FINRA Sanctions Citi, Wells Fargo, Morgan Stanley Over ETF Sales

The Financial Industry Regulatory Authority on Tuesday sanctioned Citigroup Inc Morgan Stanley, UBS AG and Wells Fargo & Co more than $9.1 million for selling leveraged and inverse exchange-traded funds "without reasonable supervision."

The agency also said the firms sold these ETFs without "a reasonable basis for recommending the securities," according to a statement.

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. They make up only $29.3 billion of the $1.15 trillion U.S. ETF market, according to Lipper.

FINRA found that, from January 2008 through June 2009, the brokerage firms did not have the supervisory systems in place to properly monitor the sales of leveraged and inverse ETFs and failed to conduct adequate due diligence regarding the risks and features of the ETFs, according to the statement.

For example, the regulator found that, during that period, Citi did not have an adequate supervision system for its brokers, or written procedures, to ensure that sales of the ETFs complied with FINRA rules, according to a settlement.

The brokerage sold more than $7.9 million of leveraged and inverse ETFs during the 2008-2009 period.

A major problem, however, is that the ETFs were not suitable for many of its customers partly because they are not buy and hold investments. For example, a 59-year old investor with a with a conservative risk profile and net worth less than $600,000 held one of the securities for 122 days in an IRA account and lost over $4,500.

At Wells Fargo, a 65-year old conservative customer with a stated net worth under $50,000 held a non-traditional ETF for 43 days and sustained losses of over $25,000.

Citigroup was fined $2 million and ordered to pay $146,431 in restitution. Wells Fargo was fined $2.1 million and ordered to pay $641,489 in restitution. Morgan Stanley was fined $1.75 million and ordered to pay $604,584, and UBS was fined $1.5 million and ordered to pay $431,488.

The firms said they supervised these non-traditional ETFs the same way they supervised traditional ETFs, but that the general supervisory systems in place were not tailored enough to address the risks and unique features involved with these products.

"UBS is pleased to have resolved this FINRA matter. More than two years ago, UBS developed and implemented enhanced training, suitability and supervisory policies and procedures regarding leveraged, inverse, and inverse-leveraged ETFs," a spokeswoman said in a statement.

A Citi spokeswoman said the firm was pleased to have the matter resolved. Spokeswomen at Morgan Stanley and Wells did not return calls immediately. (Reporting By Jessica Toonkel; Editing by Gerald E. McCormick, Walden Siew and Andre Grenon)