Serious Concerns Arise Concerning Complex Exchange Traded Funds (ETFs)


Executives at some financial firms are calling for tighter regulation on certain types of complex Exchange Traded Funds (ETF’s). According to a recent article in InvestmentNews executives at BlackRock Inc. and Invesco PowerShares Capital Management LLC are asking regulators to address suitability requirements for the sale of highly complex ETFs, such as commodities-based, inverse and leveraged funds.

The firms and the regulators have valid reasons to look into greater control over investments in complex ETFs. According to InvestmentNews, trading in ETFs has been growing at a very rapid pace, passing $1 trillion in assets at the end of last year. A large portion for that growth is from retail investors.

What the firms are concerned about is a horror story in a section of the ETF industry that could cause ETF’s to be viewed in the same light as Collateralized Debt Obligations-the structured finance product that drove the mortgage crisis.

According to Pratt H. Davis of Page Perry, “Most investors have no idea of the substantial risk involved with owning certain types of ETFs, particularly leveraged and inverse funds.” These sentiments are also echoed by many in the financial industry. For example, Commodity ETFs were named by a recent Bloomberg BusinessWeek article as the “Worst Investment in America.”

Regulators have also expressed concerns about these products. In 2009, the SEC and Financial Industry Regulatory Authority Inc. published notices warning investors about leveraged and inverse ETFs. The SEC has stopped approving new ETFs that use derivatives. The SEC is investigating whether ETFs are being used to hide large bets based on inside information. The SEC has also indicated that it wants to see if additional investor protections are warranted, particularly for leveraged and inverse ETFs. Similarly, FINRA recently came out with a notice regarding the disclosures necessary for commodity futures-linked ETFs.

According to Mr. Davis, “Whether or not new suitability rules are issued that restrict the sale of certain types of ETFs remains to be seen. What is clear right now is that there are a lot of retail investors out there who have ETF’s in their portfolios and have no idea of what they have gotten into or the risk exposure they have.”

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 40 occasions. Page Perry’s attorneys are actively involved in representing institutional and corporate investors in ETF cases. For further information, please contact us.