Regulators Investigate Sales of Leveraged and Inverse ETFs

 

In her recent article in the Wall Street Journal, Eleanor Laise reports that sales of Leveraged and Inverse Exchange Traded Funds (ETFs) have exploded to $32.8 billion as of June 2009, almost tripling the $11 billion held at the start of 2008. The number of such ETFs has increased to 119, an increase of 86%, over the same period. “The explosive growth in this area over the past year reflects an aggressive sales effort,” said William F. Galvin, Secretary of the Commonwealth of Massachusetts. These products are unsuitable for and should not have been sold to most investors.

Leveraged ETFs used borrowed money to double or triple the performance of an underlying benchmark, while Inverse ETFs move in the opposite direction to their benchmark. But these ETFs do not always move in the direction that investors expect. If held for a longer term, due to compounding, these ETFs can lose big even when an investment I the underlying benchmark would have gained. For example:

  • The Dow Jones U.S. Oil & Gas Index gained 2 percent, while an ETF seeking to deliver twice the index’s daily return fell 6 percent and the related ETF seeking to deliver twice the inverse of the index’s daily return fell 26 percent.
  • An ETF seeking to deliver three times the daily return of the Russell 1000 Financial Services Index fell 53 percent while the index actually gained around 8 percent. The related ETF seeking to deliver three times the inverse of the index’s daily return declined by 90 percent over the same period.

See posting on July 24, 2009 (“Leveraged and Inverse Exchange-Traded Funds (ETFs) Are Dangerous to Investors Financial Health”).

During the 12 month period ending July 24, 2009, 55% of Leveraged ETFs and nearly 88% of Inverse ETFs were “flipped,” i.e., investment in them lost money when the underlying benchmarked gained, and vice versa. These funds are designed for traders to “hedge” their bets. “Hedges aren’t supposed to become less trustworthy when you really need them,” says Morningstar’s director of ETF analysis, Scott Burns.

This past Friday, Massachusetts regulators subpoenaed Ameriprise, UBS, LPL, among others, to produce information on sales, revenues, broker training and marketing materials related to these products. Firms that have not been subpoenaed, such as Charles Schwab and Morgan Stanley Smith Barney, are sounding cautionary notes, warning of the intricacies of these products, but still selling them to retail investors. See posting on August 3, 2009 (“Beware Leveraged and Inverse Exchange Traded Funds”).

Atlanta attorney J. Boyd Page of Page Perry noted “These are highly toxic securities. Several of our clients lost hundreds of thousands of dollars within a short period last year as a result of investing in these products.”

If you have suffered losses in leveraged and/or inverse ETFs, you should contact qualified counsel to determine your potential rights and remedies.

Page Perry is an Atlanta-based law firm with over 125 years collective experience representing investors in securities-related litigation and arbitration. While past results are not indicative of future success, Page Perry’s attorneys have recovered over $1,000,000 for clients on more than 30 occasions. Page Perry’s attorneys are actively involved in representing institutional and corporate investors in securities cases. For further information, please contact us.