Wednesday, July 20, 2011

Dishonest Sales of LEFTs by RBC Capital Markets

Secretary Galvin Charges RBC Capital Markets and Agent with Dishonest Sales of Leveraged and Inverse Leveraged Exchange Traded Funds

The Enforcement Section of the Massachusetts Securities Division of the Office of the Secretary of the Commonwealth alleges that Michael Zukowski, a registered representative of RBC Capital Markets, made “numerous unsuitable recommendations and sales” of leveraged and inverse leveraged exchange traded funds (ETFs) to clients who did not understand the risks of such ETFs. Through approximately 629 transactions, Zukowki’s 35 clients lost over $790,000 in their investments in leveraged and inverse ETFs. Furthermore, the Enforcement Section alleges that RBC Capital Markets did not provide any training for registered representatives on such ETFs at the time these were recommended and sold. RBC Capital Markets, therefore, failed to provide adequate supervision of Zukowski which led him to make such unsuitable recommendations. For more information, see the Complaint and Exhibits Leveraged ETFs leverage an index and inverse ETFs are investments that return the inverse of the return of an index. Both ETFs experienced huge growth in the past few years, from$200 million in assets under management in mid-2006 to \$32 billion in mid-2010. One key risk is that, for those who hold leveraged and inverse ETFs for longer than one or two days, long-term returns of the ETFs adversely deviate from the long-term returns of the ETFs’ benchmark index due to the daily rebalancing of portfolios. The Enforcement Section alleges that this key risk was not properly understood by, or communicated to, Zukowki’s clients.

SLCG has written a paper on leveraged and inverse leverage ETFs. In the paper, we show that many investors hold ETFs for period longer than one or two days and estimate how much such investors can lose when investing in leveraged and index ETFs.