New York Securities Fraud Lawyers Blog
Wall Street is constantly crafting complex and volatile products that somehow end up in the investment accounts on Main Street. The latest turbulence in the stock markets has already been in part attributed to one of the latest Wall Street machinations: exchange-traded-products (ETPs) linked to volatile exchanges – specifically, products linked to the Chicago Board Options Exchange (CBOE) Volatile Index (VIX). Today alone, the Dow Jones Industrial Average closed more than 1000 points down from yesterday, and due to the volatility that is still ongoing, the devastating fallout is largely unrealized and has left investors scrambling.
Since its inception in 1993, the VIX was one of the earlier attempts to create an index that broadly measured volatility in the market. One such ETP linked to the VIX is Credit Suisse’s VelocityShares Daily Inverse VIX Short-Term ETN (ticker symbol XIV), which the issuer just announced it will be shutting down after losing most of its value earlier this week. Products that may be at similar risk include Proshares SVXY, VelocityShares ZIV, iPATH XXV, and REX VolMaxx VMIN. But the risks associated with these ETPs have been well known to professionals in the securities industry, and investors who were recommended these products should have received a complete and balanced disclosure of these risks at the time of purchase.
In October of 2017, the Financial Industry Regulatory Authority (FINRA) ordered Wells Fargo to pay $3.4 million in restitution to investors relating to unsuitable recommendations of volatility-linked ETPs. FINRA also published a warning to other firms in Regulatory Notice 17-32 regarding sales practice obligations, stating that “many volatility-linked ETPs are highly likely to lose value over time” and “may be unsuitable to retail investors, particularly those who plan to use them as traditional buy-and-hold investments.” This was not the first warning from the regulator.
In 2012, FINRA called for heightened supervision by brokerage firms regarding complex investment products in Regulatory Notice 12-03. The agency specifically called for more oversight related to investment products tied to the VIX, and in its notice to member firms, stated that such investments “may not be well understood by many investors” and that some of these products carry inverse or leveraged risk exposure.
ETPs are complex products, and by design, they are not unlike other structured and risky products with derivatives, such as reverse convertibles. In a way, the Wall Street issuers of ETPs are taking bets with retail investors who purchase these products, not unlike the way a Casino offers a game to its patrons. Investors, however, should be wary of the widely-held wisdom that “the house always wins.”
The issuers of ETPs typically create an enhanced risk exposure through complex derivatives. Derivatives, as the name suggests, derives value for the investment away from the product, such as from the performance of another asset it is linked to – i.e., any security or index. A derivative can have a very simple link to an underlying asset, or, much more likely in the case of ETPs, can be linked with complex math formulas that can obscure the true risks of the product and can make it hard for the ordinary investor to comprehend. In ETPs, the value of the products can be linked to an established index like the S&P 500, but also more volatile indices like the VIX.
The appeal of volatility-linked ETPs is that they typically pay higher yields than bonds or other more straightforward index/exchange traded funds. Unbeknownst to many investors, structured products like ETPs also tend to pay higher commissions to the brokers and firms who push these products. Investors can be further swayed to buy these products if the investment professional rationalizes that the product adds a hedge or measure of diversification to a portfolio. But at the investment adviser’s mere mention of higher yields, it is difficult to put the cat back in the bag. ETPs thus have the potential to lure unwary investors away from their moderate and conservative investment objectives, with the potential to cause sudden and substantial losses to a retirement portfolio. Indeed, in boilerplate fashion, the prospectuses for these products generally warn that investors can lose their entire investment, and inevitably, that may be what has happened just this past week.
If your financial adviser led you to believe that ETPs provided safety for your portfolio and you have experienced losses in your account, contact the attorneys at Malecki Law for a free consultation. We have experience in recovering investment losses for investors and retirees. Our typical contingency fee arrangement ensures that we do not get paid unless we recover your investment losses first.