Consumer advocates and regulators tend to dislike so-called "exotic" or "leveraged" Exchange Traded Funds ("ETFs"). Many of the concerns are legitimate; however, too often the criticism demonizes the product rather than the laziness and stupidity of those who invest without an understanding of what they're buying. In contrast to the naysayers, professional traders and savvy amateurs often love a number of the unusual ETFs. No matter where you come down on the debate, there is simply no excuse for a lack of due diligence before investing -- and there should be no tolerance for any brokerage firm or stockbroker who fails to fully explain to a customer the risks of any recommended investment. Consider this recent FINRA arbitration case in which a customer sues a former brokerage firm and stockbroker over losses from one such ETF.
Case In Point
In a Financial Industry Regulatory Authority ("FINRA") Arbitration Statement of Claim filed in January 2012, and as thereafter amended, public customer Claimant Solomon asserted causes of action including fraud and breaches of fiduciary duty and contract in connection with his allegations that Respondent Ridgeway & Conger and Respondent Gurvin had engaged in unsuitable repeated high risk purchases of ultrashort securities described as Proshares Ultra Short Securities. Claimant sought $650,000 in compensatory damages plus punitive damages, interest, attorneys' fees, and costs. In the Matter of the FINRA Arbitration Between NAME, Newton Solomon, an individual and as beneficiary of the Newton Solomon IRA and Trustee of the Newton Solomon Trust, Claimants, vs Ridgeway & Conger, Inc. and Robert Gurvin, an individual, jointly and severally, Respondents (FINRA Arbitration # 12-00255, March 6, 2015).
Respondents generally denied the allegations and asserted various affirmative defenses. Respondents also requested the expungment of this matter from Respondent Gurvin's Central Registration Depository records ("CRD"), which Claimant opposed.
SIDE BAR: 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 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. . .
The FINRA Arbitration Panel found Respondents Ridgeway & Conger, Inc. and Gurvin jointly and severally liable to and ordered the to pay to Claimant $378,000.00 in compensatory damages.The Arbitrators denied and dismissed with prejudice the requested expungement for Claimant Gurvin.