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FINRA Slaps $9 Mln Fine On Nation's Biggest Banks Over Risky Products

 May 02, 2012 10:30 AM

(By Mani) The Financial Industry Regulatory Authority (FINRA) has slapped a fine of more than $9 million on four of the country's biggest banks for selling leveraged and inverse exchange-traded funds (ETFs) without reasonable supervision and for not having a reasonable basis for recommending the securities.

The firms -- Citigroup Global Markets, Inc; Morgan Stanley & Co., LLC; UBS Financial Services; and Wells Fargo Advisors, LLC – neither admitted nor denied the allegations, but consented to the entry of the regulator's findings.

FINRA, the largest independent regulator for all securities firms doing business in the United States, said the firms were fined more than $7.3 million and are required to pay a total of $1.8 million in restitution to certain customers who made unsuitable leveraged and inverse ETF purchases.

Wells Fargo topped the list with a fine of $2.1 million, followed by Citigroup ($2 million), Morgan Stanley ($1.75 million) and UBS ($1.5 million).

An exchange-traded fund (ETF) is an investment fund traded on stock exchanges, much like stocks. Most ETFs track an index, such as the S&P 500, and they may be attractive as investments due to their low costs, tax efficiency, and stock like features.

Leveraged ETFs seek to deliver multiples of the performance of the index or benchmark they track. Inverse ETFs seek to deliver the opposite of the performance of the index or benchmark they track. Investor can profit from the short positions in derivatives, in a falling market.

However, both leveraged and inverse ETFs have certain risks not found in traditional ETFs, such as the risks associated with a daily reset, leverage and compounding. Accordingly, investors were subjected to the risk that the performance of their investments in leveraged and inverse ETFs could differ significantly from the performance of the underlying index or benchmark when held for longer periods of time, particularly in the volatile markets that existed during January 2008 through June 2009.

FINRA found that from January 2008 through June 2009, the 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 over the risks and features of the ETFs.

FINRA alleged that the firms advisers made unsuitable recommendations of leveraged and inverse ETFs to some customers with conservative investment objectives and/or risk profiles. 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.

"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 trained their sales force before the products are offered to retail customers. Firms must conduct reasonable due diligence and ensure that their representatives have an understanding of these products." said Brad Bennett, FINRA Executive Vice President and Chief of Enforcement.

Recently, ETFs has gained more prominence in Wall Street and thereby subjected to increased regulatory scrutiny.

Assets in US listed Exchange Traded Funds (ETF) and Exchange Traded Notes (ETN) rose 12 percent to about $1.21 trillion at March 2012 month-end, according to ETF Industry Association.

ETF/ETN net cash inflows reached approximately $13.2 billion for the month of March 2012, with year-to-date net cash inflows reaching $55.9 billion, a record for the first quarter of a calendar year.

At March 2012 month-end, there were 1,446 U.S. listed products, an increase of 23 percent from 1,173 U.S. listed products at the same time last year.



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