On February 28, 2018, FINRA Enforcement entered into a settlement via Acceptance, Waiver and Consent (“AWC”) with Respondent Western International Securities, Inc. (“WIS”) (CRD# 39262). Specifically, without admitting or denying any wrongdoing — WIS consented to paying a fine of $521,908, in addition to restitution to certain investors in the amount of $125,000 — in connection with FINRA’s findings of fact that from January 2011 – November 2015, WIS allegedly failed to supervise its registered representatives with regard to sales of certain leveraged, inverse, and inverse-leveraged Exchange-Traded Funds (“Non-Traditional ETFs”).

As our firm has highlighted in a number of recent blog posts, Non-Traditional ETFs are extremely complicated and risky financial products. Non-Traditional ETFs are designed to return a multiple of an underlying benchmark or index (or both) over the course of one trading session (typically, a single day). Therefore, because of their design, Non-Traditional ETFs are not intended to be held for more than a single trading session, as enunciated by FINRA Enforcement in its recent AWC as concerns Respondent WIS:

“[t]he performance of Non-Traditional ETFs over periods of time longer than a single trading session ‘can differ significantly from the performance… of their underlying index or benchmark during the same period of time.” FINRA Regulatory Notice 09-31.

Furthermore, because of the inherent complexities and risks embedded in Non-Traditional ETFs, FINRA has explicitly advised broker-dealers and their registered representatives that Non-Traditional ETFs “[a]re typically not suitable for retail investors who plan to hold them for more than one trading session, particularly in volatile markets.” Id. [emphasis added].

Pursuant to the AWC, FINRA’s findings of fact allege that WIS registered representatives solicited and effected Non-Traditional ETF purchases that were unsuitable for specific customers. For example, in one instance, FINRA determined that a 73 year-old customer with a net worth of $200,000 and an investment objective of growth and a conservative risk profile was purportedly steered into five Non-Traditional ETFs. As alleged by FINRA, this elderly investor held the Non-Traditional ETFs for an average of 356 days, resulting in a net loss of $20,232.

In another instance of purported unsuitable recommendations, FINRA Enforcement determined that a WIS customer with a net worth of $200,000 and an investment objective of growth and a conservative risk profile was also purportedly steered into five Non-Traditional ETFs. As alleged by FINRA, this investor held the Non-Traditional ETFs for an average of 350 days, resulting in a net loss of $32,865.

Brokerage firms like WIS have a duty under NASD Rule 2310 and FINRA Rule 2111 — the so-called suitability rule — to, among other things, perform reasonable diligence to understand the nature of the recommended security. This due diligence “[w]ith respect to leveraged and inverse ETFs… means that a firm must understand the terms and features of the funds, including how they are designed to perform, how they achieve that objective, and the impact that market volatility, the ETFs use of leverage, and the customer’s intended holding period will have on their performance.” See FINRA Regulatory Notice 09-31 and FINRA Regulatory Notice 12-03.

The attorneys at Law Office of Christopher J. Gray, P.C. have significant experience in representing investors who have incurred losses in connection with various alternative investments, including leveraged and inverse ETFs, as well as various active investment strategies. Investors may contact our office at (866) 966-9598 or via email at newcases@investorlawyers.net for a no-cost, confidential consultation.

Investors who bought into Credit Suisse’s Velocity Shares Daily Inverse VIX Short Term Exchange-Traded Note (“XIV”) on the recommendation of their broker or financial advisor may be able to recover their losses in FINRA arbitration. As we discussed in several recent blog posts, inverse volatility-linked investments are designed to return a profit when the market experiences periods of calmness, or low volatility. However, unlike more traditional investments and strategies such as a buy-and-hold stock portfolio, investing in volatility-linked products is extremely complex and risky, and therefore, not likely a suitable strategy for the average, retail investor.

By design, Credit Suisse’s XIV was structured to provide investors with the opposite return of the CBOE Volatility Index (the “VIX”), or the so-called ‘fear-index’, and was thus essentially a bet that the market would remain calm. Earlier this month — as the market’s prior 12-month rally gave way to a sharp rise in volatility and an approximate 8% loss in the S&P 500 index, this inverse or short volatility trade proved to be an absolute train wreck.

As stocks returned all the year’s gains in trading on Monday, February 5, the VIX skyrocketed to 37 by close of trading, an increase of 95%. Unsurprisingly, many inverse volatility-linked investment vehicles sustained massive losses. Among the hardest hit ETNs was Credit Suisse’s XIV, which plunged approximately 90% in value. In light of XIV’s losses, Credit Suisse recently announced that the last day of trading for VelocityShares Daily Inverse VIX Short-Term Exchange-Traded Note will be Tuesday, February 20, 2018. Credit Suisse has elected to trigger an accelerated liquidation of XIV because the product could no longer perform as it was designed.

Many retail investors in XIV — as well as other hard-hit inverse volatility positions including ProShares Short VIX Short-Term Futures ETF (which collapsed in value by approximately 97%) — sustained massive losses. Of concern, these investors may well not have understood, or been informed by their financial advisor, of the extreme risk associated with investing in such complex and exotic investment products. At a minimum, investors who are steered into inverse volatility-linked products as XIV should be fully informed of the following characteristics and risk components of such investments:

• XIV TRADING – XIV trades like a stock, and can be bought, sold, or sold short during market hours, including pre-market and after-market time periods;
• NATURE OF INVESTMENT – unlike a stock, however, XIV does not give an investor a share of a corporation or business enterprise. There are no sales, no profits, no quarterly reports, and no prospect of ever receiving dividend income;
• XIV VALUE – while XIV’s value is set by the market, it’s value is tied to the inverse of an index that manages a hypothetical portfolio of the two nearest-to-expiration VIX futures contracts;
• RISK ASSOCIATED WITH FUTURES – because there is no way to invest directly in the VIX, investors are left to invest in products tied to highly risky and complex futures contracts and options on futures. On a daily basis, investors in volatility-linked products such as XIV were subject to the daily roll of VIX futures contracts — at market close, a portion of the shorter-term contracts were sold, and longer-term contracts were purchased in their place. Because futures contracts have a finite lifespan and regularly expire, over time volatility-linked ETFs and ETNs may encounter substantial difficulties in tracking an index’s performance;
• COMPOUNDING RISK – investment vehicles such as XIV are designed to be held for a single trading day, as compounding risk can otherwise significantly impact the performance of the investment. During periods of higher than normal volatility, compounding will cause results to vary from the underlying benchmark or index, with the effect being more pronounced as volatility increases.

