October 25, 2013
There seems no end in sight for the growth of exchange traded funds ("ETFs"). Frankly, whatever floats your boat is fine with me provided that the customer isn't being pushed into buying some nonsense without a basic appreciation for the risk; and, as many of us know, that is all too often what happens in the Wall Street world of watered down "suitability." Join me now, as we explore one regulator's unhappiness with how a brokerage firm handled sales of certain ETFs.
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, Saxony Securities, Inc. submitted a Letter of Acceptance, Waiver and Consent ("AWC"), which FINRA accepted. In the Matter of Saxony Securities, Inc., Respondent (AWC 2012030788301, October 14, 2013).
Saxony Securities, Inc. is an introducing broker-dealer with approximately 100 registered representatives and 50 branch offices. The AWC asserts that the member firm had no relevant prior disciplinary history.
The AWC alleges that between April 1, 2009, and March 1, 2010, Saxony permitted its registered representatives to recommend and sell non-traditional ETFs to firm customers, notwithstanding that:
- Saxony did not investigate the characteristics and risk factors of such products before allowing its representatives to recommend them to customers; and
- Saxony's written supervisory procedures did not address the sale or supervision of non-traditional ETFs during the relevant time frame.
SIDE BAR: In order to better understand the issues in this matter, READ:
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. . .
The AWC alleges that Saxony did not provide its representatives or supervisors with any training or other guidance specific to whether and when non-traditional ETFs might be appropriate for their customers. That's a fairly harsh allegation -- the regulator is asserting that the member firm did not provide "any training," which is a significant no-no when it comes to in-house compliance. Moreover, the AWC alleges that Saxony did not use or make available to its supervisory personnel any reports or other tools to monitor either the length of time that customers held open positions in non-traditional ETFs or any unrealized losses occurring in those positions. FINRA deemed such misconduct to constitute violations of NASD Conduct Rule 3010 and FINRA Rule 2010.
In accordance with the terms of the AWC, FINRA imposed upon Saxony a $15,000 fine and a Censure.
AWCs expressly provide that a respondent may attach a Corrective Action Statement, which is characterized as:
a statement of demonstrable corrective steps taken to prevent future misconduct. The respondent understands that it may not deny the charges or make any statement that is inconsistent with the AWC in this Statement. . . .
In accordance with that option and subject to its proscriptions, Saxony submitted the following:
STATEMENT OF CORRECTIVE ACTION SUBMITTED BY SAXONY SECURITIES. INC. IN CONNECTION WITH FINANCIAL INDUSTRY REGULATORY AUTHORITY LETTER OF ACCEPTANCE, WAIVER AND CONSENT NO. 2012030788301
As noted in the AWC, Saxony did allow the purchase and sale of leveraged and/or inverse exchange traded units by Registered Representatives of the Firm between April 1, 2009 and March 1, 2010 ("the relevant period").
FINRA released Regulatory Notice 09-31 regarding leveraged and inverse exchange-traded funds and the sales practice obligations of the member Firms in June, 2009. Saxony did not, at that time, have training and procedures in place specifically for non-traditional ETFs, although it did provide training and guidance regarding complex and/or non-conventional products to both its Registered Representatives and Supervisors during the 2008 through 2012 annual compliance meetings.
In late February 2010, Saxony sent a "Compliance Alert" to all Registered Representatives that discussed in detail non-traditional ETFs. This Compliance Alert identified that, as of March 1, 2010, any Saxony Representative who wanted to recommend or sell a non-traditional ETF to a customer was required to take specified training regarding these products. Saxony Representatives who subsequently sold non-traditional ETFs were required to take this additional training. In conjunction with the release of the "Compliance Alert," and as of March 1, 2010, Saxony also required customers who sought to purchase non-traditional ETFs to complete and sign a Leveraged And Inverse ETF Questionnaire & Agreement. This Questionnaire provided a number of disclosures of risks regarding non-traditional ETFs and required the customer to provide and confirm detailed suitability information. Additionally, Saxony has developed and created an ad-hoc, in-house "flag" for nontraditional ETF transactions using information obtained from the Options Clearing Corporation's website of reported and traded non-traditional ETFs.
Saxony believes that the procedures and requirements documented above, in combination with general supervisory procedures and exception reports already in place, will prevent further violations of the type alleged in this AWC.
This Corrective Action Statement is submitted by Saxony Securities, Inc. ("Saxony"). It does not constitute factual or legal findings by FINRA, nor does it reflect the views of FINRA, or its staff.
Bill Singer's Comment
I believe that FINRA has created the Wall Street equivalent of a moral dilemma because investors may be mislead into believing that other speculative and/or risky products (not leveraged/inverse ETFs), may be relatively "safe" or "traditional." While, in theory, the implementation of what has been described as enhanced disclosure and training protocols for more exotic ETFs is sensible, there are many toxic and dubious securities products out there that continue to slip under the radar -- and I simply do not believe that the SSO or QID ETFs, for example, necessarily pose a greater risk to investors than some of the crap that is pushed on them daily under the guise of "approved house product." Pointedly, much of what is foisted upon the pigeons on the Street doesn't get sold subject to understandable disclosure; and, further, those pumping the garbage rarely comprehend the nuances of the product and whatever training has been provided is more likely oriented to overcoming buyers' objections.
Bite Your Tongue?
Finally, I have never, ever been a fan of Corrective Action Statements and rarely, if ever, advocate their use. Given that the premise of the AWC is that it is a settlement made without admitting or deny the findings, I don't particularly understand the need to offer a statement that tends to typically come off as so much gnashing of teeth, ringing of hands, and, in the end, simply draws more undesired attention to the matter. Frankly, if you feel compelled to attach a Corrective Action Statement, then you may want to pause before signing the AWC and ask yourself if you might not be better advised to argue your case before a Hearing Panel and, if necessary, on appeal afterwards. If you ultimately conclude that the costs and/or risks of contesting the charges aren't worth it, then just sign the damn AWC and get over it. In my opinion, you're not gaining much (if anything) by posting a parting shot in the guise of a corrective statement and, worse, you may actually be setting yourself up down the road for more problems. Yes, there are exceptions to my position, but they strike me as few and far between.