Know Your Client – Leveraged ETF Version

This is obviously an absurd outlier, I highly doubt most brokers are doing shit like this – but still, it takes one’s breath away:

A former Morgan Keegan registered rep agreed to be barred permanently from the industry for putting 10 of his middle-class clients into “unsuitable” investments –- highly leveraged ETFs, regulators said.

According to FINRA, Michael Venable of Tyler, Texas, made unsuitable investments for “unsophisticated clients with conservative investment objectives and risk profiles” by putting them in Direxion ETFs, some of which short various market segments. Half of those accounts traded Direxion on margin — a fact many of the investors had not been told about. The investors ranged in age from 40 to 91, with incomes from $25,000 to $50,000.

And by the way – the Direxion ones aren’t the double long and short ETFs, they are the triples!  What the hell is wrong with this guy?  We’re using some leveraged ETFs in my practice today, but in a very controlled, tactical way.  But I’ve seen used the wrong way too.

One of the few accomplishes under my belt as a retail brokerage supervisor during 2008 and 2009 (aka the worst years of my life) was to put a new rule into place when leveraged ETFs first hit the scene.  We had a bunch of guys who were using them to take advantage of the gigantic up and down swings of that era, and the key thing for us to get our arms around was the fact that not everyone – brokers and clients – really understood the nature of them.

The daily resetting meant serious skew away from the underlying indexes the longer they were held – which meant they were suitable for short-term trading only.  And then the question became whether or not each individual account was suitable for any kind of short-term trading to begin with.

Ultimately, we forced brokers to bring us a signed letter with all of the risks of leveraged ETFs disclosed.  The broker also had to demonstrate that each client he wanted to do them with was sophisticated enough to bear the risks.  If it were up to me I would have banned them outright because my brokers were definitely not sophisticated enough, forget about the clients  – but that’s a story for another day.

God, I’m glad to be done with all that…

FINRA Bars Rep From Industry for Investments in Unusual, Leveraged ETFs (Financial Planning)