Our nation’s financial system nearly collapsed in 2008 when Bear Stearns and Lehman Brothers failed, Merrill Lynch nearly failed, and other financial institutions such as Citibank, J.P. Morgan Chase, and AIG needed billions of dollars of government bailouts. One cause was the banks’ reckless use of leverage. Accompanying that leverage was the banks’ creation of and investment in various complex and opaque structured investment products. It often was impossible to determine what the products held. Now, the SEC apparently is considering whether to allow investment management firms to offer non-transparent, actively managed exchange-traded funds (“ETFs”). We are baffled as to why the SEC would consider approving such lack of transparency in the wake of one of the worst financial disasters this country has ever seen. We believe that the SEC’s approval would open the door to a new wave of investment fraud.
Money managers argue that they need to conceal their portfolio holdings so that competitors cannot steal their investment strategies. But the lack of transparency could lead to the same type of significant investor harm that occurred around 2008, when billions, if not trillions of dollars of investor wealth was lost. This is especially troubling because ETFs often are sold to investors who are neither wealthy nor sophisticated. If the SEC approves the sales of non-transparent ETFs investors will be forced to place their entire trust in the brokerage firms and financial advisors who sell the ETFs, with the hopes that those financial professionals perform sufficient due diligence to determine which ETFs are legitimate and which have holdings that are consistent with the investor’s investment objective and risk tolerance. If history is any guide, this will not end well for investors. The fallout from 2008 led to thousands of FINRA arbitration claims by aggrieved investors. Our securities lawyers will brace for the same if the SEC approves non-transparent ETFs.