WASHINGTON, D.C. (July 31, 2019)—The North American Securities Administrators Association (NASAA) today released a report on broker-dealer sales practices for non-traditional Exchange Traded Funds (ETFs), such as leveraged and inverse ETFs, which can present greater risks to investors than do traditional ETFs due to their complexity.
Exchange-traded funds have become popular investment vehicles for investors who want liquidity and investment costs that are generally lower than actively managed mutual funds. Traditional ETFs are typically structured such that their performance will closely approximate the performance of their underlying reference assets over an extended period. Non-traditional ETFs, such as those that are leveraged and/or inverse, however, perform differently than traditional ETFs.
“Broker-dealers should carefully consider whether to permit purchases of leveraged and/or inverse ETFs in retail customer accounts,” said Michael S. Pieciak, NASAA President and Vermont Commissioner of Financial Regulation. “Registered representatives who recommend these products without fully understanding them and without receiving appropriate supervision by their firms pose a great risk to investors.”
The NASAA report recommends tailored supervisory procedures be established for firms that allow leveraged and/or inverse ETF transactions. Further, that the supervisory procedures address the heightened and specific risks associated with these complex products.
NASAA’s Broker-Dealer Section’s Investment Products and Services Project Group collected information from 118 broker-dealers to gain a better understanding of whether registered representatives are recommending the purchase and sale of leveraged and/or inverse ETFs and, if those purchases and sales are permitted, how firms are supervising such transactions.
The analysis of the information resulted in a recommendation that firms review and update their supervisory procedures as they apply to leveraged and/or inverse ETFs. Most responding firms that allow customers to purchase and hold leveraged and/or inverse ETFs confirmed they have procedures for these transactions. When asked about those procedures, however, a lesser number of firms indicated they are addressing and monitoring customer suitability, including holding periods. “This suggests that there is room for improvement in the development and implementation of leveraged and/or inverse ETF-specific supervisory procedures,” the report concludes.
When registered representatives and their customers are permitted to purchase leveraged and/or inverse ETFs, the report encourages firms to ensure they have robust supervisory procedures in place to guard against unsuitable recommendations and inappropriate holding periods. The report also offers recommendations broker-dealers should consider when customizing policies and procedures for sales of leveraged or inverse ETFs. The full report is available on NASAA’s website, www.nasaa.org.