US regulators have issued a stern warning to broker dealers and financial advisers to stop selling “unsuitable” volatility-linked exchange traded products to retail investors.
The harshly worded statement has been released by a division of the Securities and Exchange Commission following Friday’s announcement that five companies had been ordered to repay a combined total of more than $3m to retail investors harmed by the products.
The release from the SEC’s Office of Compliance Inspections and Examinations said a financial professional recommending a complex or risky product should understand the dangers of the product, consider if it is suitable for their client and ensure the investment is monitored daily.
In addition, financial services firms should also make sure the advisers that recommended their products were not solely responsible for assessing their suitability, it said. “Firms that offer their financial professionals access to a full scope of products on a platform . . . should review the design and implementation of their policies and procedures so that product analysis is not solely left to each financial professional.”
Volatility ETPs track futures indices based on the Chicago Board of Trade’s Volatility Index (Vix) and almost always lose money over the long term.
The SEC action on Friday was brought against American Portfolios Financial Services/American Portfolios Advisors, Benjamin F Edwards & Company, Royal Alliance Associates, Securities America Advisors and Summit Financial Group.
In Friday’s ruling, the SEC noted that although the offering documents for the products clearly stated that they were intended for short-term use, the firms had recommended that their customers and clients “buy and hold the products for longer periods, including in some circumstances, for months and years”.
“We take these failures seriously, and we will continue to look for sales that expose customers to unsuitable investments,” said Stephanie Avakian, director of the SEC’s division of enforcement in Friday’s statement.
The FT has teamed up with ETF specialist TrackInsight to bring you independent and reliable data alongside our essential news and analysis of everything from market trends and new issues, to risk management and advice on constructing your portfolio. Find out more here
The volatility-linked products gained notoriety in 2018 when several inverse Vix ETPs collapsed after the Vix index of volatility shot to its highest level in two and a half years while the S&P 500 suffered its biggest one-day decline since 2011.
Subsequent analysis of the meltdown by the Bank for International Settlements concluded that the volatility ETPs had a role in producing the extreme market movements, creating a “feedback loop”.
In a similar case, JPMorgan Securities was censured by the Financial Industry Regulatory Authority in June 2020 and ordered to pay a fine and financial restitution after being found to have inadequately supervised the sale of volatility ETPs.
Experts warned earlier this year that a surge of interest in leveraged and inverse ETPs could be luring inexperienced investors into investments that were little better than gambling.