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Leveraged ETF Class Action Suit On The Horizon

by Michael Johnston on August 6, 2009

I suppose we should have known that it was only a matter of time. The Miami-based securities law firm of Dimond Kaplan & Rothstein, P.A. announced yesterday that it is “investigating claims involving investment losses in leveraged and short exchange traded funds.” Among the broker-dealers mentioned specifically as having sold leveraged ETFs are Merrill Lynch, Wells Fargo Advisors, Smith Barney, LPL Financial, Ameriprise, Edward Jones, UBS, and Morgan Stanley Smith Barney.

Noting that leveraged ETFs are suited for investors with a very short time horizon, the firm goes on to note:

“But investors often are not told of the true risks of these products, and ETFs have been recommended to investors seeking both safe investments and longer-term investing. And as a result, many investors have unknowingly taken on unsuitable risk of loss and have suffered unexpected losses in ETFs. The most widely sold ETFs are created by Rydex Investments, Direxion Funds, and ProShares, a unit of ProShare Advisors LLC.”

It’s not exactly clear from the press release (which is available here) exactly who the target of such an investigation will be, and a message left with the firm seeking clarification wasn’t immediately returned. It seems, however, like the scrutiny over the use of leveraged ETFs is finally shifting away from the firms that sponsor and issue products (i.e., Direxion, ProShares, and Rydex) and towards the broker-dealers that have been recommending them for inclusion in clients’ portfolios.

Issuers of leveraged ETFs have been vilified in recent months amidst accounts of their products being used inappropriately. Despite an abundance of warnings from both issuers and third parties regarding the intended uses and limitations of leveraged ETFs, it seems that certain investors and asset managers have rushed into these investments without doing even a cursory amount of research.

Read more about the issues resulting from compounding returns here and the myths about leveraged products here.

Disclosure: No positions at time of writing.