FINRA Cracks Down Non-Traditional ETFs

Financial oversight authorities in the U.S are cracking the whip on Non-traditional Exchange Traded Funds (ETFs) amidst a wave of outcry from investors who have lost a substantial amount of money.  In addition, several investment fraud lawyers have also opened probes and already started representing investors who might have lost money on brokers the risky yet suspicious ETF stocks.

What are Non-Traditional Exchange Traded Funds (ETFs)?

Non-traditional exchange traded funds (ETFs) are generally buckets of stocks that are leveraged or inverse to the markets.  In lay man’s terms it means that the ETF stock seeks to deliver multiples of a stock index.  A 2X S&P ETF stock will try to deliver 2 times the daily performance.  An inverse ETF stock tries to move opposite or hedge a market.

It should be pointed out that non-tradition ETFs are neither bad, nor investment fraud and could be part of investor’s portfolio.  I personally have invested in these type of ETFs, but I fully understand the risks with them. The key thing is understanding the risks. Many could say the same thing about trading options or futures.

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Risks of Non-Traditional ETFs

While nontraditional complex investment products are designed to fulfill certain performance, they are not for every investor, given the risks they come with. These types of ETFs are inverse and inverse-leveraged, which essentially extrapolates the risk that investors are exposed to. For that reason, brokers are required to assess the suitability of such investment products on a customer-by-customer basis instead of recommending them to all investors.

The Financial Industry Regulatory Authority (FINRA) has warned brokerages about the risks and put out information on non-tradition ETFs. In their recent FAQ regarding Non-Traditional ETFs FINRA stated, “While it is not FINRA’s position that all leveraged and inverse ETFs are unsuitable for all retail customers, firms that recommend them must carefully consider their suitability for each customer. Of particular concern, in light of their reset feature, is whether one is recommended as an intermediate or long-term investment rather than as part of a closely monitored trading or hedging strategy.”

Likewise, non-traditional exchange-traded funds are not appropriate for long term or intermediate investors. These type of investment products should only be part of a highly supervised or sophisticated trading strategy. Similarly, brokers can only recommend them to investors whose portfolios can handle risks or complexity.

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It has since emerged that most of the people who lost their money in the nontraditional investment products were never advised of the risks involved. For those reasons, authorities and law firms have lodged investigations as brokers and brokerage firms need to have advised their investors of the risks involved before putting their money to work.

FINRA Crackdown

FINRA has already suspended two brokers from Corinthians Partners.  The agency alleges that the brokers solicited more than 1900 purchases and over 1660 sales of non-traditional ETFs. The transactions allegedly led to $279 million in the purchase and approximately $890 million in commissions.

FINRA in its charge sheet maintains that the two brokers and their firm principals failed to supervise and make sure that they had reasonable grounds to recommend the non-traditional ETFs to investors. Likewise, the brokers are also accused of failing to detect red flags warning of unsuitable trading involving the risky financial products.

This is not the first time that FINRA has moved to crack the whip on the risky non-traditional ETFs. In 2016, the agency ordered brokerage firm, Oppenheimer, to pay $715K in restitution to retail customers. The order came on the brokerage firm selling leveraged, inverse and inverse leveraged ETFs to older investors.

ABS REPORT

In 2019, FINRA also barred Northcoast Securities stockbroker, Dominic Anthony Trapiano for recommending non-traditional ETFs while knowing very well they were not suitable for customers. The brokerage firm ended up paying $1.5 million to its customers for selling without reasonable grounds 866 ETFs

Haselkorn & Thibaut, a national investment fraud law firm, is seeking investors who might have lost money unknowingly on their brokers selling them, the non-traditional ETFs. The law firm is open to exploring any legal options where possible, given its vast experience in dealing with retail investors as well as seniors and retirees.

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