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The Daily Brief
NASAA President Mike Pieciak
NASAA President Mike Pieciak

State Regulators Urge Heightened Supervision of Inverse, Leveraged ETFs

Although most broker/dealers have policies and procedures in place to address these products, firms need to improve the suitability review and add more controls around holding periods, NASAA says.

A majority of broker/dealers (73%) allow clients to hold leveraged and/or inverse exchange traded funds, products that have come under fire by securities regulators and been the subject of several customer complaints. A recent analysis by the North American Securities Administrators Association (NASAA) found 83% of the firms that sell these funds have policies and procedures to address them, yet more should be done to improve the suitability review of these products.

“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. “Registered representatives who recommend these products without fully understanding them and without receiving appropriate supervision by their firms pose a great risk to investors.”

NASAA said its analysis of 118 broker/dealers and their use of these ETFs was driven in part by customer complaints. Morgan Stanley, for instance, had to pay $100,000 in 2013 when the New Jersey Bureau of Securities found it didn’t properly train its reps who sold leveraged and inverse ETFs to elderly investors.

At the same time, NASAA’s report found that the number of complaints and regulatory actions at broker/dealers who sell the products was low, with 72% of the firms that allow them reporting no customer complaints in the past three years.

In addition, the analysis found that usually less than 10% and often less than 1% of clients at these b/ds hold such products.

And while most firms have policies and procedures in place for these products, those policies don’t go far enough, NASAA says. More than a third (36%) of the firms allowing the products have no established criteria for customers looking to buy them. Only 19% of firms that use the products address concentration limits in their policies and procedures.

Only 27% of firms that allow these products subject orders to a heightened suitability review prior to executing transactions in these ETFs.

Further, just 29 firms, or 34% of those that allow these ETFs in customer accounts, monitor the holding period of positions in the funds, and just 26% generate an exception report if these products are held longer than one trading session.

One reason the products have come under fire is that, in many cases, they’re being used as long-term vehicles, not their intended use.

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