Over the past six months, leveraged and inverse Exchange Traded Funds (ETFs) have become an increasingly popular target for securities class action law suits. As we noted in our August 24, 2009 post, Regulators Warn Investors About Leveraged and Inverse ETFs, both the SEC and FINRA are concerned that retail investors may not fully understand the performance objectives of leveraged and inverse ETFs, that they trade throughout the day like a stock, use exotic financial instruments, and promise the potential to provide greater than market returns as the value of the underlying assets rise or fall. Given their volatility, the SEC and FINRA warn that these funds typically are not suitable for most retail investors.
Since August, a rash of new class action suits have been filed alleging, among other things, that the defendants (the funds, the funds’ investment advisers or managers, the funds’ distributors, and the funds’ trustees or directors) failed to disclose to investors the true scope and nature of the risks associated with the investments. As we discussed in our August 24, 2009 post, Regulators Warn Investors About Leveraged and Inverse ETFs:
the primary risk [of these investment vehicles] is that leveraged and inverse ETFs “are designed to achieve their stated objectives on a daily basis. Their performance over longer periods of time — over weeks or months or years — can differ significantly from the performance (or inverse of the performance) of their underlying index or benchmark during the same period of time. This effect can be magnified in volatile markets.”
For the most part, the suits filed against leveraged and inverse ETFs recently allege that the funds did not disclose the magnified risk of loss if investors held their shares over time, and the extent to which returns would diverge from the chosen benchmark over time.
The most recent and significant ETF suits have been filed against:
- ProShares Trust UltraShort Real Estate ProShares Fund, August 5, 2009 S.D.N.Y.
- ProShares UltraShort Financials Fund,August 20, 2009 S.D.N.Y.
- ProShares Ultrashort MSCI Emerging Market Funds, September 2, 2009 D.Md.
- Direxion Shares Daily Financial Bear 3X Shares, September 19, 2009 S.D.N.Y.
- ProShares UltraShort Oil and Gas Fund, September 30, 2009 S.D.N.Y.
- ProShares Ultra Short Dow 30 Fund, October 1, 2009 S.D.N.Y.
- ProShares Ultra Financials Fund, 10/12/09 S.D.N.Y.
- ProShares UltraShort S&P 500 Fund, October 30, 2009 S.D.N.Y.
- ProShares Double Leveraged Funds (UltraShort FTSE/Xinhua Funds; UltraShort S&P 500 Funds; UltraShort DJ UBS Crude Oil), October 30, 2009 S.D.N.Y.
- ProShares Ultra Oil and Gas Fund, November 4, 2009 S.D.N.Y.
- ProShares UltraShort Basic Materials Fund, December 3, 2009 S.D.N..Y.
- ProShares Ultra QQQ Fund, December 7, 2009 S.D.N.Y.
As all of these cases are similar, if not identical, it is possible that they may be combined at some point. It is also possible that, given the uniformity of the claims, the SEC may act to tighten disclosure and other rules regulations for these more exotic ETF products to address some of their concerns.