SEC Charges Five Firms for Unsuitable Exchange-Traded Product Sales

The companies’ advisers told clients to hold complex short-term investments for as long as a year or more, contrary to warnings in offering documents.

The US Securities and Exchange Commission (SEC) has settled actions against three investment advisory firms and two broker/dealer (B/D) advisory firms for violations related to unsuitable sales of complex volatility-linked exchange-traded products (ETPs).

The actions, which the regulator said will lead to the return of more than $3 million to harmed investors, were filed against American Portfolios Financial Services/American Portfolios Advisors Inc., Benjamin F. Edwards & Company Inc., Royal Alliance Associates Inc., Securities America Advisors Inc., and Summit Financial Group Inc.

According to the complaints against the companies, the actions concern the sales of exchange-traded products that attempted to track short-term volatility in the market. The SEC said the offering documents for the products explicitly warned that the products were intended for a very short investment horizon, and were likely to experience a decline in value if held over a longer period. Nevertheless, the firms’ representatives recommended their clients buy and hold the products for months and even years in some instances, according to the orders.

“It is important for firms to put the appropriate protections in place to ensure complex products are properly evaluated and understood by their representatives,” Stephanie Avakian, director of the SEC’s Division of Enforcement, said in statement. “Failing to do so puts investors at risk.”

The SEC’s orders against each of the firms said they failed to implement written policies and procedures to prevent violations of the Investment Advisers Act. For example, the order against American Portfolios Advisors said the firm failed to supervise certain brokerage representatives who recommended their customers buy and hold volatility-linked products.

“APA failed to adopt and implement policies and procedures reasonably designed to prevent unsuitable recommendations of complex ETPs,” said the complaint against the firm. “APA did not have policies and procedures that would allow it to determine whether its investment adviser representatives were fulfilling their fiduciary obligation to provide only suitable investment advice.”

The complaint said American Portfolios’ compliance manual did not contain policies and procedures specific to complex products, and it didn’t provide for any review procedures concerning such recommendations or training regarding such products, despite being aware that its representatives were recommending the products to their retail clients.

The order against Benjamin Edwards said that although the offering documents for complex ETPs disclosed that they carried a higher risk of significant losses if held for extended periods, the firm’s advisers recommended that their clients hold them for several months at a time as a hedge.

“Benjamin Edwards’s brokerage and advisory representatives misunderstood the complex ETPs, or ignored these disclosures, and made unsuitable recommendations,” according to the complaint. “A number of these brokerage and advisory representatives also misled their customers and clients about the complex ETPs’ benefits and risks.”

And, according to the complaint against Summit Financial, at least 92 of the firm’s advisory client accounts held a security called the iPath S&P 500 VIX Short–Term Futures ETN for several months and, in certain instances, more than a year. As a result, all but one of them experienced “meaningful losses.”

Without admitting or denying the findings, each firm agreed to cease and desist from future violations of the charged provisions, a censure, and to pay disgorgement and prejudgment interest. American Portfolios and Benjamin Edwards each agreed to pay a civil penalty of $650,000; Securities America and Summit agreed to pay a civil penalty of $600,000 each; and Royal Alliance agreed to pay a civil penalty of $500,000.

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