Morgan Stanley Smith Barney, the retail brokerage arm of the American multinational corporation, has agreed to pay an $8m penalty and admit wrongdoing to settle charges related to its selling of single inverse ETF investments to advisory clients.
Morgan Stanley Smith Barney has agreed to pay an $8m penalty and admit wrongdoing to settle charges related to its selling of single inverse ETF investments to advisory clients.
In the US, ETFs are typically registered unit investment trusts (UITs) or open-end investment companies whose shares represent an interest in a portfolio of securities that track an underlying benchmark or index. Inverse ETFs seek to deliver the opposite of the performance of the index or benchmark they track, profiting from short positions in derivatives in a falling market.
Inverse ETFs have certain risks not found in traditional ETFs due to a daily reset of the fund’s underlying position. Investors in inverse ETFs are subjected to the risk that the performance of their investment could differ significantly from the performance of the underlying index when held for longer periods of time, particularly in volatile markets.
The US Securities and Exchange Commission’s order found that Morgan Stanley did not adequately implement its policies and procedures to ensure that clients understood the risks involved with purchasing inverse ETFs.
Among the order’s findings, Morgan Stanley failed to obtain from several hundred clients a signed client disclosure notice, which stated that single inverse ETFs were typically unsuitable for investors planning to hold them longer than one trading session unless used as part of a trading or hedging strategy.
Morgan Stanley solicited clients to purchase single inverse ETFs in retirement and other accounts, the securities were held long-term, and many of the clients experienced losses.
The SEC’s order further found that Morgan Stanley failed to follow through on another key policy and procedure requiring a supervisor to conduct risk reviews to evaluate the suitability of inverse ETFs for each advisory client.
Among other compliance failures, Morgan Stanley did not monitor the single-inverse ETF positions on an ongoing basis and did not ensure that certain financial advisers completed single inverse ETF training.
“Morgan Stanley recommended securities with unique risks and failed to follow its policies and procedures to ensure they were suitable for all clients,” said Antonia Chion, Associate Director of the SEC Enforcement Division.