SEC Official Warns Leveraged Funds Could Hurt Reputation of ETFs

(Bloomberg) -- Investment products that use derivatives to improve returns are threatening the reputation of the $3.6 trillion market for exchange-traded funds, according to one of five commissioners at the U.S. Securities and Exchange Commission.

“The risk with levered ETFs is that the entire asset class will be painted with this brush,” said Robert Jackson Jr., adding that he fears Americans will buy and hold these products in their retirement accounts, and then get a nasty surprise when they lose their money. Jackson spoke at an event organized by Bloomberg LP and the CFA Society of New York on Friday.

Exchange-traded products that use leverage account for just 1 percent of the exchange-traded market. They’ve faced greater scrutiny since February, when soaring volatility prompted one note to close and caused an ETF to lose 90 percent of its value. The SEC’s Fixed Income Market Structure Advisory Committee recently proposed new terminology to differentiate these funds and notes from other types of ETPs.

The proposals make a lot of sense, but they may not be a complete solution, Jackson said. He was one of two commissioners who earlier this year demanded that more be done to address geared, or leveraged, ETFs as officials debate whether to ease the path to market for straight-forward funds via the so-called ETF rule.

“I want to be sure we address it before we give the industry what they want in the ETF space,” Jackson said.

The commissioner, who holds one of the Democratic party seats on the SEC, also reiterated his opposition to companies that have two classes of publicly traded shares. However, he said it’s up to the exchanges, rather than indexers or fund issuers, to encourage these firms to move toward equal voting rights.

The Council of Institutional Investors, with the backing of money managers including BlackRock Inc. and T. Rowe Price Group Inc., recently petitioned the New York Stock Exchange and Nasdaq Inc. to eliminate dual-class listings with a seven-year sunset clause.

“I hope they’ll take seriously their role in corporate governance,” Jackson said of the venues. “To the degree our exchanges want to be treated as, and understood as, self-regulatory organizations entitled to special treatment under our securities laws, they should regulate.”

To contact the reporter on this story: Rachel Evans in New York at revans43@bloomberg.net

To contact the editors responsible for this story: Jeremy Herron at jherron8@bloomberg.net, Eric J. Weiner, Dave Liedtka

©2018 Bloomberg L.P.