The firms were fined more than $7.3m and are required to pay a total of $1.8m in restitution to certain customers who made unsuitable leveraged and inverse ETF purchases.
FINRA sanctioned the following firms:
- Wells Fargo – $2.1m fine and $641,489 in restitution
- Citigroup – $2m fine and $146,431 in restitution
- Morgan Stanley – $1.75m fine and $604,584 in restitution
- UBS – $1.5m fine and $431,488 in restitution
Brad Bennett, FINRA Executive Vice President and Chief of Enforcement, said, 'The added complexity of leveraged and inverse exchange-traded products makes it essential that brokerage firms have an adequate understanding of the products and sufficiently train their sales force before the products are offered to retail customers. Firms must conduct reasonable due diligence and ensure that their representatives have an understanding of these products'.
ETFs are typically registered unit investment trusts (UITs) or open-end investment companies whose shares represent an interest in a portfolio of securities that track an underlying benchmark or index. Leveraged ETFs seek to deliver multiples of the performance of the index or benchmark they track. Inverse ETFs seek to deliver the opposite of the performance of the index or benchmark they track, profiting from short positions in derivatives in a falling market.
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. The firms' registered representatives also made unsuitable recommendations of leveraged and inverse ETFs to some customers with conservative investment objectives and/or risk profiles. Each of the four firms sold billions of dollars of these ETFs to customers, some of whom held them for extended periods when the markets were volatile.
Leveraged and inverse ETFs have certain risks not found in traditional ETFs, such as the risks associated with a daily reset, leverage and compounding. Accordingly, investors were subjected to the risk that the performance of their investments in leveraged and inverse ETFs could differ significantly from the performance of the underlying index or benchmark when held for longer periods of time, particularly in the volatile markets that existed during January 2008 through June 2009. Despite the risks associated with holding leveraged and inverse ETFs for longer periods in volatile markets, certain customers of these firms held leveraged and inverse ETFs for extended time periods during January 2008 through June 2009.
In settling these matters, the firms neither admitted nor denied the charges, but consented to the entry of FINRA's findings.