By Suzanne Barlyn
Dec 3 (Reuters) - An investment adviser must pay a total of
$1.8 million to a group of investors in a securities arbitration
ruling that lawyers say is among the first to involve losses
tied to leveraged and inverse exchange-traded funds.
Nicholas Rowe and his firm, Focus Capital Wealth Management
Inc of Bedford, New Hampshire, were found liable in a case
alleging negligence, civil fraud, and other misdeeds, involving
the sale of risky ETFs to nine investors, according to a ruling
by a Financial Industry Regulatory Authority arbitration panel.
Some of the investors were in their fifties and sixties,
including two widows.
Leveraged and inverse ETFs are designed to amplify
short-term returns by using debt and derivatives and are
considered more suitable for professional traders than for
long-term retail investors or anyone who cannot tolerate a
high-risk portfolio. Only a handful of cases involving the
securities are pending, say arbitration lawyers. But that figure
is likely to grow, say lawyers, as investors dabble in such ETFs
to attain higher yields in a low-interest environment. Many
investors do not understand the magnitude of the risks, lawyers
Leveraged and inverse ETFs make up just $27 billion of the
$1.29 trillion U.S. ETF market, according to Lipper, a mutual
fund information company owned by Thomson Reuters. In 2009,
FINRA and other regulators began issuing warnings about the sale
of leveraged and inverse ETFs because they worried that
securities brokers were selling them to buy-and-hold investors -
a strategy likely to cause heavy losses.
FINRA arbitration may be the last hope for some investors
whose advisers guided them to leveraged and inverse ETFs and
then mismanaged the investments. In September, a New York judge
dismissed a class-action lawsuit by exchange-traded fund
investors who claimed that the funds' adviser and distributor
did not fully disclose risks associated with investing in the
ETFs. The case stemmed from 44 leveraged and inverse ETFs
managed by ProShares Advisors LLC.
Of the $1.8 million award in the Focus case, the investors,
collectively, received $1.29 million for damages and about
$500,000 for legal fees, interest and costs, according to the
ruling issued Nov. 27. The investors originally asked for $9
million from several parties and it is unclear from the ruling
how much of that was directly attributable to their losses.
Aside from the final rulings, documents involved with FINRA
arbitration proceedings are not made public.
A lawyer for the investors was not available for comment.
Rowe, principal owner of Focus, did not return calls requesting
Investors in the Rowe case were all heavily concentrated in
leveraged and inverse ETFs, according to Craig McCann, a
Fairfax, Virginia-based expert witness who testified on the
investors' behalf. Rowe increased the investors' risk by buying
and holding the ETFs for as long as a few months, McCann said.
That strategy is nearly guaranteed to lead to losses, since the
investments effectively require betting on whether the market is
going up or down, McCann said.
"The rule of thumb is that if you plan on holding these
funds any longer than a day, then they are not going to do what
you think," said Ben Johnson, director of ETF research at
Rowe and Focus, which managed $23.9 million in assets at the
end of 2011, according to regulatory filings, are also the
subjects of a civil enforcement proceeding by the New Hampshire
Bureau of Securities Regulation. The Bureau has been trying to
revoke the licenses for Rowe and Focus since August, a process
that can take months. The Bureau received complaints from some
of Rowe's customers about heavy losses caused by trading in the
leveraged and inverse ETFs, New Hampshire regulators said.
Separately, a New Hampshire court last week issued a
temporary order prohibiting Rowe and Focus from conducting
business, other than to transfer or liquidate accounts,
according to Jeff Spill, deputy director of the New Hampshire
(Additional reporting by Jessica Toonkel)
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