A new report highlights the risks to investors and greater need for supervisory procedures
Most ETFs are promoted and sold as simple, straightforward investment vehicles that offer diversified exposure to financial securities. Inverse and leveraged ETFs represent an exception, requiring more sophistication and understanding — and a group of regulators is underscoring that fact.
In a new report released Wednesday, the North American Securities Administrators Association (NASAA) said that leveraged and inverse ETFs can pose greater risks to retail investors compared to traditional ETFs. NASAA’s membership includes state and provincial securities regulators across the US and Canada.
“Broker-dealers should carefully consider whether to permit purchases of leveraged and/or inverse ETFs in retail customer accounts,” said Michael S. Pieciak, NASAA President and Vermont Commissioner of Financial Regulation, in a statement announcing the report. “Registered representatives who recommend these products without fully understanding them and without receiving appropriate supervision by their firms pose a great risk to investors.”
To better understand the degree to which registered representatives are recommending and allowing the purchase and sale of the complex ETFs, NASAA’s Broker-Dealer Section’s Investment Products and Services Project Group polled 118 broker-dealers. Of those polled, the survey found 86 that allowed leveraged and/or inverse ETFs to be held in retail customer accounts.
Among those 86 firms, 52% permitted reps to recommend leveraged and/or inverse ETFs to customers, and 83% confirmed they have policies and procedures to specific to transactions in such ETFs. However, only 59% addressed the review of customer suitability, while just 26% generated an exception report for positions held for more than one trading session.
“Significantly, 31 broker-dealers (36% of the Firms Allowing L/I ETFs) responded that the firm had no established eligibility criteria for customers who wished to purchase leveraged and/or inverse ETFs,” the report said.
The report looked at various possible eligibility requirements or limitations, including specific margin requirements, age requirements, net worth, holding periods, and concentration limits. It found that for any given requirement or limitation, no more than 36% of firms that allow leveraged or inverse ETFs were acting to enforce it against customer purchases.
Only 19% of firms allowing the complex ETFs had written supervisory policies and procedures (WSPs) that focused on leveraged and/or inverse ETF concentration limits. Among such firms, concentration limits varied widely; that includes three firms that allowed limits to be set on a case-to-case basis, and one allowing a concentration of up to 40%.
When asked whether they provide customers with educational materials or written disclosures regarding the risks of leveraged and/or inverse ETFs, 48% said yes, while the rest said they do not. Less than half of the firms allowing complex ETFs (45%) indicated that they provide mandatory training to registered representatives specifically related to those products.
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