Regulator fines broker-dealer for recommending leveraged ETPs

The US Financial Industry Regulatory Authority hit two Stifel broker-dealer divisions with $2.3mn in fines and restitution over unsuitable recommendations on leveraged exchange traded products.

The Stifel broker-dealers failed to implement policies that would limit recommendations of leveraged and inverse ETPs and ETFs to only be held briefly, according to a settlement published last week.

Instead, such products were held too long, costing 381 customers $1.3mn in total. The entities were also fined an additional $1mn in total.

Spokespersons for Stifel and Finra declined to comment.

This article was previously published by Ignites, a title owned by the FT Group.

In January 2014, Stifel Nicolaus and Stifel Independent Advisors, both St. Louis-based broker-dealer divisions of Stifel, settled with Finra for just over $1mn for failing to establish suitability policies for recommending non-traditional ETFs.

Between June 2014 and March 2018, the same two Stifel divisions implemented new policies, but they were not “reasonably designed to achieve compliance with their suitability obligations in connection with transactions” of leveraged and inverse ETPs and ETFs, the order stated.

Leveraged and inverse ETPs are designed to be held for just short periods of time, such as a single day or month, Finra warned in 2009.

“Stifel failed to take reasonable steps to detect and address hundreds of potentially unsuitable recommendations that customers buy and hold [non-traditional ETPs] for longer periods of time than they were designed to be held, resulting in realised losses for customers,” the order stated.

Stifel’s written supervisory procedures, required from the January 2014 settlement, did not require supervisors to align recommended exit or hold strategies aligned with a product such as a leveraged or inverse ETF or ETP.

Such written policies said supervisors “could consider” and discuss “the recommendation and the ‘intended exit strategy’ with the representative”, the order noted.

But they did not require these steps to be taken, “or any other steps”, and supervisors were not given any guidance on how to implement the steps, the order added.

Stifel also did not reasonably design ways to identify unsuitable recommendations of leveraged or inverse ETPs and ETFs, Finra found.

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The firm implemented an alert that would notify when such products were held more than 30 days, but the firms “almost immediately deactivated this alert after it resulted in over 2,000 hits per day”.

Stifel reactivated the alert in March 2015, but the firm failed to provide supervisors “with any training on how to evaluate the red flags”, the order found, resulting in clearing of alerts without any suitability analyses.

In August 2016, Stifel brokers’ compliance departments discovered that the products were being recommended beyond their intended holding period, the order stated.

The compliance teams ordered a resulting “clean-up” effort that was insufficient, however, because supervisors were merely encouraged, not required, to speak with representatives and customers about the issue.

This led to 381 customer accounts’ receiving unsuitable recommendations to hold these products beyond their intended use, the order stated.

Affected customers included an 87-year-old who purchased a non-traditional ETP and held it for 454 days, resulting in $5,000 in losses, as well as a 77-year-old customer who purchased a “daily reset” non-traditional ETP and held it for more than a year, resulting in about $13,000 in losses.

Stifel Nicolaus was fined $920,000 and was ordered to return $1.2mn in assets to customers plus interest, while SIA was fined $80,000 and ordered to return $100,000 to customers plus interest. Finra set the interest rates at those set out in the tax code between March 2018 and March 2020.

Non-traditional ETFs, which have taken off since the Securities and Exchange Commission finalised its 2019 ETF rule, have been scrutinised and criticised by regulators.

Last May, the SEC ordered a small North Dakota-based adviser to pay out $1 million for investing client assets in leveraged ETFs. In July 2021, the SEC fined UBS Financial Services, now owned by Credit Suisse, $8mn for holding short-term, volatility-linked ETPs for customers longer than designed.

The SEC should require brokers to provide additional warnings and disclosures about certain non-traditional ETFs and ETPs at the point of sale, the SEC Investor Advisory Committee recommended last June. The advisory committee also recommended single-stock ETFs, which have exposure to only one security that is often leveraged or inverse, be renamed because they do not have the diversified qualities of other ETFs or ETPs.

The SEC should not impose additional disclosure burdens, much less ban any leveraged ETPs or ETFs, Dalia Blass, former director of the SEC’s Division of Investment Management, told Ignites.

Industry participants seeking to launch non-traditional ETPs and ETFs, including single-stock ETFs, should scrutinise their disclosures in their filings, Ryan Charles, a principal at Kelley Hunt & Charles, told Ignites last June.

*Ignites is a news service published by FT Specialist for professionals working in the asset management industry. Trials and subscriptions are available at ignites.com.