Exchange Traded Funds (ETFs)

Attorneys are investigating potential claims on behalf of retail customers who purchased leveraged exchange traded funds (ETFs) and leveraged inverse ETFs and held them in brokerage accounts for longer than one day.

FINRA's regulatory notice 09-31, issued in June, 2009, states that "inverse and leveraged ETFs typically are not suitable for retail investors who plan to hold them for more than one trading session, particularly in volatile markets."

Investors may have experienced a decrease in the value of their investment because they held onto their ETF for too long, not realizing the risks associated with holding a leveraged ETF for longer than one day.

Allegations include that the defendants failed to disclose the risks associated with the investment, especially the likelihood of losses if the funds were held over time, and that the defendants did not divulge the degree to which the results of the funds were likely to deviate from their benchmark over time.

Investors who purchase ETFs buy into a pool of securities and other assets that are bought or sold through a broker-dealer. They are often attractive investments because of low costs, tax efficiency and ease of diversification. However, ETFs are not meant to be held over time, in some cases not more than one day.

ETFs are similar to traditional mutual funds—in fact, the book "ETFs for Dummies" refers to them as "cousins of mutual funds". However, ETFs can be bought and sold on a stock exchange throughout the day—much like an individual stock, and just like an individual stock, an ETF's market price fluctuates throughout the day. With a mutual fund, the fund's price is typically set once a day, and usually after the trading has closed for the day. ETFs are also bought and sold through a broker-dealer. Financial institutions purchase and redeem the shares from the ETF in large blocks from 25,000 to 200,000 shares.

Essentially, ETFs are index funds that are traded on the stock market; index funds aim to achieve the same rate of return as a benchmark group of stocks or funds (i.e., the "index").

Leveraged ETFs work the same way by following a benchmark index, however, a leveraged ETF attempts to achieve returns that outperform the benchmark index—not just track with it, as is the case with a non-leveraged ETF. Leveraged ETFs are usually marketed as bull or bear funds. Basically, leveraged ETFs are designed to go up when the market goes up and go down when the market goes down, but they are meant to yield higher returns than the benchmark index when the market moves. In many instances, a multiple is set as a target for which the leveraged ETF is expected to outperform the benchmark index. For example, a leveraged ETF may aim to provide 2-3 times the return of that which the benchmark index is providing.

An inverse ETF works much the same way as an ETF, but the aim of in inverse ETF is to perform in the opposite direction of the benchmark index that it is tracking against—hence the name "inverse". With an inverse ETF, the value of the ETF increases when the value of the benchmark index it is correlated to goes down. Inverse ETFs commonly involve buying or selling options.

Two of the largest providers of leveraged and short ETF securities are ProShares and Direxion Shares. The two companies, according to etfguide.com amassed more than $32 billion in those funds by the end of June, 2009. Other companies that reportedly offered ETFs include Rydex/SGI, Fidelity Funds, UBS Wealth Management Americas (a division of UBS AG), Ameriprise Financial, Edward Jones, LPL Financial Group and Morgan Stanley Smith Barney. However, after the FINRA Regulatory Notice 09-31 was issued, these firms banned, temporarily halted or severely restricted the sales of such ETFs.

Lawsuits have now been filed against some of these firms alleging investors were not properly warned about the risks associated with ETFs.

Exchange Traded Funds (ETF) Legal Help

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Last updated on Mar-17-10