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FINRA Fines Multiple Firms for Leveraged and Inverse ETF Sales
As noted in this press release from FINRA, Wells Fargo, Citigroup, Morgan Stanley, and UBS were fined for failing to supervise sales of leveraged and inverse ETFs. FINRA also alleged failures of a reasonable basis to recommend the securities (i.e. suitability).
FINRA found that: “from January 2008 through June 2009, the firms did not have adequate supervisory systems in place to monitor the sale of leveraged and inverse ETFs, and failed to conduct adequate due diligence regarding the risks and features of the ETFs. As a result, the firms did not have a reasonable basis to recommend the ETFs to their retail customers.”
Many inverse and leveraged exchange traded funds, including some by Proshares and Direxion, were designed to seek multiples of the exchange they were designed to track. However, many of these ETFs were designed to reset daily, thereby creating drastic differences in their performance over time compared to the index they were designed to track. We have seen many situations where many of the risks of these funds were not disclosed to customers.
The prospectus for the Proshares leveraged and inverse ETFs from September 2007 makes clear that these investments were an aggressive day-trading tool, not an investment appropriate or suitable for most retail investors. Specifically, the prospectus stated:
p. 7: ‘The Funds do not seek to achieve their stated investment objective over a period of time greater than one day because mathematical compounding prevents the Funds from achieving such results.’
p. 8: ‘The Funds use investment techniques that may be considered aggressive, including the use of futures contracts, options on futures contracts, securities and indices, forward contracts, swap agreements and similar instruments.’
p. 9: ‘Certain Funds are ‘leveraged’ funds in the sense that they have investment objectives to match a multiple of the performance of an index on a given day. These Funds are subject to all of the correlation risks described above. In addition, there is a special form of correlation risk that derives from these Funds’ use of leverage, which is that for periods greater than one day, the use of leverage tends to cause the performance of a Fund to be either greater than or less than the index performance times the stated multiple in the fund objective, before accounting for fees and fund expenses’
In June of 2009, FINRA issued a Regulatory Notice (09-31) regarding these Non-Traditional ETFs. The Notice states: ‘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.’
If you suffered losses in your brokerage accounts resulting from your broker’s trading in ETFs, and you would like to discuss your potential claim with an attorney, please contact Greco & Greco.
Consequential Damages for Auction Rate Securities Unresolved
As set out in this Kansas City Star article Wachovia and JP Morgan Chase have joined UBS, Morgan Stanley, and Citigroup in settling charges related to their sale of Auction Rate Securities. Although the settlement agreements with exact details are not completed, it appears that the firms will be buying back frozen auction rate securities sold to individuals and small businesses.
Left open is the recovery of consequential damages suffered by buyers of the allegedly liquid ARS who couldn’t access their cash. The press releases and articles related to the settlements reference that customers will be able to seek recovery of their consequential damages through arbitration, with the firms admitting liability, but not conceding damages.
If you or your business suffered monetary damages as a result of having your funds frozen in ARS, please contact Greco & Greco for a free consultation with one of our attorneys to discuss options for recovery of your damages.
Auction Rate Securities Failures
Auction Rate Securities and Auction Rate Preferred Securities (ARS) are securities made up of long term bonds or preferred stock with variable interest rates and yields. The yields are periodically reset through Dutch auctions. ARS are often marketed and sold by a single dealer with the only resale market being through a successful auction. Problems have arisen in recent months as a result of the failures of the auctions, leaving investors in the lurch and unable to redeem the security. As set out in this SmartMoney article, ARS have been marketed as a safe, liquid alternative to money market funds. Investors believing they had their money in a safe liquid investment are understandably concerned by the failures in the marketplace for these securities, and our firm has been monitoring the situation closely and discussing the matter with concerned individuals and businesses. Misrepresentations and omissions in the sale of a security can form the basis for a claim for securities fraud as well as other legal claims for recovery of damages.
As recently as 2006, the SEC censured 15 of the largest brokerage firms for sales and auctions of Auction Rate Securities. As stated by the SEC in its press release, “since the firms were under no obligation to guarantee against a failed auction, investors may not have been aware of the liquidity and credit risks associated with certain securities.” The SEC further stated that “the firms violated Section 17(a)(2) of the Securities Act of 1933, which prohibits material misstatements and omissions in any offer or sale of securities.” The fifteen firms which were censured were Bear, Stearns & Co., Inc., Citigroup Global Markets, Inc., Goldman Sachs & Co., J.P. Morgan Securities, Inc., Lehman Brothers Inc., Merrill Lynch, Pierce, Fenner & Smith Incorporated, Morgan Stanley & Co. Incorporated/ Morgan Stanley DW Inc., RBC Dain Rauscher Inc., A.G. Edwards & Sons, Inc., Morgan Keegan & Company, Inc., Piper Jaffray & Co., SunTrust Capital Markets Inc., Wachovia Capital Markets, LLC, and Banc of America Securities LLC. Read the SEC Order here.
UBS appears to be the first firm to actually begin lowering the values of auction rate securities on its customers’ statements, as reported by many news sources on March 29 including this Reuters article. Citing a Wall Street Journal article, Reuters reported that the markdowns could exceed 20 percent for some customers. Additional concessions from other firms may be forthcoming as the first quarter of 2008 ends.
State Regulators, including Massachusetts, have also begun investigations of the auction rate securities market with Massachusetts reportedly issuing subpoenas to UBS, Merrill Lynch, and Bank of America.
The Financial Industry Regulatory Authority (FINRA) released an Investor Alert on March 31, 2008 regarding auction rate securities which purports to set out various options for investors stuck with these products. FINRA, which claims to be a “trusted advocate for investors,” notably fails to mention contacting an attorney or filing an arbitration claim as options. If you are an investor who was sold Auction Rate Securities, and you would like to discuss your legal options with an attorney, please Contact Greco & Greco.
Posted by W. Scott Greco on 03/03/08.
Auction Rate Securities (ARS) • Bonds • Brokerage Firms • A.G. Edwards • Banc of America • Bear Stearns • Citigroup • Deutsche Bank • Ferris Baker Watts • Lehman Brothers • Merrill Lynch • Morgan Keegan • Morgan Stanley • Piper Jaffray • RBC Dain Rauscher • Suntrust • UBS • Wachovia • FINRA • State Regulators • Massachusetts • Suitability • Permalink
Morgan Stanley Fined Over Failure to Produce E-mails in Arbitrations
Morgan Stanley was fined $3 million and forced to pay $9.5 million in restitution to arbitration Claimants as a result of its failure to produce emails in response to document requests in arbitrations with customers. According to the FINRA press release, Morgan Stanley incorrectly represented in the arbitration proceedings that “the destruction of the firm’s email servers in the Sept. 11, 2001 terrorist attacks on New York’s World Trade Center resulted in the loss of all pre-9/11 email.”
The unknown at this point is the amount of financial benefit gained by Morgan Stanley by this behavior through arbitration settlements and awards, and whether this benefit far exceeds the relatively small punishment ordered by FINRA.
Morgan Stanley fined for corporate bond overcharges
As set out in this FINRA press release Morgan Stanley was fined and forced to pay restitution to retail customers for overcharging for corporate bond sales and for “having an inadequate supervisory system for monitoring the pricing of corporate fixed income securities sold to customers.”
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