Three investment advisory firms and two dually registered broker-dealer and advisory firms settled SEC charges related to improper sales of volatility-linked exchange-traded products.

According to the SEC Orders, representatives of the five firms recommended that clients buy and hold certain volatility-linked exchange-traded products despite the fact that the offering documents made it clear that the products were intended for short-term holding. The SEC found that the firms failed to implement adequate policies and procedures concerning suitability and volatility-linked exchange-traded products. The SEC further found that the two dually registered broker-dealer firms failed to supervise certain brokerage and investment advisory representatives who recommended that clients buy complex exchange-traded products and hold them for extended periods of time.

As set out in all five Orders, the firms violated Section 206(4) of the Investment Advisers Act ("IAA") and IAA Rule 206(4)-7 ("Compliance Procedures and Practices"), both of which require the firms to maintain written compliance policies. Additionally, as set out in the two Orders for the dually-registered firms (see here and here), the SEC found that the firms violated Section 15(b)(4)(E) of the Exchange Act for failing to reasonably supervise their respective registered representatives in an effort to prevent violations of Sections 17(a)(2) and 17(a)(3) of the Securities Act.

To settle charges, each firm agreed to pay civil money penalties: two Orders for the dually-registered firms set the penalty at $650,000 (see here and here), two Orders, at $600,000 (see here and here), and one Order, at $500,000 (see here). Additionally, each firm agreed to (i) a censure, (ii) pay disgorgement and prejudgment interest, and (iii) cease and desist from future violations.

Commentary

These cases stand out as the first cases generated by the SEC Enforcement Division's Exchange-Traded Products Initiative. The initiative is being led by the Division's Complex Financial Products Unit and uses data analytics to identify potential unsuitable sales and related violations. While the SEC has brought similar cases in the past for selling unsuitable exchange-traded funds to retail clients, the packaging of these cases together and the announcement of the new initiative makes it clear that the SEC will remain focused on the sale of exchange-traded products and that there will be more of these kinds of cases in the near future.

Primary Sources

  1. SEC Press Release: SEC Charges Investment Advisory Firms and Broker-Dealers in Connection with Sales of Complex Exchange-Traded Products
  2. SEC Order: American Portfolios Financial Services, Inc. and American Portfolios Advisors, Inc.
  3. SEC Order: Benjamin F. Edwards & Company, Inc.
  4. SEC Order: Summit Financial Group, Inc.
  5. SEC Order: Securities America Advisors, Inc.
  6. SEC Order: Royal Alliance Associates, Inc.

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