FINRA Warns Investors Over Leveraged And Inverse ETFs

Tyler Durden's picture

Stifel Nicolaus has been fined more than $1 million by FINRA for the "unsuitable sales of leveraged and inverse ETFs." While the fine in de minimus compared to the JPMorgan-esque amounts, the remarks by FINRA raise considerable risks for any apparent fiduciary bucket-shop promoting these popular instruments... "performance can quickly diverge from the performance of the underlying index or benchmark. It is possible that investors could suffer significant losses even if the long-term performance of the index showed a gain. This effect can be magnified in volatile markets." Nothing we don't already know but this time from a regulator...



The Financial Industry Regulatory Authority (FINRA) today announced that it has ordered two St. Louis-based broker-dealers – Stifel, Nicolaus & Company, Incorporated and Century Securities Associates, Inc. – to pay combined fines of $550,000 and a total of nearly $475,000 in restitution to 65 customers in connection with sales of leveraged and inverse exchange-traded funds (ETFs). Stifel and Century are affiliates and are both owned by Stifel Financial Corporation.


Brad Bennett, FINRA Executive Vice President and Chief of Enforcement, said, "The complexity of leveraged and inverse exchange-traded products makes it essential for securities firms and their representatives to understand these products before recommending them to their customers. Firms must also conduct reasonable due diligence on these and other complex products, sufficiently train their sales force and have adequate supervisory systems in place before offering them to retail investors."


Leveraged and inverse ETFs "reset" daily, meaning that they are designed to achieve their stated objectives on a daily basis so their performance can quickly diverge from the performance of the underlying index or benchmark. It is possible that investors could suffer significant losses even if the long-term performance of the index showed a gain. This effect can be magnified in volatile markets.


FINRA found that between January 2009 and June 2013, Stifel and Century made unsuitable recommendations of non-traditional ETFs to certain customers because some representatives did not fully understand the unique features and specific risks associated with leveraged and inverse ETFs; nonetheless, Stifel and Century allowed the representatives to recommend them to retail customers. Customers with conservative investment objectives who bought one or more non-traditional ETFs based on recommendations made by the firms' representatives, and who held those investments for longer periods of time, experienced net losses.


FINRA also found that Stifel and Century did not have reasonable supervisory systems in place, including written procedures, for sales of leveraged and inverse ETFs. Stifel and Century generally supervised transactions in leveraged and inverse ETFs in the same manner that they supervised traditional ETFs, and neither firm created a procedure to address the risk associated with longer-term holding periods in the products. Further, both firms failed to ensure that their registered representatives and supervisory personnel obtained adequate formal training on the products before recommending them to customers.


Stifel agreed to pay a fine of $450,000 and to make restitution of nearly $340,000 to 59 customers. Century agreed to pay a fine of $100,000 and to make restitution of more than $136,000 to six customers.


In settling this matter, Stifel and Century neither admitted nor denied the charges, but consented to the entry of FINRA's findings.

It's too soon to say if this is the start of a broader class-action suit from VXX-holders and the like, but one thing is likely, regulators are now clearly keeping an eye on this rapidly growing segment of leveraged risk-taking.

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slotmouth's picture

FINRA instead encourages investors to daytrade TWTR options instead.  FINRA would also like to reiterate that triple short gold ETNs are a perfectly safe long term strategy.

kaiserhoff's picture

ETFs track the underlying like a drunk on roller skates?  Who knew?

Thank gawd for FINRA and the rest of the tyrant class.

In related news, trees are made of wood.

asteroids's picture

Where have these jokers been for the last 5 years. No complaints when the 3X Bull ETFs make money eh?

MeelionDollerBogus's picture
This overlay chart shows hvu, a favourite of mine, but uvxy moves just like it.
I should make some scatterplots for it vs SPY, DIA, etc.

not sure if the multiplier is the same given I don't have the scatterplot yet but they look almost the same.


the math I got looks like -11x multiplier, still no scatterplot, equation (this is real technical analysis, not the crap people call technical analysis) is 234 = UVXY(1/11) x SPY,

so if you want to compute estimated prices of UVXY (revise this with a good scatterplot & trendline detected by LibreOffice spreadsheet/openoffice,excel), you'd use this:

UVXY = (234 / SPY)11

and that's that for now. Good pick. I'll stick with HVU (tsx) because it's a cheaper share price and in CAD$ which is my local currency but I like what you FOUND. is my technical analysis of HVU vs SPY (1x s&p500)

Confundido's picture

In particular, commodity ETFs based on futures are the true Ponzi scheme. It can be easily demonstrated, because in order to keep paying the always desproportionate fees on the monthly rolls (to their friends), they need to dilute the value of the units and cover it with more issuance. Thus, a classical Ponzi scheme. I once suggested this to a lawyer, but I guess his IQ was too low to understand it. I am glad something is happening, although the ETF lobby will kill any extrapolations of this. What is even more astonishing is that people keep falling for it.

slightlyskeptical's picture

That could be said for any investment vehicle that carries fees. The problem with these ETF's is that the models don't work. I would point to UNG as an example.

Best way to play these is just to short both the long and the short leveraged ETF and you will make fees + inefficiencies.

SSO and SDs seem to move pretty much in line with their objectives. They can also be a great way to play real volatility by going long both sides and buying puts on both.

Confundido's picture

Not quite, because once the fees eat all the capital, the ETF should be unwound. That is not the case. The dilution is covered with constant issuance. This is what makes the scheme a Ponzi scheme.

