Regulators eye exotic ETFs in information sweep

* Finra seeks details on sales, marketing of levered ETFs

* Focus is on one-day investment horizon of 'exotic' ETFs

* Sale to unsophisticated investor on Finra' radar screen

* ProFunds defends ETFs' use, plans education campaign

By Herbert Lash

NEW YORK, July 2 (Reuters) - A battle is brewing over leveraged exchange-traded funds, a derivatives cocktail whose growing popularity some say was at the center of sharp market volatility after the collapse of Lehman Brothers in September.

The Financial Industry Regulatory Authority recently conducted an information sweep of U.S. firms that sell the non-traditional ETFs, seeking a host of details about their sales to investors with accounts smaller than $10 million.

Finra, the industry's own watchdog, targeted ETFs that use leverage and aim to provide double or triple the return of an index, or its inverse performance, and that were held for more than 10 days.

Finra issued Regulatory Notice 09-31 on June 11 to remind brokers that any security they offer must be suitable for their customers. The performance of some of the ETFs in question suggests their returns can differ greatly over longer periods than their stated investment horizon of a single day, it said.

Finra said the non-traditional ETFs "typically are not suitable for retail investors who plan to hold them for more than one trading session, particularly in volatile markets."

The one-day profile of these ETFs lies at the heart of a potential fight over their use by retail investors, who along with institutional investors helped make an ETF offered by Direxion Funds the No. 4 best-selling U.S. fund in May, data from Financial Research Corp show.

ProFunds, the leading provider of non-traditional ETFs, agreed with Finra that leveraged ETFs may not be suitable for certain investors. But it disputes that they are one-day only investments, and plans to roll out an education program for both retail investors and the brokers who sell them.

Unlike other ETFs, which invest in a sector or group of stocks, non-traditional ETFs routinely include futures, options on futures, forward contracts and swap agreements. ProFunds has termed these instruments, among others employed, "aggressive."

"We actually support the Finra notice, except for one piece of it, we're very supportive of the effort to educate," Michael Sapir, chairman and chief executive of ProFunds, told Reuters in an interview.

"For unsophisticated investors, these are not products ... they should be using," Sapir said. He added later: "Don't buy it unless you understand it."

Finra's request for information concluded June 12 but the regulator is still analyzing the data, said spokesman Herb Perone, who called the ETFs in question "exotic," and "extremely complicated and confusing products."