A recent spike in stock market volatility has brought into focus the enormous risks associated with certain exchange-traded-products (ETPs) linked to the Chicago Board Options Exchange (CBOE) Volatility Index (VIX). However, these products have previously been the subject of several warnings by the Financial Industry Regulatory Authority (FINRA).

Created in 1993, the VIX attempts to track broadly measured volatility in the market. VIX is an index, not a security, but certain ETPs have attempted to allow investors to track the performance of the VIX index. One such ETP is Credit Suisse’s VelocityShares Daily Inverse VIX Short-Term ETN (ticker symbol XIV), which the issuer shuttered earlier this month after investors experienced unexpectedly large losses during a spike in the VIX. Other ETP products that may pose similar risks include Proshares SVXY, VelocityShares ZIV, iPATH XXV, and REX VolMaxx VMIN.

ETPs have previously come under scrutiny by FINRA. In October of 2017, FINRA ordered Wells Fargo to pay $3.4 million in restitution to investors relating to unsuitable recommendations of volatility-linked ETPs. FINRA also has published Regulatory Notice 17-32, regarding sales practice obligations, which cautions brokerage firms that many volatility-linked ETPs are highly likely to lose value over time and may be unsuitable to retail investors, particularly those who plan to use them as traditional buy-and-hold investments. Previously, in 2012, FINRA called for heightened supervision by brokerage firms regarding complex investment products in Regulatory Notice 12-03, specifically warning of the risks posed by investment products tied to the VIX.

Certain ETPs are structured to provide investors with returns that are positive when the VIX falls, and negative when the VIX rises, and investors in these products essentially are taking the view that the market will remain relatively steady. However, earlier this month stock market volatility and the VIX rose rapidly as the stock market whipsawed erratically.

ETFs that lost value during this market turmoil include the following:

VelocityShares Daily 2X VIX Short-Term ETN (TVIX)

ProShares Short VIX Short-Term Futures (SVXY)

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

VelocityShares Daily Inverse VIX Short-Term ETN (XIV)

ProShares Ultra VIX Short-Term Futures (UVXY)

ProShares VIX Short-Term Futures (VIXY)

The attorneys at Law Office of Christopher J. Gray, P.C. have significant experience in representing investors who have sustained losses due to unsuitable recommendations of high-risk financial products by 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 bought into inverse volatility-linked exchange traded funds (ETFs) on the recommendation of their broker or financial advisor may be able to recover their losses in FINRA arbitration. 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.

Certain inverse ETFs are structured to provide investors with returns that are positive when the CBOE Volatility Index (the “VIX”) falls, and negative when the VIX rises, and investors in these products essentially are taking the view that the market will remain relatively steady. However, earlier this month stock market volatility and the VIX rose rapidly as the stock market whipsawed erratically.

ETFs that lost value during this market turmoil include the following:

VelocityShares Daily 2X VIX Short-Term ETN (TVIX)

ProShares Short VIX Short-Term Futures (SVXY)

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

VelocityShares Daily Inverse VIX Short-Term ETN (XIV)

ProShares Ultra VIX Short-Term Futures (UVXY)

ProShares VIX Short-Term Futures (VIXY)

Last year, FINRA reminded member firms of the dangers of selling such volatile products to ordinary investors. However, according to Bloomberg, these products have rapidly grown in popularity, and as much as $8 billion of financial products may have been tied to the VIX index alone.

Some investors with losses in these complex financial products may not have understood, or been informed by their financial advisor, of the extreme risk associated with investing in inverse ETFs. At a minimum, investors who are steered into inverse volatility-linked products as XIV should be fully informed of the characteristics and risk components of such investments. Furthermore, under FINRA Rule 2111, the so-called suitability rule, stockbrokers and investment advisors must have a reasonable basis for any investment recommendations that they make to a customer.

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.

Recently, the Financial Industry Regulatory Authority (“FINRA”) ordered Wells Fargo & Co. to pay a $3.4 million fine in connection with sales practice issues related to recommendations of volatility-linked exchange-traded funds (“ETFs”) and volatility-linked exchange-traded notes (“ETNs”) to customers. Specifically, FINRA determined that between July 2010 and May 2012, some Wells Fargo brokers affiliated with the company’s wealth management business recommended that their customers purchase volatility-linked exchange-traded funds (“ETFs”) and volatility-linked exchange-traded notes (“ETNs”) “without fully understanding their risks and features.” In addition, FINRA indicated that Wells Fargo lacked the appropriate supervisory procedures and safeguards to facilitate sales of the volatility-linked investment products.

By their very nature, volatility-linked investments are designed to return a profit when the market experience choppiness (or volatility) and are not intended for ordinary investors. In fact, when volatility-linked ETFs began rolling out to retail investors in early 2011, Michael L. Sapir, Chairman and CEO of ProShare Capital Management, stated that “The intended audience for these ETFs are sophisticated investors.”

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). Furthermore, 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)- products that are beyond the understanding of ordinary retail investors.

As addressed in a March 2016 Barron’s article by Chris Dieterich – The Fear Gauge: Investors Should Avoid VIX ETFs – the stock market’s short-term roller-coaster ups and down have increased interest in exchange-traded products linked to the CBOE Volatility Index, or VIX. Dietrich asserts that these products, “… offer the chance to catch lightning in a bottle but, like all hedging tools, are virtually guaranteed to lose money longer term.” Dietrich goes on to describe how these VIX-related ETFs and ETNs are essentially “souped-up versions of short-selling bear-market funds, which ‘hedge’ stock holdings by rising when the major stock benchmarks sink.”

Aside from the risks associated with investing in derivatives, volatility-linked ETFs and ETNs also face certain structural limitations, including the fact that the funds are not directly tied to the VIX itself. These products are linked to the futures market, and because futures contracts have a finite lifespan and regularly expire, the ETFs and ETNs may face additional difficulties in tracking the index’s performance.

The attorneys at Law Office of Christopher J. Gray, P.C. have considerable experience in representing investors who have sustained losses in non-traditional, or exotic investment products, including managed futures, structured notes, and non-traditional ETFs. Investor facing losses due to an investment in a volatility-linked fund or note may contact our office at (866) 966-9598 or newcases@investorlawyers.net for a no-cost, confidential consultation.