Articles Posted in Exchange Traded Funds

The U.S. Securities and Exchange Commission is barring Nicholas Rowe, the former owner of registered investment advisor Focus Capital Wealth Management, from the industry. The charges come in the wake of parallel proceedings in New Hampshire where state regulators barred him from being licensed as an investment adviser. The New Hampshire Bureau of Securities Regulation also said he had to pay $20K.

Rowe and his RIA are accused of using inverse and leveraged exchange-traded funds in a way that was not suitable for clients. They also purportedly made misrepresentations regarding the fees that the clients would be charged.

Focus Capital had been registered with the SEC until 2012 when it registered with New Hampshire instead. The state launched a probe into the RIA’s investment practices, which allegedly included placing the assets of older investors into unsuitable strategies without notifying them that was what was happening. A number of elderly clients, including three widows, allegedly lost close to $1.M.

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The Securities and Exchange Commission says that Virtus Investment Advisers will pay $16.5M to resolve charges accusing the investment management firm of misleading mutual fund investors and others using ads with false historical performance information about exchange-traded fund portfolio strategy AlphaSector. According to the regulator, the firm publicized a performance track record that it got from F-Squared that was substantially overstated. Virtus had hired F-Squared as a mutual fund subadvisor as well as a subadvisor for those that followed AlphaSector.

The SEC, following its probe, said that Virtus falsely stated in SEC filings, client presentations, marketing collateral, and other communications that the AlphaSector’s strategy had a performance history going as far back as 2001 and had for a number years outperformed the S & P 500 Index. The investment management firm is accused of accepting F-Squared’s misrepresentations as fact while disregarding the red flags that raised doubts about these statements.

Six years ago Virtus recommended that shareholders of specific mutual funds and the boards of trustees approve a modification in strategy and management to AlphaSector and F-Squared. This recommendation was made because of the false historical data on AlphaSector.

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A Financial Industry Regulatory Authority panel has awarded The Elliot Family Trust DTD, Eugene Elliot, Genraza LLC, and Shawn Elliot Over $1M in their securities arbitration case against J.P. Morgan Securities (JPM).

The claimants are contending fraud, breach of fiduciary duty, misrepresentation and omissions, failure to control and supervise, and violations of federal and state securities laws related to the alleged short trading of US Treasury securities and the unsuitable purchase and allocation of securities, including leveraged exchange-traded funds and unspecified options. They had initially sought compensatory damages no lower than $1.75M, rescission of the purportedly unsuitable investments, punitive damages, legal fees, and other costs. Meantime, the financial firm sought to have their case dismissed.

Following the pleadings, the FINRA arbitration panel decided that the respondent is liable for and must pay claimants over $1.145M in compensatory damages, interest on that amount, and over $43,000 in other fees.
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SEC to Propose Reforms to Improve Liquidity Management for Open-End Funds
The Securities and Exchange Commission voted to propose a package of rule reforms to improve effective liquidity risk management for open-end funds, including exchange-traded funds and mutual funds. If approved, both would have to put into place liquidity risk management programs and improve disclosure about liquidity and redemption practices. The hope is that investors will be more able to redeem shares and get assets back in a timely fashion.

The liquidity risk management program of a fund would have to include a number of elements, including classification of the fund portfolio assets liquidity according to how much time an asset could be converted to cash without affecting the market, the review, management, and evaluation of the liquidity risk of a fund, the set up of a fund’s liquidity asset minimum over three days, as well as board review and approval. The proposal also seeks to codify the 15% limit on illiquid assets that are found in SEC guidelines.

Commission Looks for Comment on Regulation S-X
The SEC announced last month that it is looking for public comment regarding the financial disclosure requirements in Regulation S-X and their effectiveness. The comments are to focus on form requirements and the content contained in financial disclosure that companies have to submit to the regulator about affiliated entities, businesses acquired, and issuers and guarantors of guaranteed securities.

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In the last five years, artificially low interest rates have resulted in yield hungry investors being drawn to investments such as iShares Mortgage Real Estate Capped ETF, an exchange-traded fund that trades under the symbol REM. Since 2010, this ETF has gathered over $1 Billion in assets, in part because of its 14% dividend.

Unlike older and more traditional REIT ETFs, REM does not own companies that possess properties. Instead, the exchange-traded fund puts its money in financial firms that borrow at short-term rates and buy long-term mortgage securities while making a profit from the difference and passing that over as income. All this creates the 14% yield.

Unfortunately, with the increased likelihood of a Fed rate hike, the yield curve has started to become flat, reducing the spread that creates the 14% yield for REM. Also, short-term rates have started going up faster than long-term ones. The result has been that REM’s price has started to drop. And, if the central bank were to initiate a rate hike, that 14% yield and REM’s performance could end up in even more trouble. Bloomberg says that already REM has been down 5% since the Memorial Day weekend.

According to Shepherd Smith Edwards and Kantas Partner and Securities Fraud Attorney Sam Edwards, “Funds like REM seem very attractive to investors, especially when rates are so low. The risk of a fund like REM is far greater than traditional REIT investments and will suffer greatly in a rising interest rate environment. The vast majority of investors in funds such as this do not comprehend the risk of such a complicated strategy and find out too late they were taking more risk than was appropriate.”
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Pacific Investment Management Co. said that the SEC has sent it a Wells notice indicating that its staff is recommending that the regulator file a civil case against the financial firm over the way securities were marked in its PimcoTotal Return Active Exchange-Traded Fund. That’s the ETF version of Pimco’s Total Return Fund.

