Massachusetts reportedly has begun an investigation concerning whether Wells Fargo Advisors engaged in unsuitable recommendations, inappropriate referrals, and other actions related to its sales of certain investment products to customers. Recently, Wells Fargo disclosed that it is evaluating whether its personnel and registered representatives may have made inappropriate recommendations and referrals concerning 401(K) rollovers and alternative investments.

Massachusetts Secretary of the Commonwealth William Galvin said the state would examine Wells Fargo’s own internal probe and wants to ensure that any Massachusetts investors who were impacted by “unsuitable recommendations” would be “made whole.” He noted that while moving investors toward wealth management accounts brings “more revenues to firms,” these accounts are “not suitable for all investors.”

Industry observers say that major stock brokerage firms have increasingly steered customers to accounts with recurring management fees based on a percentage of assets under management, rather than transaction-based commissions. As Barron’s magazine reports, referring clients to managed accounts tends to earn fee-based advisors significantly more over the long term.

The Barron’s article goes on to note that Galvin is looking into the use of managed accounts related to the US Department of Labor’s Fiduciary Rule, which includes best practices standards for the protection of consumers. However, that rule was recently overturned by a federal appeals court, calling into question its continued vitality.

Galvin is reportedly not the only regulator scrutinizing Wells Fargo over possible inappropriate sales recommendations. Bloomberg reports that according to a source, the SEC is also investigating the firm’s Wealth Management unit although. the investigation has not been made public.

Suitability of investment recommendations is governed by FINRA Rule 2111. See 75 Fed. Reg. 71479 (Nov. 23, 2010) (Order Approving Proposed Rule Change, File No. SR-FINRA-2010-039). Rule 2111 went into effect as of July 9, 2012, and represents a codification of former National Association of Securities Dealers (“NASD”) Rule 2310 and former New York Stock Exchange (“NYSE”) Rule 405, as well as regulatory guidance interpreting both rules. Rule 2111 mandates that a broker-dealer or associated person “have a reasonable basis to believe that a recommended transaction or investment strategy involving a security or securities is suitable for the customer, based on the information obtained through the reasonable diligence of the [firm] or associated person… .” This rule would prohibit a recommendation for a customer to move to a management-fee based account if that recommendation lacked a reasonable basis.

Attorneys at Law Office of Christopher J. Gray, P.C. have represented investors in a number of cases involving unsuitable investments and investment strategies and alleged broker and financial advisor misconduct. Investors may contact a securities arbitration attorney by telephone at (866) 966-9598, or by e-mail at 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.