The attorneys at Law Office of Christopher J. Gray, P.C. have significant experience in representing investors who have sustained losses due to the negligence or misconduct of stockbrokers or investment advisors. Investors may contact a securities arbitration lawyer at Law Office of Christopher J. Gray, P.C. at (866) 966-9598 or newcases@investorlawyers.net for a no-cost, confidential consultation.

Investors who have lost money on the recommendation of their broker or financial advisor to invest in volatility related financial products may be able to recover their losses in FINRA arbitration. As we discussed in a recent blog post, inverse volatility-linked investments are designed to return a profit when the market experiences periods of low volatility. Unlike more traditional investments and corresponding strategies such as a buy-and-hold stock portfolio, investing in volatility-linked products is likely not a suitable strategy for the average, retail investor. In fact, when volatility-linked ETFs first began rolling out in early 2011, Michael L. Sapir, Chairman and CEO of ProShare Capital Management, stated that “The intended audience for these ETFs are sophisticated investors.”

Put simply, investing in a volatility-linked product is a very risky enterprise that is likely only suitable for professional investors seeking to trade on a short-term basis (e.g., several hours or day trading). Further, because the VIX or so-called ‘fear index’ is not actually tradeable, investors who wish to invest in the VIX must trade derivatives instead (including volatility-linked ETFs and ETNs). And when it comes to investing in derivatives, such as future contracts and options on futures, the majority of retail investors do not fully understand the extreme volatility and risk associated with these complex investment products.

Earlier this month, equity indices declined sharply following a steady rally in the prior 12 months that saw the benchmark S&P 500 stock index gain nearly 20%. It was during this year-long market rally that many retail investors were lured into investing in inverse volatility-linked products, essentially seeking to capture even bigger gains, provided that there was no price correction. However, the idea of shorting volatility, or betting on calm stock market conditions, is a strategy best suited for sophisticated, institutional investors.

Because of the complexity of volatility-linked products, including the fact that they are not designed to be purchased and held in the same manner as long-term investments in common stock, or mutual funds, these products are unsuitable for the average, retail investor. Such unsuitable volatility-linked investment products include the following:

ProShares Short VIX Short-Term Futures (SVXY)

ProShares Ultra VIX Short-Term Futures (UVXY)

ProShares VIX Short-Term Futures (VIXY)

VelocityShares Daily 2X VIX Short-Term (TVIX)

VelocityShares Daily Inverse VIX Short-Term ETN (XIV)

iPath S&P 500 VIX Short-Term Futures ETN (VXX)

Nomura Next Notes S&P 500 VIX Short-Term Futures Inverse

Daily Excess Return Index ETN

The attorneys at Law Office of Christopher J. Gray, P.C. have significant experience in representing investors who have sustained losses due to the negligence or misconduct of stockbrokers and financial advisors. In particular, the firm has represented investors in cases involving non-traditional, or exotic investment products, including managed futures and leveraged and/or inverse ETFs. Investors may contact a securities arbitration lawyer at Law Office of Christopher J. Gray, P.C. at (866) 966-9598 or newcases@investorlawyers.net for a no-cost, confidential consultation.

According to the claim, the woman was sold non-traded REITs and other alternative investments by Jonathan Pyne, a broker for Berthel Fisher. The claim argues that her age and low risk tolerance made the investments unsuitable for her. The investments included:

• Inland American Real Estate Trust
• Wells REIT
• Cornerstone Core Properties REIT
• Gulf Coast Rig & Equipment
• REEF Oil & Gas Income and Development
• Leaf Equipment Leasing Income Fund III

Securities arbitration lawyers say that these investments are illiquid and, in many cases, may have been negligently misrepresented. In this woman’s case and possibly many others, the investments also allegedly represented a concentration level of her liquid net worth that was too large to be suitable.

Firms have an obligation to properly supervise their brokers and fully disclose all the risks of a given investment when making recommendations, and those recommendations must be suitable for the individual investor receiving the recommendation given their age, investment objectives and risk tolerance.

Non-traded REITs are attractive to investors because they carry a relatively high dividend or interest. According to investment fraud lawyers, however, these investments are inherently risky and illiquid, which limits access of funds to investors and makes them unsuitable for many individuals with conservative risk tolerances and those who need easy access to funds, especially when over-concentrated. Leveraged and inverse ETFs are designed to meet daily objectives, and “reset” each day. As a result, the performance of these investments can diverge from the performance of the underlying benchmark or index very quickly, and the problem is exasperated in volatile markets, making these investments unsuitable for many investors as well.

If you were sold unsuitable alternative investments from a Berthel Fisher broker, including non-traded REITs, inverse and leveraged ETFs and/or Oil & Gas Partnerships, you may be able to recover your losses through a securities arbitration claim. To find out more about your legal rights and options, contact a securities arbitration lawyer at Law Office of Christopher J. Gray, P.C. at (866) 966-9598 or newcases@investorlawyers.net for a no-cost, confidential consultation.