SEC Announces Review of Complex ETPs
07 October 2021
On October 4, 2021, SEC Chair Gary Gensler issued a statement indicating that he has directed the SEC staff to study the risks of complex financial products that are traded on U.S. securities exchanges. These products, generally referred to as exchange traded products, or "ETPs," include leveraged and inverse leveraged funds and debt securities. In addition, he requested that the SEC staff consider potential rulemaking proposals to address those risks. Mr. Gensler's full statement can be found here.
The statement reflects the SEC's continuing interest in these products, and whether they are being purchased by investors who understand their associated risks. In making the statement, Mr. Gensler noted a variety of prior SEC activity in which the SEC has warned investors as to the potential risks of these products, and/or solicited comments from the public about ETPs. In addition, he noted that the SEC has previously sanctioned several broker-dealers and investment advisers who made improper recommendations of these instruments.1
Mr. Gensler's statement follows on the heels of a recent October 2021 determination by the SEC to approve the listing and trading of two complex ETPs, each of which consists of a fund that will invest in volatility futures.2 Accordingly, the statement appears to reflect a certain degree of discomfort about the fact that, while the SEC's rules permit a wide range of complex ETPs to be issued and listed, not all of them are appropriate for some of the investors who may invest in them, and market participants continue to develop new, and sometimes more complex, ETPs.
In a related statement issued on the same day, SEC commissioners Allison Herren Lee and Caroline Crenshaw, emphasized their view that the SEC should take steps to update the regulatory framework for complex ETNs. Their statement can be found here. In particular, these commissioners outline three key principles that they believe the SEC should follow in updating the regulatory framework:
a) Ensure strong, consistent regulatory oversight of all complex exchange-traded products
b) Take a consistent, holistic approach to the review of exchange-traded products
c) Provide heightened protections with regard to investors’ trading of complex exchange traded products
Of course, at this early stage, it is difficult to predict the precise steps that the SEC will take in connection with these initiatives. Complex ETPs consist of instruments that are regulated in some cases by the Securities Act of 1933, and in some cases by the Investment Company Act of 1940, and cover a broad range of underlying assets, from equities, to currencies to commodities. The targeted investor varies from product to product.
Pending any rulemaking activity, we anticipate that issuers and distributors of complex ETPs will continue to strive to ensure that their disclosure documents adequately communicate the relevant risk factors relating to their products. They are also likely to continue to carefully monitor their distribution channels, to help determine that their distributors are taking steps to recommend these instruments only to customers with an appropriate degree of sophistication.
Authors: Lloyd Harmetz, Partner, Margaret Sheehan, Partner
1 For example, see our article, SEC fines securities firm in connection with sales of volatility-linked ETNs .
2 See https://www.sec.gov/rules/sro/cboebzx/2021/34-93230.pdf
