On June 11, the Financial Industry Regulatory Authority issued Regulatory Notice 09-31, reminding firms of their obligations with respect to sales practices relating to leveraged and inverse exchange-traded funds (ETFs). Inverse and leveraged ETFs generally track the leveraged performance or the inverse performance of an index, meaning they aim to produce returns equal to a multiple, inverse or multiple inverse of the target index. Most inverse and leveraged ETFs are structured to accomplish this goal on a daily basis only and they “reset” at the end of each trading session. Over longer periods of time, particularly when markets are volatile, the impact of compounding leads to performance that may differ significantly from the stated daily objective. In other words, despite tracking a multiple or inverse of the target index successfully on a daily basis, the fund performance may vary significantly from that multiple or inverse of the target index over a longer period of time.
Regulatory Notice 09-31 reminds firms that sales practice obligations dictate that they (i) fully understand the product they are recommending; (ii) recommend the product only to customers whose financial situation and goals are in line with such a product; (iii) ensure sales materials fairly and accurately represent the product; and (iv) maintain adequate supervisory procedures to meet these obligations.