U.S. SEC warns investors on leveraged exchange-traded funds

By Reuters Staff
August 18, 2009

Securities and Exchange Commission Chairwoman Mary Schapiro

By Ross Kerber
BOSTON, Aug 18 (Reuters) – Federal securities officials warned investors for the first time on Tuesday that leveraged exchange-traded funds could lead to big losses.

The warning by the U.S. Securities and Exchange Commission on leveraged ETFs follows similar statements from the financial industry and the secretary of state in Massachusetts, who is known as outspoken on securities issues.

The funds have drawn scrutiny because they can yield big losses for investors over time in choppy markets. In an alert to investors issued on Tuesday the SEC urged investors to carefully consider the details of these funds.

“It is possible you could suffer significant losses even if the long-term performance of the index showed a gain,” the SEC said.

The leveraged funds use exotic techniques such as swaps or options aiming to amplify the one-day returns of their target index.

Some “inverse” or short leveraged ETFs bet on declines in their underlying index. But in volatile markets such as those of recent months these features can quickly compound losses.

The SEC’s alert was issued jointly with the industry’s self-regulating body, the Financial Industry Regulatory Authority.

In July the agency warned brokers they should closely supervise clients’ use of the instruments. Massachusetts Secretary of State William F. Galvin has subpoenaed information from brokerage firms selling the funds.

An SEC spokesman said the agency would not discuss if it is also investigating the area. Several major brokerage houses have already suspended their sales of the instruments.

The SEC’s chair, Mary Schapiro, previously headed Finra, and Tuesday’s notice marked the second time the two organizations have issued a joint investor alert, said Finra senior vice-president John Gannon.

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