FINRA Warns of Risks Associated with Investing in ETFs and Other ETPs

It is telling that a recent article about exchange-traded funds (ETFs) and other exchange-traded products (ETPs) on the Financial Industry Regulatory Authority’s (FINRA) website is accompanied by a picture of a rollercoaster. As FINRA notes, while ETFs and other ETPs have surged in popularity in recent years, “[e]asy as it is to trade ETPs, risks vary for each product, with some types of ETPs exposing investors to both complexity and significant danger of losses.”

Indeed, ETFs and other ETPs can be very risky for retail investors. These investments can present a variety of different risks, and if investors do not fully understand these risks, they can invest with virtually no hope of a successful outcome unless they simply get lucky. Fraud is a significant concern in the ETP markets as well, with misleading disclosures, omissions and outright scams leaving investors with substantial losses in many cases.

Understanding the Risks Associated with ETFs and Other ETPs

Exchange-traded products are a type of investment vehicle that, in theory, provides diversification while also benchmarking against relatively reliable market indicators such as the price of gold or the S&P 500. They are traded on exchanges similar to stocks, and they are regulated by the U.S. Securities and Exchange Commission (SEC), U.S. Commodities and Futures Trading Commission (CFTC) and other federal authorities.

However, they also carry several inherent risks. While, as FINRA notes, the risks vary with each individual type of ETP, overall the risks associated with these products make them ill-suited to casual retail investors. Making informed decisions about ETPs requires a clear understanding of how these products operate, the various market forces involved, and all of the other factors that can impact an ETP’s value over the short or long term.

Then, there is the risk of fraud.

While ETPs are regulated similarly to securities and other investment products, also similar to other investment products, ETPs present various risks for fraud. Despite oversight from the SEC, CFTC and other authorities, firms and companies that promote ETPs often fall short of meeting their obligations—whether inadvertently or intentionally. In both scenarios, disclosure violations and other issues amount to investment fraud, and defrauded investors will need to take legal action to recover their losses in many cases. This is true for all types of ETPs, including:

• Exchange-Traded Funds (ETFs) – ETFs are “pooled investment opportunities that typically include baskets of stocks, bonds and other assets grouped based on specified fund objectives.”
• Exchange-Traded Notes (ETNs) – ETNs are similar to ETFs in structure; however, instead of holding assets, they hold “debt securities issued by a bank or other financial institution, similar to corporate bonds.”
• Commodity Pools – Similar to ETFs and ETNs, commodity pools combine investor contributions in order to diversity. However, instead of investing in stocks, bonds or debt securities, they invest in commodity futures and option contracts.
• Leveraged ETPs – Leveraged ETPs increase both investors’ upside potential and investors’ risk exposure. As their leverage “resets” on a daily basis, they require active management and are not suitable as long-term investments.
• Inverse ETPs – Inverse ETPs operate similarly to leveraged ETPs; however, instead of tracking the positive returns of an index or other benchmark, they focus on tracking the opposite of a benchmark’s returns.

Due to their complexity and risks, ETPs are not suitable investments for most individual investors. Yet, many investors find themselves targeted with advertisements or faced with recommendations from their brokers or advisors. As a result, many people invest in ETPs without understanding how these investment products work, and they end up losing their principal while others profit at their expense.

Volatility-Linked ETPs: A Particularly High-Risk “Opportunity” for Investors

Among all of the various types of ETPs, one of the riskiest investment options for retail investors is the volatility-linked ETP. Volatility-linked ETPs seek to profit not from the overall movement of a price against a benchmark but rather from short-term price swings—or, in some cases, anticipated price swings in the future. As FINRA explains:

“A variety of volatility-linked ETPs exist. The most basic offers long exposure to the Cboe Volatility Index (VIX). The VIX is not based on actual price fluctuations experienced on a given day (or over some other timeframe) but instead reflects an expectation of stock market volatility over the next 30 days as implied by S&P 500 Index options prices.

“Crucially, the VIX itself is not investible. You’d generally obtain exposure to volatility using VIX futures or other derivatives. . . . While VIX futures prices are generally highly correlated with movements in the VIX, they don’t track it precisely, and their degree of correlation can depend on the maturity date. The price ‘sensitivity’ of VIX futures to the underlying VIX may be quite a bit less than you might expect, and this sensitivity generally gets weaker the farther out the futures go.”

As a retail investor, there is nothing stopping you from investing in ETPs. In fact, today it is easier than ever. But, while ETPs expand the options you have available, they present a high degree of risk—including both market risk and the risk of fraud. If you receive an unsolicited advertisement for an ETP, you should be very cautious about investing, and, if your broker or advisor recommends an ETP, you should not invest unless you are confident that you understand the risks involved.

What if You Suffer Fraudulent ETP Investment Losses?

If you invest in ETPs on your own and suffer losses despite having access to complete information, you may have little choice but to accept your losses and move on. However, if you received incomplete, false or misleading information, you may have a claim for investment fraud. In this scenario, recovering your losses may involve pursuing securities litigation or FINRA arbitration, and in either case, your first step will be to engage an experienced lawyer who can identify any and all claims you have available.

Speak with a Lawyer About Your ETP Investment Losses

Do you have questions about pursuing a claim for ETP investment fraud? If so, we invite you to contact us for more information. To request a free and confidential consultation with an experienced lawyer at Zamansky LLC, please call 212-742-1414 or send us a message online today.