SEC Files Civil Charges Against Five Firms Involving Complex “VIX-Related” Exchange-Traded Products
On November 13, 2020, the Securities and Exchange Commission (SEC) announced certain settled actions against three investment advisory firms and two dually registered firms related to the sales of complex and risky exchange-traded products (ETPs). The SEC alleged that the firms allowed investment advisers and brokers, who purportedly did not understand the products sold, to recommend for the long term certain volatility-linked ETPs designed to be held, in some cases, for a single trading session. These recommendations caused significant investment losses from January 2016 to April 2020 across 744 customer accounts. Pursuant to the settlements, the firms agreed, among other things, to return more than $3 million to the affected customers.
The actions follow a new SEC Division of Enforcement program tracking analytical data about ETP sales. In the cases at hand, the SEC charged Holbrook, NY-based American Portfolios Financial Services, Inc./American Portfolios Advisors, Inc., St. Louis, MO-based Benjamin F. Edwards & Company, Inc., Jersey-City, NJ-based Royal Alliance Associates, Inc., La Vista, NB-based Securities America Advisors, Inc., and Boca Raton, FL-based Summit Financial Group, Inc. with allowing certain of the firms’ investment advisers and/or brokers to make unsuitable recommendations to customers to buy and hold complex ETPs for extended periods of time, without having a reasonable basis to do so. The complex ETPs primarily included the iPath S&P 500 VIX Short-Term Futures ETN (BATS: VXX), and the ProShares VIX Short-Term Futures ETF (NYSE: VIXY).
VXX and VIXY are volatility-linked securities that offer exposure to futures contracts of specified maturities on the Chicago Board Options Exchange volatility index (CBOE: VIX). As alleged by the SEC, the advisers and brokers erroneously marketed these products to their clients as a hedge against market decline, either misunderstanding or ignoring certain warnings in the products’ offering documents about long-term holding periods. Because of how these complex ETPs are designed to sell front-month VIX futures contracts and then buy more expensive second-month contracts, there is a risk that holding such products for longer than a single trading session can lead to considerable losses for investors. As we have previously discussed, the Financial Industry Regulatory Authority (FINRA), charged by the SEC with overseeing broker-dealers and their affiliated members, has offered cautionary guidance as to the sale of ETPs by brokers, especially when “the performance of such products may be linked to unfamiliar indices or reference benchmarks, making them difficult for the average investor to comprehend.”
As alleged by the SEC in the settled actions, the investment advisers and brokers were required to, among other things, make suitable recommendations to their clients in light of their financial circumstances and objectives, exercise a high degree of care, ensure that their clients received adequate and accurate information about the investment products, and have an adequate basis in fact for the recommendations. As further alleged by the SEC, the firms’ failures to adequately supervise their employees rose to the level of violating applicable securities laws and firm policies and procedures.
Shortly following the conclusion of the settled actions, the SEC stated that it is “critically important for registered investment advisers and broker-dealers to implement robust and effective policies and procedures reasonably designed to prevent violations of the federal securities laws, which included ensuring that their financial professionals understand the risks and purposes of the products they advise on and/or recommend to firm clients and customers.” Furthermore, the SEC cautioned firms to “consider which products are complex, suitable only for sophisticated investors, not suitable for investors who plan to hold them for longer than one-trading session or not suitable for longer-term investment.”
The attorneys at Giarrusso Law Group LLC have extensive experience with complex investments such as esoteric exchange traded products linked to futures contracts and options on futures. Investors may pursue a claim to recover losses through securities arbitration before FINRA, or in some instances, through litigation. Investors who wish to discuss a possible claim are invited to contact us at (201) 771-1115 or info@gialawgroup.com for a no-cost, confidential consultation.