The Wells notice is related to the valuation of smaller positions in mortgage-backed securities that the government did not guarantee for several months in 2012, as well as disclosure regarding performance and procedures and policies related to compliance. Bloomberg reports that according to someone that knows bout the investigation, The regulator has been looking at whether the total return ETF bought small lots of bonds at a discount price and marked them up when valuing holdings to artificially inflate returns.

Although the ETF has continued to see deposits, the Total Return mutual fund experienced redemptions, especially after the departure of founder Bill Gross last year. News of his exit came within days of the news that the SEC was probing whether Pimco had inflated ETF returns.

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A Financial Industry Regulatory Authority panel arbitration panel says that Morgan Stanley (MS) must pay at least $2.4M to settle the latest client claims accusing its former broker, Steven Mark Wyatt, of mishandling their investments. The brokerage firm fired Wyatt in 2012.

According to a group of doctors and their loved ones, Wyatt, who was their broker, made unauthorized and excessive trades in the stock market that cost them during and after the 2008 financial crisis. Wyatt bought thinly-traded stocks for the investors and placed speculative bets on exchange-traded funds and other securities in their portfolios.

This is the latest batch of claims against Wyatt, Morgan Stanley, and managers at the Mississippi branch where he worked. The claimants believe that Morgan Stanley failed to detect warning signs of Wyatt’s purported wrongdoing. Other employees named in this securities case are adviser Hilary Zimmerman, currently a Morgan Stanley senior vice president, and branch manager Fred Eugene Brister III. The claimants contend that Brister failed to properly supervise Zimmerman and Wyatt. They say that their accounts were mismanaged and suspect trading occurred.

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Exchange-traded fund manager F-Squared Investments Inc. has filed for bankruptcy. The firm wants the U.S. Bankruptcy Court for the District of Delaware to allow it to sell its intellectual property, including its investment strategies and contracts to manage money, to Broadmeadow Capital, a Chicago-based money manager.

It was in December that F-Squared agreed to pay investors $35 million to settle Securities and Exchange Commission charges alleging that the firm misled investors about the performance of its Alpha Sector investment strategy. The regulator said that the ETF fund manager falsely marketed the strategy as having a successful track record that was based on actual performance.

Instead, contends the SEC, the data was from a hypothetical performance for a past period that was generated from backtesting. Also, a performance calculation error caused results to be inflated by 350%.

Advisers were attracted to this inflated performance record and F-Squared’s contention that its strategy could get around tough market shifts by engaging in opportunistic trading in and out of multiple industrial-sector ETFs. In seven years, the firm went from being practically a nonentity to having a $28.5 billion strategy as of last year.

F-Squared became the largest marketer of index products using ETFs. By the end of the year that ended in March 2015, however, the firm experienced a close to $8 billion asset decline. It reduced its workforce by 25%.
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A client of Wells Fargo Advisors (WFC) is looking to recover at least $100,000 in damages for losses he sustained from investing with F-Squared Investments Inc. The arbitration case comes six months after F-Squared consented to pay $35 million to resolve Securities and Exchange Commission charges accusing the asset manager of making false claims about its flagship investment product’s performance. The 68-year-old widower’s claim will test whether investors can pursue broker-dealers for selling F-Squared products.

The claimant, a moderately conservative investor who was looking for moderately conservative growth for his retirement account assets, began working with a Wells Fargo financial adviser in 2011. The brokerage firm made F-Squared managed-accounts available to advisors in 2013.

According to InvestmentNews, The investor’s advisor put about $900K of the client’s money-most of his savings, says his attorney-in products managed by two ETF strategists. Over 50% of the money went into F-Squared’s AlphaSector Allocator Select. Meantime, the investor said it paid Wells Fargo about $19,000 in fees for recommending the products. He believes that the firm had a conflict when it recommended investments because they came with such high commissions. Also, the fees erased potential capital gains for the claimant.
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Kara Stein, an SEC commissioner, is calling on the Securities and Exchange Commission to examine whether exchange-traded funds and alternative funds are managing to get around certain rules and placing investors at risk. Stein said that both types of funds, which use high-risk complex investment strategies or place their money in illiquid assets, frequently “operate in a gray area” when it comes to regulation.

During a speech at the Brookings Institution, the SEC Commissioner noted that alternative mutual funds, which act like hedge funds and are often called liquid alts, don’t have to abide by the Investment Company Act of 1940 rules regarding leverage and liquidity. Stein said that the promise of benefits like those that come with investing in hedge funds along with liquidity of more traditional mutual funds are part of why alternative mutual funds appeal to investors. However, alternative mutual funds don’t necessarily provide the protections that accompany their more traditional counterparts.

Now, Stein is suggesting that the SEC propose rules regarding liquidity and the use of derivatives in alternative mutual funds. She said that the industry and regulators should ensure that retail investors continue to receive protections.

Earlier this month, the SEC announced that it is open for feedback from the public to help determine how to best review the listing and trading of unusual, new, or complex exchange-traded products. Because investment strategies of ETPs have expanded in recent years, there has been a growth in the amount of new ETPs and kinds of complexities. Meantime, individual and institutional investors continue to seek out these types of products.

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