The Financial Industry Regulatory Authority, Inc. ("FINRA") has been quite clear on its views of "non-traditional exchange traded products," such as leveraged inverse exchange-traded notes ("ETNs") and exchange-traded funds ("ETFs"). Because these products have features such as inverse leverage and daily resets, FINRA views these products as unsuitable for retail investors who plan to hold them for more than one trading session, particularly in volatile markets.1 Consequently, when member firms or their personnel fail to heed this advice, such as when selling these products to retail investors, allowing those investors to hold these in their accounts for extended periods of time and failing to supervise, or failing to enforce written supervisory procedures intended to prohibit such sales, FINRA has taken action. In a recent trio of cases, similar sets of facts brought FINRA enforcement proceedings. The salient points of one pair of related cases were these:

  • Member firms failed to establish, maintain and enforce a supervisory system reasonably designed for the review of transactions in non-traditional ETFs;
  • Supervisory procedures were written, but not enforced;
  • Representatives were not trained regarding the risks of non-traditional ETFs;
  • No written materials were created to provide guidance to representatives on determining suitability of recommendations of non-traditional ETFs;
  • No exception reports or other procedures were in place for reviewing the holding periods of non-traditional ETFs.2

These facts were exacerbated by the firms' telling their FINRA examiners that they were implementing corrective actions, but not actually doing so. In both cases, customers held the non-traditional ETFs for extended periods of time, in some case up to two years. Consequently, both firms violated FINRA Rule 3110, which requires broker-dealers to establish and maintain a supervisory system, including written supervisory procedures, reasonably designed to achieve compliance with applicable securities laws, regulations and rules. The firms also violated FINRA Rule 2010, which requires a member, in the conduct of its business, to observe high standards of commercial honor and just and equitable principles of trade.

In a similar case involving sales of non-traditional ETFs and ETNs, and violations of the same FINRA rules, the member firm failed to ensure the suitability of recommendations to its customers of such products or to ensure that customer files contained letters or e-mails memorializing discussions of the relevant risks and volatility of the ETFs and ETNs with the customers before they invested in those products.3

In a separate case, a registered representative communicated with customers and conducted securities business through text messaging, in violation of the member firm's written procedures. These actions violated FINRA rules requiring a member firm to review and retain public communications and making and preserving books and records, as required by FINRA Rule 2210(b).4

Originally published in REVERSEInquiries Volume 2, Issue 5.

Footnotes

1. See FINRA Regulatory Notice 09-31, "Non-Traditional ETFs" (June 2009).

2. See Parkland Securities, LLC, case no. 2016052300601 and Sigma Financial Corporation, case no. 2016052300602.

3. See Corinthian Partners, LLC, case no. 2016047621801.

4. See Farrukh S. Kazmi, Order Accepting Offer of Settlement (Mar. 22, 2019).

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