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.
While the SEC’s inability to properly regulate inverse and leveraged ETFs during that period would never make a SportsCenter-type highlight reel of SEC scandals from that period—collateralized debt obligations, or CDOs and credit default swaps (CDSs) have to take first place there—but the lack of oversight on leveraged and inverse funds is just another example of the body’s inability to stay ahead of the curve.
And here we are, more than six years after some of these products have launched, and nearly 20 years after the launch of the first ETF and the SEC has finally decided to send out an educational bulletin that reads like a mailer sent by your local Lion’s Club chapter advertising an upcoming pancake breakfast.
What is perhaps most ironic about the timing of the SEC bulletin is just how out of touch it is with the reality of the inverse and leveraged ETF market.
While none of the laundry list of lawsuits aimed at recouping losses from the improper disclosure on inverse and leveraged prospectuses have to-date been settled, those legal actions have done a much better job than has the SEC in scaring issuers and advisors into guiding unsophisticated investors away from these products.
And even more ironically, inverse and leveraged ETFs have never been more popular. There is currently more than $30 billion in assets invested in leveraged and inverse ETFs, but there is currently no source that allows us to break those assets down by investor type.
Anecdotally, however, it’s high-net-worth and institutional investors who are using these products, not some unknowing investors without any knowledge of the perils of daily rebalances, compounding and volatility.
It is this fact that makes the latest bulletin feel so hollow.
If naive individual investors are no longer buying these funds, and the shortcomings of prospectus language have been largely addressed by the issuers, what impact is this bulletin going to have?
It feels as if the SEC finally cleared its backlog of regulatory issues that required their attention, came upon the leveraged and inverse risks, and asked some low-level intern to type up a memo on the subject. That will get them off our backs!
Well, this toothless bulletin does little to address the concerns facing any of the remaining unknowing investors who may still have access to these funds through their discount brokerage.
Without creating real ETF “gates” as my colleague Dave Nadig made the case for back in March, the SEC is just spinning its wheels, and seemingly covering its tracks without offering any new insight on the problem.
If the SEC were serious about preventing the types of losses experienced back in 2008 that rightfully opened up the discussion of tighter regulations on inverse and leveraged funds nearly half a decade ago, it would have outlined real solutions, and not just regurgitated its three-year-old warnings.