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Regulatory Sanctions

Non-Traditional ETFs: Supervision Problems at Garden State Securities

July 10, 2017

by Howard Haykin


It's generally not a popular decision when a firm restricts the sale of certain speculative or volatile securities – e.g., non-traditional ETFs. But that's the appropriate thing to do until such time as a firm can adequately supervise such transactions. Of course, how many firms seek to do the “right thing” and safeguard their customers – or for that matter, are willing to let compliance dictate certain of its business practices?


Garden State Securities agreed to a $25K fine to settle FINRA charges that it failed to establish, maintain, and enforce a reasonably designed supervisory system and WSPs regarding the sales of leveraged, inverse and inverse-leveraged exchange-traded funds (Non-Traditional ETFs). The fine also reflects the firm’s alleged failure to properly mark and report short sale transactions.


Non-Traditional ETFs are designed to return a multiple of an underlying index or benchmark, the inverse of that benchmark, or both, over only the course of one trading session-usually a single day. As a result, the performance of Non-Traditional ETFs over periods of time longer than a single trading session "can differ significantly from the performance . . . of their underlying index or benchmark during the same period of time.”


Because of these risks and the inherent complexity of these products, FINRA has advised B/D’s and their reps that Non-Traditional ETFs "are typically not suitable for retail investors who plan to hold them for more than one trading session, particularly in volatile markets."


BACKGROUND.   Garden State Securities (“GSS”), a Red Bank, NJ-based broker-dealer, has been in business since 1981. The firm conducts a general securities business, has 10 registered branch offices, and employs about 79 registered persons.


FINRA FINDINGS.    From July 2011 through June 2012, GSS did not have adequate written supervisory policies and procedures (WSPs) for sales of leveraged, inverse, and inverse-leveraged exchange-traded funds (''Non-Traditional ETFs"). Such violations would be in violation of NASD Rule 3010 and FINRA Rule 2010.


Yet, during the period in question, more than a dozen GSS reps sold Non-Traditional ETFs to customers, many of whom held these products for periods longer than one trading session. These volatile positions went virtually undetected or left undisturbed because GSS supervisory personnel were ill-prepared to monitor these transactions:


  • GSS had no WSPs that specifically addressed the suitability or supervision of Non-Traditional ETFs.
  • GSS did not have a system that enabled the Firm's supervisory personnel to adequately review Non-Traditional ETF transactions to ensure their suitability.
  • GSS supervisors had to rely on a manual blotter for review and detection of potentially unsuitable Non-Traditional ETF transactions, even though the manual blotter did not even differentiate between traditional and Non-Traditional ETFs.
  • GSS had no exception reports specific to Non-Traditional ETFs, and failed to implement any system to monitor Non-Traditional ETF holding periods and losses.


This case was reported in FINRA Disciplinary Actions for June 2017.

For details on this case, go to ...  FINRA Disciplinary Actions Online, and refer to Case #2013035131702.