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What A Difference A Day Makes For Leveraged ETFs
May 4, 2015
The incomparable Dinah Washington. What a voice. But did you know that she was also one hell of a Wall Street regulator, who was way ahead of her time when she warned against holding leveraged Exchange Traded Funds beyond one trading day. Ah, yes . . . what a difference a day makes!
Case In Point
For the purpose of proposing a settlement of rule violations alleged by the Financial Industry Regulatory Authority ("FINRA"), without admitting or denying the findings, prior to a regulatory hearing, and without an adjudication of any issue, Daniel Grieco submitted a Letter of Acceptance, Waiver and Consent ("AWC"), which FINRA accepted. In the Matter of Daniel Grieco, Respondent (AWC #2013035076201, April 21, 2015).
In 1983, Grieco entered the securities industry and by 1984 had become registered. He has been registered with FINRA member firm First Allied Securities, Inc. since August 2010. The AWC asserts that Grieco had no prior relevant disciplinary history.
Leveraged ETFs
[T]he ETFs were designed to achieve their objectives over the course of a single day only. Nevertheless, the ETFs were held for much longer periods, in some cases for more than five years. As evidenced by these extended holding periods, Grieco failed to appreciate the nature of the ETFs at the time of his recommendations, to wit, that they were not designed to achieve their objectives for extended holding periods. As such, he did not have reasonable grounds to believe his recommendations were suitable. Grieco thereby violated NASD Rules 2310 and 2110 for the period from July 21,2008, through December 14, 2008, NASD Rule 2310 and FINRA Rule 2010 for the period from December 15, 2008, through July 8, 2012, and FINRA Rules 2111 and 2010 for the period from July 9, 2012, through July 19, 2013.
Suitability Sanctions
In accordance with the terms of the AWC, FINRA imposed upon Grieco a $7,500 fine and a 15-business-day suspension from association with all FINRA members in all capacities.
Bill Singer's Comment
In order to better understand the issues in this matter, read:
FINRA Regulatory Notice 09-31 (June 2009): Non-Traditional ETFs: FINRA Reminds Firms of Sales Practice Obligations Relating to Leveraged and Inverse Exchange-Traded Funds. In the Executive Summary of the FINRA ETF Notice:
Exchange-traded funds (ETFs) that offer leverage or that are designed to perform inversely to the index or benchmark they track-or both-are growing in number and popularity. While such products may be useful in some sophisticated trading strategies, they are highly complex financial instruments that are typically designed to achieve their stated objectives on a daily basis. Due to the effects of compounding, their performance over longer periods of time can differ significantly from their stated daily objective. Therefore, inverse and leveraged ETFs that are reset daily typically are unsuitable for retail investors who plan to hold them for longer than one trading session, particularly in volatile markets.This Notice reminds firms of their sales practice obligations in connection with leveraged and inverse ETFs. In particular, recommendations to customers must be suitable and based on a full understanding of the terms and features of the product recommended; sales materials related to leveraged and inverse ETFs must be fair and accurate; and firms must have adequate supervisory procedures in place to ensure that these obligations are met. . .
Direxion Investments, a leading provider of ETFs, notes, among other issues, the following on its "About Us" webpage
A Broad Array of Non-Traditional ETFs and Mutual FundsSince 1997, Direxion investments has been offering non-traditional investments to accommodate various market cycles.For financial advisors, individual investors, institutions, and active traders, Direxion specializes in providing solutions that deliver:
- A means toward seeking specific outcomes, such as broader diversification, dampened volatility and income or alpha generation
- Efficient access to non-correlated asset classes and strategies
- Flexibility to position portfolios opportunistically for near- and long-term market trends
- Liquid, cost effective access to sophisticated strategies
Our role is to complement your core investment strategies, not to replace them. Our funds allow you to seek opportunities in all market conditions offering fresh solutions to challenge old standards.For short-term traders, Direxion's leveraged and inverse ETFs provide opportunities to:
- Magnify your short term perspective with daily 3x leverage
- Utilize bull and bear funds for both sides of the trade
- Trade through rapidly changing markets
Although prescription and over-the-counter drugs are generally sold in the United States subject of Federal Drug Administration approved "Label Use," many drugs are still subject to widespread "Off-Label Use" in which providers prescribe and/or patients use the drugs contrary to the recommended/approved terms; e.g., giving adult medicine to children, taking lesser or greater doses over shorter or longer periods of time, and using the drug for a condition for which it is not intended. Who among us doesn't know someone who insists on taking an antibiotic left over from a previous bacterial illness for the cold or flu -- even though antibiotics are not generally effective against viruses? All of which brings us back to the fact that leveraged ETFs, which are largely designed for intraday trading, wind up being held for longer terms.Q. Are Direxion Shares ETFs appropriate for buy and hold investing?A. No, this is not recommended. Leveraged ETFs seek daily investment results and should therefore be considered primarily for short-term trading purposes. It may, however, be appropriate to hold the funds for periods longer than one day depending on the performance path of the fund's underlying benchmark index and the investor's risk tolerance. Investors who choose to hold leveraged ETFs for periods longer than one day should recognize that their holding period is not in line with the fund's objective and such investors should regularly monitor and adjust their position to maintain a level of exposure consistent with their investment objective.
Whether the warning is voiced by the self-regulatory organization FINRA or by industry participant Direxion, the message is consistent: Leveraged ETFs are typically not designed to be held beyond a one-day holding period. Although circumstances may arise that prompt investors to hold beyond one day, when the decision to extend beyond the trading day occurs, investors must be sensitive to the fact that they are engaging in an Off-Label Use of the investment product. Always be mindful of the sage warning from regulator Dinah Washington:
Also READ:
- Customer Wins $378,000 in Ultra Short ETF Lawsuit
- Leveraged ETFs Marked As Unsolicited
- Leveraged And Inverse ETFs Snag Broker Dealer
- Customers Sue Wells Fargo Over Leveraged ETF Trades
- Morgan Stanley To Pay Nearly $2.4 Million ETF Fine and Restitution
- UBS To Pay Nearly Nearly $2 Million ETF Fine and Restitution
- Citigroup To Pay Over $2 Million ETF Fine and Restitution
- Wells Fargo To Pay Over $2.7 Million ETF Fine and Restitution