SEC Once Again Late To The ETF Party

August 15, 2012

The SEC's toothless bulletin does little to address the real issues.

 

The SEC released a bulletin on Monday detailing the risks of leveraged and inverse funds. Too bad it was about five years too late.

For reasons unknown to anyone but the commission, the SEC’s Office of Investor Education and Advocacy decided to publish a bulletin aimed at educating investors about ETFs, which includes a warning of the perils of leveraged and inverse ETFs. While the sentiment behind the bulletin is commendable, the timing is bizarre.

First of all, the SEC and FINRA published an investor alert three years ago nearly to the date.

That alert covered the same issues relating to inverse and leveraged funds that are in the latest bulletin: Inverse and leveraged funds are risky because most rebalance daily. That means that long-term investors will see much different returns than they may expect, and such funds typically come with outsized fees.

But what on earth would compel the SEC to essentially republish this warning three years later without any meaningful changes to the language or regulations? Beats me.

Then again, this is just the latest example of the SEC’s impotence in providing credible regulation of an industry in desperate need of it. If being behind the curve were an Olympic event, the SEC would clean house, dominating the medal tally in the same way U.S. women did in London.

Back in 2008, when the credit crisis was unfolding, many investors turned to leveraged and inverse ETFs—many of which were still relatively new at the time—in order to protect themselves or profit from the unraveling of the housing bubble.

The problem was, there was still a huge educational gap with these products. Investors expected one, two or three times the exposure—or its inverse—to a real estate index, for example, only to find out their actual returns differed greatly.

Instead of getting ahead of this problem, realizing these products should only be used by sophisticated investors and implementing regulations to ensure the suitability of these products, the SEC stood idly by and watched as people lost millions in this new corner of the ETF market.

As with any market failure, people looked to point fingers, and in this case it meant big, class-action-type lawsuits against the issuers of these funds and firms providing access to them.

It wasn’t until August 2009 that the SEC and FINRA decided to step in with its “investor alert.”

It’s not as if the SEC didn’t have ample time to raise these same concerns earlier. After all, many of the still quite popular ProShares funds launched in June of 2006.

Never mind the long gestation period of filing and launching the funds.

 

 

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