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Investments - Unsuitable

Unsuitable Sales of Exchange Traded Products

May 8, 2020



by Howard Haykin



Exchange Traded Funds (or “ETFs”) are the investment of choice for many investors looking to get into the stock market. They’re usually low-cost alternatives to mutual funds and investors can buy and sell them much like stocks. Investors currently have over $4 trillion invested in ETFs and that number could hit $50 trillion by 2030, according to Bank of America. [Note: That forecast made before Covid-19 rattled the markets.]


The largest and most common ETFs contain baskets of stocks that track an underlying index, such as the S&P 500. They do so by owning all the stocks in that index. And the costs of running the funds are kept low because the portfolios are passively managed – meaning they do not have an investment manager who actively buys and sells securities.


In contrast to these ‘plain vanilla’, traditional ETFs, a smaller universe of Non-Traditional Exchange Traded Products (or “NT-ETPs”) employ sophisticated financial strategies and instruments so as to deliver outsized returns on their baskets of stocks.


Leveraged NT-ETPs use financial derivatives and debt to multiply the returns of an underlying index. Such funds may include the terms “double,” “ultra,” “triple,” or similar language in their security name or description. NT-ETPs, which focus on daily investment returns, are designed for use by traders and sophisticated investors – not intermediate and long-term investors.



WHAT WENT WRONG.    Unfortunately, brokers (perhaps unwittingly) mistake NT-ETPs for ‘plain vanilla’ ETFs, and they purchase these unsuitable investments for their customers’ accounts for extended holding periods. Customers are exposed to enormous risks and often incur significant market losses.Take, for example, the broker with International Assets Advisory (“IAA”) who, over a 12-month period, recommended that 5 of his customers purchase twenty-one NT-ETPs and then held those securities for periods ranging from 30 to 758 days. [None of these securities were intended to be held beyond a single trading session.] Had the broker read the prospectuses for these NT-ETPs, he would seen the warnings 'that the products were risky, intended to be daily trading tools for sophisticated investors, and should be actively and frequently monitored, even intra-day.' 



Note: To its credit, International Assets Advisory compensated the customers for their $93,000 in losses. Then the firm promptly revised its policies so as to prohibit all solicited purchases of NT-ETPs. Finally, IAA retained this veteran broker on its payroll. Despite his errors in judgment, he has had a relatively clean disciplinary record throughout a 27-year career.



INVESTOR TAKEAWAYS.     Most investors would do well to limit their portfolios to mutual funds or ETFs (that seek to simply match or replicate broad-based stock or bond market indexes), and avoid any fund or product that tries to boosts its returns with a range of complex investment strategies.



Got questions or need help deciding? Let Financialish, a Financial Watchdog, be of assistance.



[For further details on the broker’s case, click on … FINRA Case #2017056579502​.]

[For further details on IAA’s case, click on … FINRA Case #2017056579501​.]