SEC Sends Mixed Signals About Cutting Edge ETFs

May 24, 2017

4x Leveraged ETFs: The Problem Of Perception

The case of the 4x leveraged ETFs is another story. As regulators review their decision, consider that these 4x leverage ETFs are unique, reaching into different divisions of the SEC than most ETFs do.

The SEC proposed a rule in 2015 aimed at limiting the use of derivatives in ETFs, discouraging their use, which impacted leveraged and inverse ETFs directly. According to Reuters, the original approval of 4x leverage ETFs suggested that effort “may be essentially dead.”

The SEC’s Division of Investment Management also had put a moratorium on granting exemptive relief to allow more people to offer these types of ETFs, Senderowicz notes.

But that moratorium never applied to funds that were not ’40 Act funds. The ForceShares ETFs are not ’40Act funds. In other words, they are not subject to the Division of Investment Management.

The registration statement must be approved by the Division of Corporate Finance, and because of the nature of the ETFs, the SEC also had to have a rule change approved by the Division of Trading and Markets in order to list it.

“Most of the controversy over the leverage and inverse ETFs has dealt with ETFs that were ’40 Act funds,” Senderowicz said. “These ETFs are not.”

To end investors, the who’s who in the roster of SEC divisions may not matter, but information is always helpful. What’s going on with the 4x leveraged ETFs in this case may not imply there’s a change of heart at the SEC regarding previous rulings on use of derivatives in ’40 Act Funds, as some suggest. At least, not yet.

“If they are reviewing the order, that’s not a great sign,” Senderowicz said of the prospect for these 4x ETFs. “To the extent we know anything, they expressed interest in granting people more flexibility to offer products, but we don’t know if this one is going to be one of the ones where they show flexibility. It may be too controversial.”

Bad Press And Perception

The initial approval of the ForceShares 4x leveraged and inverse ETFs could be interpreted as the work of a more lenient SEC under a Trump administration.

But news of the approval made headlines in every major financial media outlet, and not in a flattering light. The level of risk associated with hyped-up leveraged funds was called into question.

“Bad press is bad press, and it might have overwhelmed regulators,” Bloomberg ETF Analyst Eric Balchunas said of the commission’s decision to review its original ruling.


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