Massachusetts Continues Leveraged ETF Crackdown

by on August 3, 2009

The controversy over leveraged ETFs continues to intensify, thanks in no small part to the efforts of Massachusetts’ Secretary of the Commonwealth William Galvin. Last month, Massachusetts announced that it was commencing an investigation into the sales and marketing practices of leveraged ETF issuers, noting that “it is important that retail investors be provided with all the information necessary to make informed choices about these products.” Now Massachusetts has made its next move in this ongoing saga, sending subpoenas to four financial institutions seeking details on how these firms sold leveraged ETFs.

Court Square In BostonAccording to a report from the Wall Street Journal, Massachusetts regulators sent subpoenas to UBS AG, Ameriprise Financial, Edward Jones, and LPL Financial Group. UBS, Ameriprise, and Edward Jones have all recently announced the suspension of sales and purchases of leveraged ETFs on behalf of their clients. LPL recently decided to cease purchasing funds that used more than 200% leverage.

In recent years, ETFs have been embraced by investors because of their reduced cost structure, tax efficiency, and enhanced transparency. But over the last few months, we’ve seen a backlash against leveraged ETFs arise from complaints that the funds aren’t suitable for individual investors who intend to hold them for multiple trading sessions without monitoring.

While the fact that subpoenas were sent to these institutions seems to place more pressure on issuers of leveraged ETFs, it’s really the brokerages that are under the microscope here. If advisers at these firms have been buying-and-holding leveraged ETFs, it would raise serious questions about the presence of suitability analyses for clients at these firms. While the nuances of leveraged ETFs are complex, certainly professional money managers have no excuse for their failure to understand exactly how they work and the risks associated with such products.

Given the fact that daily volumes on leveraged ETFs haven’t moved since the announcement of suspended sales, I doubt that Galvin’s inquiries are going to yield too many surprises.

Disclosure: No positions at time of writing.