CvlDobd's picture

Stifel is usually pretty good to their customers. The specifics of that case sound interesting. When I worked at Wells I wouldn't touch the leveraged ETFs with a cent of client money. I don't see where there is any incentive for a broker/FA to recommend or even use such an item. Just begging for angry clients.

slightlyskeptical's picture

The equity based leveraged ETF's worked really well to get exposure while still keeping money on the sidelines after the crash. SSO and UWM worked very well in this regard. They both captured over 95% of their objective since the end of the last crash. So you coukl have stayed 50% in cash and still kept up with the markets for the most part. With higher bond yields it could be a permanent solution.

Urban Redneck's picture

Which is scarier- that someone could pass a series 10/66 and not know any better, or that Stifel would hire such retards and allow them to manage their brokers? A brokerage developing policies and procedures regarding investment suitability is not exactly rocket science... Hell, GS can draft procedures to explicitly facilitate muppet raping, but ignoring the reg and not having at least a documented (CYA) policy is beyond stupid.

MeelionDollerBogus's picture

and yet I hear many banks (not sure if I recall Wells) saying they'll happily sink money into PUT options.
Those things expire & typically cost MORE than the inverse ETFs and most options expire worthless.
you can adjust the $ figure down for total input to an inverse ETF and they don't expire,
Which means if you chose PUTS and not inverse ETFs you lose even more money for your clients, even faster, with much higher risk.
Good move.

ThisIsBob's picture

These things are for day / vst trading or hedging, etc.  Most sponsors tell you that if you take the time to read their rap.

Its Only Rock N Roll's picture

Seems like it would currently be prudent for FINRA to warn investors about long only equity ETF's and mutual funds.

Sudden Debt's picture

rule 1: trade in what you know

Gromit's picture

Better late than never.

Dr. Engali's picture

If you are putting money into any leveraged ETF you are not investing you are speculating. The only placed leveraged "assets" belong is in a speculative trading account, and you better be willing to lose it all.

NoDebt's picture

Leverage ETFs should be outlawed.  If you can't qualify for a margin account the usual way, you shouldn't be playing with margin.

'Speculation' is a kind word compared to the one I'd use.

MeelionDollerBogus's picture

dumbest thing I ever heard.
margin accounts are 99.99% a method of taking way more money than you ever should be willing to lose.
You can't get a margin call - and shouldn't want one anyhow - using leveraged ETFs.
That's the right way to trade.
margin is not.

endorush's picture

the right way to trade is to max out your margin account on triple leverage etf options

MeelionDollerBogus's picture

oh yes, especially to triple-mortgage your house to get the capital for the margin account.

Here comes HELOC-opter Ben!

wisehiney's picture

They do this every time the shorts are about to make a buck.

Blues Traveler's picture

M, U on wong blog bud, go dig a tunnel.

Musashi Miyamoto's picture

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MeelionDollerBogus's picture

it's only -3x and not reliably so.

HVU and VXX are more reliable inverse, VXX being -2.5x to -4.5x and HVU being -11x to the market indexes S&P500 or DOW.

And way way cheaper.

Overlay graph to compare;

spanish inquisition's picture

The only logical explanation of FINRA action is they are behind in their campaign contributions.

Solarman's picture

They see the Tsunami coming and want to be on record as being ahead of the curve.  This coming selloff will be breathtaking.

RaceToTheBottom's picture

What?  You don't like our Financial Innovations?

WTF, are you communist?

Customers?  We can always find new Customers.  Go to any field and yell "BAAHHHH"

slightlyskeptical's picture


Feb 28, 2009 = $ 17.31 (577 Shares)

Dec 31, 2013 = $102.46

$10,000 investment = $59, 000


Feb 28, 2009 = 364.04 (27 shares)

Dec 31, 2013 = 29.66

$10,000 investment = $815 Today

So basically by buying both SSO and SDS in equal increments, your $20,000 investment is now worth about $60,000. A 200% return. During the same time the S&P Total Return earned 179%.

The reason it works out this way is the math behind these ETF's . When the market goes in the same direction as the leveraged ETF, the multiplier effect gives more than the 2X leverage. Likewise when it falls, the multiplier effect gives what turns out to be less than 2X leverage.

Do these results surprise any of you?

MeelionDollerBogus's picture

indeed. Inputting various balances of holdings & various price targets for the future makes it easy to make a simple spreadsheet, and a chart, indicating what the estimates gains or losses could  be.
Doing this I don't need anyone else to advise me. I know my total $ risk and what the potential reward could be, and I know that "potential" means "may never happen" so I price in my entry accordingly.

That's why I'm happily taking on HVU shares (acts as 11x power-inverse to SPY) because it's very cheap to enter (low risk in total $) and very rewarding on a market crash. Maybe it never works out but the nthe total $ input is also very low to BALANCE this possible outcome.

Spungo's picture

Don't worry guys. This only affects the small minority of people who don't use trailing stops.

MeelionDollerBogus's picture

or people for whom trailing stops have failed because they have no guarantees. Properly selecting a trading window & etf/inverse etf can in fact work better, safer, than a trailing stop system where the stops are ignored by the broker (and it does happen)

MeelionDollerBogus's picture

Clearly some people don't understand: vxx, spxu, hvu (tsx), faz are meant to be leveraged risk reduction of OTHER holdings of inverse correlation.

If you want to calculate it right you aim for a bottom-target of various market-positive correlated securities & a small amount of hvu, vxx, etc., to balance it out.

If betting only in the inverse etf's again adjust accordingly as to what target you're aiming for & how many $ you will maximum be willing to risk.

Simple scatterplots can reveal price targets from equations, like SPY x HVU(1/11)=219 to 220 therefore HVU = (219/SPY)11 or for that matter the ETF decay also can be seen & calculated (HVU seen here )