Kalos Capital, Inc. and Darren Kubiak Sanctioned for Alleged Sales of Leveraged Inverse Exchange Traded FundsSaturday, September 28, 2019
According to a FINRA Acceptance, Waiver, and Consent agreement, between August 2011 and January 2015, Darren Kubiak recommended the purchase of Leveraged and Inverse Exchange Traded Funds (LIETFs) to 17 customers without having a sufficient understanding of the risks and features associated with the LIETFs and thereby failing to have a reasonable basis to make these recommendations. Kubiak allegedly recommended these customers purchase a total of 19 LIETFs, which the customers then held for an average of 722 days. According to FINRA, Kalos failed to reasonably supervise Kubiak, the Firm’s sole registered representative who sold LIETFs to customers, by failing to ensure that Kubiak had a reasonable basis to recommend LIETFs.
Leveraged and Inverse ETFs LIETFs are considered non-traditional ETFs because they seek to deliver returns that are multiples of the performance of the index or benchmark they track. Some non-traditional ETFs are “inverse” or “short” funds, meaning that they seek to deliver the opposite of the performance of the index or benchmark they track. Some funds are both inverse and leveraged, meaning that they seek to achieve a return that is a multiple of the inverse performance of the underlying index or benchmark. To accomplish their objectives, LIETFs use swaps, futures contracts and other derivative instruments. Non-traditional ETFs are highly complex financial instruments that typically “reset” daily, meaning they are designed to achieve their stated objectives only on a daily basis. Due to the effects of compounding, their performance over longer periods can differ significantly from their stated daily objective. Therefore, non-traditional ETFs that reset daily typically are unsuitable for retail investors who plan to hold them for longer than one trading session.
With respect to non-traditional ETFs, it is particularly important that registered representatives understand the terms and features of the funds, including how they are designed to perform, how they achieve that objective and the impact that market volatility, the ETF’s use of leverage, and the customer’s intended holding period will have on their performance.
According to FINRA, Kubiak recommended 19 LIETF purchases in 17 customer accounts. All of these transactions were solicited. The customers held these positions for periods ranging from 294 days to, in one case, almost six years. The average holding period was 722 days. These extended holding periods caused Kubiak’s customers to incur approximately $98,000 in losses. FINRA thus alleges Kubiak failed to perform a reasonable basis suitability analysis of LIETFs to understand the unique features and specific risks associated with these products before offering the products to his customers. Specifically, he planned for the customers to hold the LIETF shares for a few weeks, even though that was contrary to the published guidance for products. According to FINRA, Kubiak moreover did not understand that LIETFs are generally expected to lose value over time and that losses are compounded because of how the LIETFs’ valuations are reset each day.
According to FINRA, from August 2011 until April 2015, Kalos failed to establish and maintain a supervisory system reasonably designed to ensure that sales of LIETFs complied with applicable securities laws and regulations and NASD and FINRA rules. Kalos did not have supervisory procedures reasonably tailored to address the unique features and risks associated with LIETFs. Additionally, FINRA alleges Kalos did not provide formal training to representatives before permitting them to sell the product to retail customers and did not have procedures to monitor LIETFs for potentially unsuitable holding periods.
As a result, FINRA imposed sanctions against Kalos including censure, a $30,000 fine, and restitution in the amount of $86,614 plus interest and against Kubiak including a $5,000 fine and a three-month suspension from associating with any FINRA member firm in all capacities.
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