Certain securities salespeople are giving the brokerage industry a bad name by putting clients into manifestly unsuitable securities, namely leveraged and inversed ETFs, which are attracting wary and watchful eyes among U.S. regulators. In 2013, FINRA brought 19 cases involving ETFs with fines totaling more than $1.5 million and restitution of nearly $780,000.
One of the latest examples of regulatory scrutiny: FINRA has fined two brokerage units of Stifel Financial Corp for allegedly selling risky, ill-suited ETF products to certain customers. The penalty for Stifel is $550,000 with restitution of $475,000 to 65 harmed customers.
"This isn't the first time securities salespeople have sold unsuitable products to unsuspecting customers, and it won't be the last," Susan Wyderko, CEO of the Mutual Fund Directors Forum tells me.
In December, FINRA ordered Atlanta-based broker-dealer J.P. Turner to pay more than $700,000 in restitution for unsuitable sales of leveraged and inverse ETFs and for excessive mutual fund switching. "FINRA found that J.P. Turner failed to establish and maintain a reasonable supervisory system and instead, supervised leveraged and inverse ETFs in the same manner that it supervised traditional ETFs," the regulator said in a statement at the time. Last year, FINRA sanctioned Citigroup Global Markets; Morgan Stanley; UBS Financial Services; and Wells Fargo Advisors a total of more than $9.1 million for selling leveraged and inverse ETFs without reasonable supervision and for not having a reasonable basis for recommending the securities.
According to Morningstar's Michael Rawson, ETFs do not need any additional regulation. Instead, financial advisors and brokers should be held to a higher standard. "After June, 2009 they should have collected documentation that their clients understood the risks of the products that were being sold to them," he said.
FINRA agrees. The rise of these fines reflect a broader trend here about how ETFs are recommended and sold to investors, according to the regulator.
Just as a doctor wouldn't prescribe Lipitor to someone with a headache, asset managers shouldn't pitch products to investors who don't need or fully understand them. In other words, FINRA doesn't have a problem with more complicated leveraged and inverse ETFs, which have certain risks not found in traditional ETFs, such as the risks associated with a daily reset, leverage and compounding. They do care about how they're marketed.
In the case of leveraged and inverse ETFs, money managers say they may be more applicable to sophisticated investors on the institutional level as opposed to the retail audience.
This is a reminder to advisors to know their customers, and a reminder to fund managers to educate on the appropriate use of products and marketing efforts.