Reuters: Regulatory News: ETF controversy puts online brokers in odd spot

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ETF controversy puts online brokers in odd spot May 2nd 2012, 18:08 By Jessica Toonkel and John McCrank NEW YORK | Wed May 2, 2012 2:08pm EDT NEW YORK May 2 (Reuters) - The recent controversy over leveraged and inverse exchange-traded products has put self-directed brokerage firms, like Charles Schwab Corp , Fidelity Investments and TD Ameritrade in a awkward position. On one hand, their business proposition rests on providing products for do-it-yourself investors. But with increasing scrutiny over complex products like exchange-traded notes and leveraged and inverse exchange-traded funds (ETFs), these firms run the risk of being sued if they don't go out of their way to make sure customers know what they are buying. "All of the major discount brokerages are trying to figure this out," said Scott Burns, director of ETF research at Morningstar Inc. "The challenge is (that) they want to be the facilitator for all of investors' trades, but they are trying to figure out what their responsibilities are." Leveraged and inverse ETFs are designed to amplify short-term returns by using debt and derivatives and are considered more suitable for professional traders than for long-term retail investors or those with anything but a high-risk investment profile. Such ETFs make up just $29.3 billion of the $1.15 trillion U.S. ETF market, according to Lipper. The Financial Industry Regulatory Authority (FINRA) and other regulators began issuing warnings in 2009 about the sale of these investments worried that brokers were selling them to customers with a conservative investment profile. On Tuesday, Citigroup Inc Morgan Stanley, UBS AG and Wells Fargo & Co agreed to pay more than $9.1 million in fines and restitution for selling leveraged and inverse exchange-traded funds "without reasonable supervision," according to a FINRA statement. Meanwhile, recent swings in an exchange-traded note that makes bets on market volatility have drawn the attention of the U.S. Securities and Exchange Commission, FINRA and the Massachusetts attorney general. That focus came after the Credit Suisse-managed VelocityShares Daily 2x Short-Term ETN in April lost half its value in just two days. Some online brokerages are considering extra measures to warn investors about the risks of such products before they buy. TD Ameritrade is contemplating adding extra alerts to make certain investors understand the complexities of exchange-traded products designed for short-term traders, said Ram Subramanian, head of products. TD Ameritrade has about 5.7 million funded brokerage accounts. To educate customers, TD Ameritrade began adding Morningstar content about leveraged and inverse ETFs and other complex exchange-traded products to its website in early 2008. It has also bolstered its own information on the topics, Subramanian said. The firm is discussing making alerts more prominent, but has no plans to limit investor access to the products, he said. Discount brokerage Charles Schwab Corp already has an alert system that pops up a warning of the risks of leveraged and inverse ETFs before a customer places trades. But that alert simply says that such ETFs usually carry higher maintenance requirements and that the fund may track an index but trades like a stock on an exchange. A link that invites customers to learn more offers an overview of buying and borrowing against securities in a margin account. Schwab, which has about 8.6 million active brokerage accounts, said it is reviewing whether or not to add a warning when a customer prepares to trade an ETN. But neither TD Ameritrade nor Schwab is considering the more extensive approach Fidelity Investments already takes. The first time a Fidelity customer places an order for a leveraged or inverse ETF or an ETN, they must agree to the terms of a "designated investment agreement," which requires them to state their risk profile. Only investors who say their investment objective is "most aggressive," can trade leveraged and inverse ETFs and ETNs. Investors must also represent or agree that they are: sophisticated and experienced, can afford to lose some or all of their investment, will independently analyze the risks, and will not rely on Fidelity for advice, information, or monitoring of such investments now - or ever. Each time the investor wants to make a subsequent trade of a leveraged or inverse ETF or an ETN, they get a warning message reminding them that they signed the agreement. Leveraged and inverse ETFs also are not part of the firm's ETF Screener, which includes about 1,000 ETFs. "Generally...we have had a very robust process online to make investors aware, and ensure that they acknowledge, any risks that might exist with leveraged ETFs, or any other leveraged or inverse exchange traded product," a Fidelity spokesman said. Fidelity has about 13.7 million retail brokerage accounts. Link this Share this Digg this Email Reprints

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