FINRA Sanctions Four Giants Of The Banking Industry Over ETF Sales

Harriet Davies

3 May 2012

The Financial Industry Regulatory Authority has sanctioned four US banking giants, fining them around $7.3 million plus $1.8 million in restitution collectively, over sales of certain exchange-traded funds.

The firms are: Wells Fargo, fined $2.1 million plus $641,489 in restitution; Citigroup, $2 million fine and $146,431 in restitution; Morgan Stanley, $1.75 million fine and $604,584 in restitution; and UBS, $1.5 million fine and $431,488 in restitution.

The sanctions were meted out because the firms sold leveraged and inverse exchange-traded funds “without reasonable supervision” or basis for doing so, FINRA says.

"The added complexity of leveraged and inverse exchange-traded products makes it essential that brokerage firms have an adequate understanding of the products and sufficiently train their sales force before the products are offered to retail customers,” said Brad Bennett, FINRA executive vice president and chief of enforcement.

The sanctions tap into a long-running debate over ETFs, as many within the industry caution that while some of these products can provide cheap and liquid access to certain investment markets, many have hidden complexities and thus they should not all be considered equal.

While traditional ETFs represent an interest in a portfolio of securities that track an underlying benchmark or index, leveraged products aim to deliver a multiple of the benchmark’s performance – which can make them highly volatile – while inverse ETFs target the inverse performance of an index or benchmark.

During the period from January 2008 to June 2009 – a volatile period in the markets – the fined firms “did not have adequate supervisory systems in place to monitor the sale of leveraged and inverse ETFs, and failed to conduct adequate due diligence regarding the risks and features of the ETFs,” FINRA alleges.

Due to this, they recommended them without reasonable basis, where they didn’t match investment objectives or risk profiles of clients for example, the regulator says.

“Each of the four firms sold billions of dollars of these ETFs to customers, some of whom held them for extended periods when the markets were volatile,” said FINRA.

In settling these matters, the firms neither admitted nor denied the charges, but consented to the entry of FINRA's findings.