Suit Slapped on Leveraged ETF Provider
A lawsuit has been filed against the creators of ProShares UltraShort Real Estate in what is the latest chapter in the war against leveraged ETFs. ProShares, creator of some of the first “ultralong” and “ultrashort” funds, is now facing a complaint filed by New York-based law firm Labaton Sucharow LLP in the U.S. District Court for the Southern District of New York.
The lawsuit claims that “as marketed by ProShares, Ultra ETFs are designed to go up when markets go up; UltraShort ETFs are designed to go up when markets go down.” Anyone who has been following funds like Direxion Shares Daily 3X Financial Bull and Direxion Shares Daily 3X Financial Bear(FAZ) or SRS for that matter, can claim that this statement does not always hold true.
According to Morningstar, in a one-year period ending July 23, the Dow Jones U.S. Real Estate Index dropped 38%, but the ProShares UltraShort Real Estate fund lost 82%. Year-to-date through July 23, SRS’ index is down 3.5%, but the ETF has fallen 67%.
Direxion faced a similar challenge with FAS and FAZ as the funds dropped nearly 70% and 90% respectively from inception through July. The low pricepoints and high volume prodded Direxion to execute a reverse split in both funds to defray transactional costs. Needless to say, both the bull and the bear strategy had moved in the same direction: down.
ProShares Advisors has issued a statement vehemently denying the claims. The rebuttal states: “The allegations reported in the complaint are wholly without merit. ProShares’ registration statements have always been accurate and complete, contained all material information, and complied with all legal requirements. We plan to defend against this suit vigorously.”
In the crusade against leveraged funds, everyone from the Massachusetts Attorney General to FINRA and brokerage firms like UBS and Wells Fargo are questioning the sales practices of leveraged-fund companies like ProShares, Direxion and Rydex. The issuers have responded to the encroaching regulation by beefing up disclosure on their Web sites and in their ads.
Where does advertising stop and responsibility begin? Investors should understand the risks involved in buying an ETF, which means probing beyond the surface. Issuers should not try to package a wolf in sheep’s clothing.
As I have stated before, regulation should focus on separating out traditional and non-traditional ETFs. ETFs are broadly known for their transparency, low-cost structure and accessibility. As more complex strategies hit the marketplace — and they inevitably will — they should be characterized as such.
ETFs that passively track the S&P 500 should not sit side-by-side with triple-down commodities funds on any Web site or in any ad. Equivocating the two vastly different strategies in any capacity is a dangerous disservice to investors. Both issuers and investors want to take advantage of the unique structure of ETFs, but they should do so responsibly.
