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The Friday List: 10 Interesting Things We Learned at Inside ETFs

Today, we offer our “Friday List,” an occasional feature summarizing a topic significant to investment management professionals interested in regulatory issues.  Our Friday Lists are an expanded “Our Take” on a particular subject, offering our unique (and sometimes controversial) perspective on an industry topic.

We made it down to Hollywood, Florida this week for Inside ETFs, the annual self-congratulatory industry confab of everything ETFs.  We saw issuers big and small, service providers, advisers, and technologists.  There were also some pretty cool special guests like Barney Frank and Derek Jeter.  We took in a lot of information over three days of sessions and networking.  For those that couldn’t make it (or for those that may have, ahem, missed a few of the sessions), we offer the ten most interesting things we learned at the conference.

10 Interesting Things We Learned at Inside ETFs

  1. Zero fees: Competition helps firms with scale but investors should consider hidden costs.
  2. Service matters: Many investors/RIAs are willing to pay more for service.
  3. Quality: Low expenses get you in the game, but performance may ultimately keep you there.
  4. Active and non-transparent: Active ETFs are not new, but non-transparent ETFs are changing the industry.
  5. ESG. ESG is a screen applied to almost any equity strategy rather than a strategy unto itself.
  6. Model portfolios. Model portfolios are better tools that RIAs can use; they don’t replace the RIA.
  7. Niche marketing. Smaller firms have to define a niche to attract clients.  A niche is a small enough cohort to differentiate but large enough to sustain growth.
  8. Fixed income. With uncertain economic conditions, fixed income ETFs are likely to become a more significant part of the industry.
  9. Mission investing. Interest group-focused products such as the LGBTQ fund will target investors looking to use their money for more than just yield.
  10. Our daughters will rule the world. Julian Guthrie’s Alpha Girls provides a “see it so you can be it” template for high-performing women in male-dominated industries.

Signal Provider Used Misleading Hypothetical, Backtested Performance

An index signal provider, who also managed assets, agreed to a fine, censure and an outside compliance consultant for utilizing misleading hypothetical backtested performance information.  The SEC alleges that the calculations of the hypothetical, backtested performance for one of its core strategies deviated significantly from the live data, failed to conform to the firm’s model rules, and utilized an unavailable commodity index.  The SEC also faults the firm for failing to properly supervise a third-party index provider hired to create the backtested performance.  The SEC charges violations of the Advisers Act’s antifraud provisions (206(2)), advertising rule (206(4)-1(a)(5)), and compliance rule (206(4)-7). 

This case against an index provider adds fuel to the fire started by Investment Management Director Dalia Blass who last year questioned whether index providers should be exempt from investment adviser registration.  Also, as we have said before, do not use hypothetical, backtested performance information in marketing and advertising. 

SEC Is Examining Registered Funds and ETFs for Oversight, Policies, and Conflicts


The SEC’s Office of Compliance Inspections and Examinations has announced a sweep of certain mutual funds and ETFs. The OCIE staff will target smaller ETFs and funds/ETFs that use custom indexes, allocate to securitized assets, exhibit aberrational underperformance, or employ inexperienced managers or private fund sponsors that manage a similar mutual fund.  The SEC will assess compliance policies and procedures and fund oversight of risks and conflicts, disclosures to shareholders and the Board, and oversight processes.  Among some of the issues of concern to the OCIE staff include bid/ask spreads for secondary market trading of smaller ETFs, portfolio management for underperforming funds, the effect of unexpected market stresses on securitized assets, and side-by-side allocations for private and public funds.  OCIE is encouraging fund sponsors and boards “to consider improvements in their supervisory, oversight, and compliance programs.”

Compli-pros and fund lawyers should mobilize to review policies and procedures for affected advisers and boards, consult about changes, and implement enhanced oversight and processes.  We recommend taking action before the OCIE staff arrives for its examination. 

Large IA/BD Fined $8 Million for Failing to Implement Suitability Procedures

The SEC fined a large IA/BD $8 Million because it failed to implement compliance policies and procedures for the sale of single-inverse ETFs.  Following warnings from FINRA and SEC OCIE staff, the respondent adopted policies and procedures requiring (i) every client to sign a Client Disclosure Notice and (ii) a supervisor to review all recommendations for suitability.  However, over a 5-year period thereafter, the SEC maintains that 44% of clients did not sign a Disclosure Notice and most did not undergo adequate supervisory reviews.  Consequently, the firm made several unsuitable recommendations including to retirement account clients.  The SEC cites violations of the Adviser’s Act’s compliance rule (206(4)-7), which requires advisers to adopt and implement policies and procedures reasonably designed to ensure compliance with the Advisers Act.

OUR TAKE: The SEC will severely punish recidivists who were notified of deficiencies during a prior exam.  In this case, the IA/BD specifically undertook to fix the identified suitability concerns but failed to implement those policies, thereby allowing the violative conduct to continue.