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FINRA Sanctions Rep and Sanctuary Securities Over NT-ETFs
July 7, 2021
Once upon a time in Wall Street Regulationland we had so-called "leveraged and inverse" ETFs; now, we have Non-Traditional Exchange Trade Funds (NT-ETFs), which have become FINRA's unloved stepchild. Because of the risks and the complexity of these exotic ETFs, FINRA deems them unsuitable for most retail investors when the investment is held beyond one trading day. Somewhat lost in FINRA's hostility seems to be a recognition, grudging as it might be, that NT-ETFs are legal, approved, and regularly traded. If I want to hold an NT-ETF for two or more trading days, what's it to you? Sometimes I even drink what's in a container of milk beyond the printed expiration date.
Pearl AWC
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, Stuart L. Pearl submitted a Letter of Acceptance, Waiver and Consent ("AWC"), which FINRA accepted. In the Matter of Stuart L. Pearl, Respondent (FINRA AWC 2019060694202)
https://www.finra.org/sites/default/files/fda_documents/2019060694202
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The AWC asserts that Stuart L. Pearl was first registered in 1986, and by April 2019, he was registered with David A. Noyes. The AWC asserts that Pearl "does not have any relevant disciplinary history."
NT-ETFs
As alleged in part in the Pearl AWC, Non-Traditional Exchange Traded Funds ("NT-ETFs") are designed to:
return a multiple of an underlying index or benchmark, the inverse of that benchmark, or both, over only the course of one trading session - usually a single day. NT-ETFs typically rebalance their portfolios on a daily basis (also known as the daily reset). As a result, due to the effects of compounding of daily returns during the holding period, the performance of NT-ETFs over periods longer than a single trading session "can differ significantly from the performance . . . of their underlying index or benchmark during the same period of time."2 Because of these risks and the complexity of the products, FINRA has advised its members that NT-ETFs "are typically not suitable for retail investors who plan to hold them for more than one trading session, particularly in volatile markets."3Between March 2017 and August 2018, Pearl recommended nine NT-ETF purchases to four of his customers at the firm.4 All of these transactions were solicited. The customers held these positions for periods ranging from about 100 to 600 days, with the average holding period approximately 400 days. These extended holding periods caused Pearl's customers to incur approximately $80,000 in losses.Pearl failed to perform a reasonable basis suitability analysis of NT-ETFs to understand the unique features and specific risks associated with these products before offering them to his customers. In fact, the prospectuses for the NT-ETFs that Pearl recommended warned that the products were risky, intended to be utilized only by knowledgeable investors who understood the features of and risks associated with NT-ETFs, and should be actively and frequently monitored on a daily basis. Moreover, Pearl did not understand that losses in NT-ETFs are compounded because of how the valuations reset each day.Therefore, Pearl violated FINRA Rules 2111 and 2010.= = = = =Footnote 2: FINRA Regulatory Notice 09-31 (addressing NT-ETFs)Footnote 3: Id.Footnote 4: Sanctuary Securities consented to a supervision charge in AWC No. 2019060694201 in relation to Pearl's unsuitable recommendations of NT-ETFs and agreed to a fine and order of restitution to be paid to the affected customers.
In accordance with the terms of the AWC, FINRA imposed upon Pearl a $5,000 fine and a three-month suspension from association with any FINRA member in any capacity.
SIDE BAR: FINRA Reminds Firms of Sales Practice Obligations Relating to Leveraged and Inverse Exchange-Traded Funds (FINRA Regulatory Notice 09-31 / June 2009)https://www.finra.org/sites/default/files/NoticeDocument/p118952.pdfAs set forth in the Regulatory Notice's "Executive Summary" [Ed: footnotes omitted]:
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. . . .
Sanctuary AWC
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, Sanctuary Securities, Inc., f/k/a "David A. Noyes & Company" submitted a Letter of Acceptance, Waiver and Consent ("AWC"), which FINRA accepted. In the Matter of Sanctuary Securities, Inc., (formerly known as David A. Noyes & Company) (FINRA AWC 2019060694201)
https://www.finra.org/sites/default/files/fda_documents/2019060694201
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The AWC asserts that David A. Noyes & Company was a FINRA member in 1939 and changed its name to Sanctuary Securities, Inc. in March 2020; and that the firm has about 190 registered representatives at 35 branches.
Insufficient NT-ETF Supervisory System
The AWC asserts that Sanctuary "has no relevant disciplinary history." As set forth in the Sanctuary AWC's "Overview" [Ed: footnotes omitted]:
From January 1, 2014 through December 31, 2018, Respondent failed to establish and maintain a supervisory system, including written procedures, reasonably designed to achieve compliance with FINRA Rule 2111 in relation to the solicited sales of inverse and leveraged exchange traded funds (collectively Non-Traditional ETFs or NT-ETFs) in that the firm's supervisory system was not sufficiently tailored to address the unique features and risks of these products. Therefore, Respondent violated FINRA Rule 3110 and its predecessor, NASD Rule 3010, as well as FINRA Rule 2010.From January 2017 through January 2019, the firm failed to review and evaluate the outside business activities of approximately 15 of its registered representatives, in violation of FINRA Rules 3270.01 and 2010.From January through December 2018, the firm distributed sales materials in connection with three private placement offerings that contained prohibited performance projections, in violation of FINRA Rules 2210(d)(1)(F) and 2010.From June 2018 through June 2019, the firm failed to file offering documents with FINRA related to eight private placements sold by the firm's registered representatives, in violation of FINRA Rules 5123 and 2010.Finally, between April and August 2019, the firm failed to terminate an offering of securities that did not meet a minimum contingency requirement under the terms of a private placement memorandum and return funds to investors, in contravention of Rule 10b-9 of the Securities Exchange Act of 1934. Therefore, the firm willfully violated Exchange Act Rule 10b-9 and FINRA Rule 2010.
In accordance with the terms of the AWC, FINRA imposed upon Sanctuary a Censure, $160,000 fine, and $370,161.39 in restitution plus interest.
Bill Singer's Comment
When all is said and one, FINRA charged Pearl with recommending nine -- count 'em: 9 -- NT-ETF purchases to four -- count 'em: 4 -- of his Sanctuary customers; and all of this went on during the span of some 18 months from March 2017 and August 2018. So --- dividing 18 months by 9 recommendations, we got about one recommendation for every two months. Not exactly a huge number. On the other hand, one recommendation a month still managed to generate some $80,000 in losses.
One thing that FINRA did right with the Pearl AWC was to include a footnote referencing Sanctuary and the Sanctuary AWC. For some reason, FINRA hasn't always seen fit to offer that cross-reference when two Respondents enter into related AWCs. Oddly, FINRA often references the other related Respondent as Respondent X and rarely provides a direct citation to that other respondent's settlement. Since I've groused about that misguided policy in the past, I will take the time here to compliment FINRA and hope that this marks a new approach.
Finally, just going by the plethora of cited misconduct in the Sanctuary AWC, I hope that FINRA gave Pearl some consideration for being registered at a shop that seems so challenged by a myriad of regulatory mandates involving NT-ETFs, OBA, and private placements. I'm not that unhappy with the $5,000 fine imposed on Pearl, but given all the attendants circumstances, I would have been okay with a one month suspension. Then again, as I always note when critiquing AWCs, I don't know what I don't know and a lot of stuff often gets left out of the final, published version of a settlement agreement as a result of horse trading between the regulator and the regulated. If Pearl was happy signing off on $5,000 and three months, so be it -- not my place to second guess.