The Securities and Exchange Commission is expanding its investigation into the use of derivatives by mutual funds and exchange trade funds, and will also focus on problems related to disclosures, valuations, transparency, market volatility, liquidity and other systemic risks associated with exchange traded funds, particularly “leveraged” funds that amplify investor bets often through the use of derivatives. See the Wall Street Journal (“SEC Reviewing Effects of ETFs on Volatility,” Andrew Ackerman).
Exchange traded funds have surged in popularity and now generate 35% to 40% of exchange trading volume, according to the article, citing Morningstar. Their use by high-frequency traders was implicated in the flash crash that occurred in May, which sent equity prices to impossible highs and lows in a matter of minutes.
Eileen Rominger, director of the SEC’s division of investment management, who testified before a Senate Banking subcommittee Wednesday, said the SEC is examining the adequacy of investor disclosure, liquidity levels, transparency of underlying instruments in which exchange-traded products invest, “fair valuations” (the way a fund values illiquid assets).
The SEC is also examining arbitrage, in which brokers or other institutions take advantage of the price difference between the stated value of an ETF share and the market price of its underlying securities.
For nearly two years, SEC staff have studied whether derivatives-based funds warrant special protections for investors. In March 2010, the SEC put a hold on requests by exchange-traded funds to invest in derivatives, pending the conclusion of the study. In August, the SEC published a “concept release” soliciting public comments. Those comments are due by the end of October.
Noel Archard, who heads product development at BlackRock Inc.’s iShares unit, said new standards for exchange-traded products are needed to enhance transparency and investor protection, particularly to designate products with greater risk. He also said that leveraged exchange-traded funds and those that employ derivatives should be labeled something other than ETFs. “Clear labeling combined with disclosure of fees and risks is a critical starting point to achieving the better clarity investors need to understand various structures,” he said.
Ms. Rominger said BlackRock’s labeling idea merited “serious consideration.” Blackrock is the largest money manager in the world and the dominant exchange traded fund seller.
Page Perry is an Atlanta-based law firm with over 150 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 45 occasions. Page Perry’s attorneys have extensive experience in representing investors in cases involving exchange traded funds (ETFs) and other alternative investments. For further information, please contact us.