Articles Posted in Enforcement

Last week, the Financial Industry Regulatory Authority (FINRA) issued a Letter of Acceptance Waiver and Consent (AWC) censuring Merrill Lynch and ordering $7.2 million in restitution to investor clients. Merrill had already reimbursed the clients as a result of an internal review and had self-reported the underlying violations to FINRA, a move that earned praise from FINRA in the AWC.

At issue was the failure to honor rights of reinstatement in connection with mutual fund purchases. Mutual fund companies usually offer various rights to their shareholders, as set forth in a fund’s prospectus or the fund’s statement of additional information. Some funds grant shareholders a right of reinstatement, which allows investors to buy fund shares without incurring a front-end charge if the investor previously sold shares of any fund within the same family. Usually, this involves A-shares, but it could apply to different classes of shares, depending on the fund company. Similarly, a right of reinstatement usually allows the investor to recoup any previously charged contingent deferred sales charge relating to the sale of a fund within the family. Rights of reinstatement typically specify that the new purchases must occur within 30 to 90 days of the prior sale, but the period could be as up to one year later, depending on the fund and the particular situation. Continue reading ›

Last month Wells Fargo Advisors Financial Network LLC agreed to settle administrative charges brought by the SEC, and will pay a $35 million civil penalty in order to resolve the matter. According to the allegations, Wells Fargo failed to supervise investment adviser representatives who recommended inverse exchange-traded funds to their customers, leading to investor losses.

Inverse ETFs allow investors to short the entire market or a sub-market, depending on the ETF involved. However, because they usually “re-set” every day, inverse ETFs are not designed to be held for longer than a single trading day. Instead, they are designed to be used by traders to implement risk hedges on an intra-day basis. If they are held on a long-term basis, they will not necessarily perform consistently with the long-term direction of the market being shorted. This is especially true in volatile markets.

These risks are often described in detail in the product prospectuses but are not often explained sufficiently by financial advisers. In fact, advisers who are not specifically trained on the products often do not understand their unique characteristics. For example, a single-inverse ETF based on a particular index will usually lose money even if the index performance remains flat. In fact, even if the index falls the ETF can lose money.

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