“The securities business is overregulated and underpoliced.” Years ago, that’s how a respected securities lawyer explained to me how Wall Street works. And he wasn’t wrong.
The latest example is the Financial Industry Regulatory Authority’s regulatory notice 22-08. The rule seeks to re-regulate a broad swath of exchange-traded funds the agency has classified as “complex products.” The notice has major implications for the ETF marketplace, financial advisors and the investing public. And it’s exactly the type of bureaucracy the ETF industry and its investors don’t need.
Impacted Products
Among the products grouped together by Finra as “complex products” are defined-outcome ETFs, which offer downside protection; leveraged long and short ETFs; and cryptocurrency-linked funds. All of these products are already heavily regulated: They come with required legal disclosures. Moreover, Finra itself admits “there’s no standard definition of complex product.”
Any regulation is harmful if it limits investment choices or throws up obstacles that intimidate the retail public and restrict their investment decisions or access to products. Any move in that direction runs counter to the spirit of free capital markets. This is especially true if such moves are done under the overzealous pretense of adding more "investor protections."
Finra should not be encouraging the public to blame the financial services industry for mistakes they make or for poor outcomes. The public already has enough goading from eager plaintiff securities lawyers as it is.
Instead, the agency should push the ETF industry to allocate more resources to public education and teach investors to accept the full responsibility for their own investment decisions.
Uniform Product Labeling
If Finra wants to prioritize anything, it should be the uniform labeling of ETFs that use leverage or have inverse performance goals.
For example, all funds that use two or three times daily leverage in any direction (long or short) should be required to put their goals and the amount of leverage they use in their fund names: ETFs, for instance, that label themselves as “Ultra or Ultra Pro ETFs,” tell us nothing about their leverage point or stated goal.
Even better would be to have such funds indicate whether their targets are daily, weekly or monthly and the amount of leverage (200% or 300%) they use in an industry-wide, uniform manner. This softer but effective regulatory approach would follow what other industries have done, like the food business, where the FDA has created uniform labeling standards for food products the public buys and consumes.
For example, all funds with 200% daily long leverage would be required to have the words "2x Daily Long Leverage" in their names. Likewise, all funds with 200% daily inverse leverage would be required to use the words "2x Daily Opposite or Inverse Leverage."