Monthly Archives: November 2012

Suitability Requirements Concerning Leveraged and Inverse Exchange-Traded Funds

FINRA declares that inverse and leveraged ETFs that are reset daily typically are unsuitable for retail investors who plan to hold them longer than one trading session, particularly in volatile markets!

Particular Features of Leveraged and Inverse Exchange Traded Funds (ETFs)

1) Typically designed to achieve stated results on a daily basis, which can lead to significantly different performance from the index or benchmark over extended periods of time due to compounding;

2) Seek to deliver multiples of performance of the index or benchmark they track. Some of these ETFs are “short” or seek to deliver the inverse or opposite performance of the index or branch they track.

3) Use swaps, futures contracts and other derivatives to produce multiple rates of return.

Two Separate Parts to Suitability Analysis under NASD Rule 2310

Before recommending the purchase, sale or exchange of a security, a firm must have a reasonable basis for believing that the transaction is suitable for the customer to whom it is recommended.

A) Product Suitability;

i) Is the leveraged exchange traded fund (ETF) suitable for any customer?

ii) Does the broker dealer (BD) understand the leveraged exchange traded fund (ETF) terms and features, etc?

iii) Does the registered representative (RR) understand the leveraged exchange traded fund (ETF) features and terms, etc?

iv) For both ii) and iii) is the how the fund is designed to perform, how it achieves those objectives, the impact on performance of market volatility, the use of leverage and the appropriate holding period for the exchange traded fund (ETF)

B) Customer Suitability.

i) Is the leveraged exchange traded fund (ETF) suitable for the customer to whom it is recommended?

ii) To determine this suitability, look at the customer’s:

a) Tax status;

b) Financial status;

c) Investment objectives; and

d) risk tolerance.

Supervision under NASD Rule 3010’s requirements

● SEC and FINRA rules are followed by broker-dealers (BD) and registered representatives (RR)

● Promotional materials are fair and balanced and not inaccurate

● Broker-dealer (BD) conducts the product suitability analysis

● Registered representative (RR) conducts the client specific suitability analysis

May Law, PC is a securities and commodities boutique firm that has a an extensive knowledge of FINRA related rules and assists registered broker-dealers (BDs) and associated persons (APs) in responding to FINRA investigations, disciplinary matters and routine one the record interviews (OTRs). The firm’s website is located at www.maylawpc.net, and the main number is 847-675-1052. Andrew May has been practicing law for 17 years and can be contacted at amay@maylawpc.net.

© 2012 May Law, PC

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EXPUNGEMENT OF MATERIALS FROM THE CRD, IS FINRA RULE 2080 THE ONLY WAY?

Are we set to expunge like its 1999? Do ancient CRD entries have “regulatory value?”

A California state appellate court, in Liss v. FINRA, recently held that the earlier trial court’s earlier decision — that FINRA’s Rule 2080 was the only path to expungement of material from the CRD — was wrongfully decided.  Importantly, the information in the CRD record need not be erroneous to seek expungement. It could be still true but arguably no longer relevant due to the amount of time between the events in question and the present day.

FINRA Rule 2080 requires the person seeking expungement to include FINRA as a party to any expungement case brought in state or federal court. FINRA’s Rule 2080 requires proving two additional items. First, the fact finder – court or arbitration panel – must make an affirmative finding. Courts routinely do this but arbitrators do not. Indeed, FINRA arbitration panels will not provide an explanation unless all parties unanimously agree by certain case milestones. Second, that finding must demonstrate one of the following occurred: (i) the claim, allegation or information is factually impossible or clearly erroneous; (ii) the registered person was not involved in the alleged investment-related sales practice violation, forgery, theft, misappropriation or conversion of funds; or (iii) the claim, allegation or information is false. Those are high hurdles for FINRA arbitration where discovery is more limited, no written opinion generally need be given and often no explanation for a decision is given.

In Liss v. FINRA, registered representative Mr. Liss requested the court use its inherent equitable powers to affect the expungement.  Equitable powers essentially means invoking the Court’s conscience to obtain relief aside from an award of money. In the case of expungement, the court must weigh the hardship to the individual with the protection afforded to society by the information being in the records.

Mr. Liss, believed the following factors warranted expungement.   All complaints on his CRD record were related to only one security. Every complaint was more than fifteen (15) years old, and he has had an unblemished record since the incidents in question. Importantly, Mr. Liss filed an affidavit that he suffered professional and financial hardship due to current and potential clients using the Internet to obtain his Broker Check history.

The Liss court latched onto something mentioned in the SEC Release approving FINRA Rule 2080: whether or not continued inclusion of the allegation(s) in the CRD have “regulatory value.”  That standard has been utilized by two other federal courts.

Why is the Liss decision so important? It demonstrates that this court believes that FINRA’s requirements in Rule 2080 are not the exclusive way to get materials erased from the CRD system despite FINRA’s arguments to the contrary. While the Liss decision is helpful to those seeking expungement, the downside to court based expungement includes its expense and the lack of privacy.

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