to customers. The firm's customers bought and sold $4.5 billion in nontraditional ETFs over the 18 months. One
UBS customer held a nontraditional ETF in his IRA for 139 days and lost $5,700, or about 43% of his initial investment, Finra said in the settlement.
“
UBS is pleased to have resolved this Finra matter,” said
UBS spokeswoman Karina Byrne. “More than two years ago,
UBS developed and implemented enhanced training, suitability and supervisory policies and procedures regarding leveraged, inverse and inverse-leveraged ETFs.”
The number of nontraditional ETFs has grown from a handful in June 2006 when they began trading on national securities exchanges to more than 100 by April 2009, with total assets of about $22 billion, according to Finra.
Finra offered an example of the results that leveraged and inverse ETFs can have when held over a long period with volatile market conditions. It said that between Dec. 1, 2008 and April 30, 2009, the Dow Jones U.S. Oil and Gas Index gained 2%, while an ETF that sought to deliver two times the index's daily return fell 6% and the related ETF that was designed to deliver twice the inverse of the index's daily return fell 26%.
