December 3, 2012 / 10:11 PM / 5 years ago

N. Hampshire investment adviser must pay $1.8 mln in ETF case

* Adviser held risky leveraged and inverse ETFs for months

* N.H. regulators trying to revoke adviser’s license

By Suzanne Barlyn

Dec 3 (Reuters) - An investment adviser must pay a total of $1.8 million to a group of investors in a securities arbitration ruling that lawyers say is among the first to involve losses tied to leveraged and inverse exchange-traded funds.

Nicholas Rowe and his firm, Focus Capital Wealth Management Inc of Bedford, New Hampshire, were found liable in a case alleging negligence, civil fraud, and other misdeeds, involving the sale of risky ETFs to nine investors, according to a ruling by a Financial Industry Regulatory Authority arbitration panel. Some of the investors were in their fifties and sixties, including two widows.

Leveraged and inverse ETFs are designed to amplify short-term returns by using debt and derivatives and are considered more suitable for professional traders than for long-term retail investors or anyone who cannot tolerate a high-risk portfolio. Only a handful of cases involving the securities are pending, say arbitration lawyers. But that figure is likely to grow, say lawyers, as investors dabble in such ETFs to attain higher yields in a low-interest environment. Many investors do not understand the magnitude of the risks, lawyers say.

Leveraged and inverse ETFs make up just $27 billion of the $1.29 trillion U.S. ETF market, according to Lipper, a mutual fund information company owned by Thomson Reuters. In 2009, FINRA and other regulators began issuing warnings about the sale of leveraged and inverse ETFs because they worried that securities brokers were selling them to buy-and-hold investors - a strategy likely to cause heavy losses.


FINRA arbitration may be the last hope for some investors whose advisers guided them to leveraged and inverse ETFs and then mismanaged the investments. In September, a New York judge dismissed a class-action lawsuit by exchange-traded fund investors who claimed that the funds’ adviser and distributor did not fully disclose risks associated with investing in the ETFs. The case stemmed from 44 leveraged and inverse ETFs managed by ProShares Advisors LLC.

Of the $1.8 million award in the Focus case, the investors, collectively, received $1.29 million for damages and about $500,000 for legal fees, interest and costs, according to the ruling issued Nov. 27. The investors originally asked for $9 million from several parties and it is unclear from the ruling how much of that was directly attributable to their losses. Aside from the final rulings, documents involved with FINRA arbitration proceedings are not made public.

A lawyer for the investors was not available for comment. Rowe, principal owner of Focus, did not return calls requesting comment.

Investors in the Rowe case were all heavily concentrated in leveraged and inverse ETFs, according to Craig McCann, a Fairfax, Virginia-based expert witness who testified on the investors’ behalf. Rowe increased the investors’ risk by buying and holding the ETFs for as long as a few months, McCann said. That strategy is nearly guaranteed to lead to losses, since the investments effectively require betting on whether the market is going up or down, McCann said.

“The rule of thumb is that if you plan on holding these funds any longer than a day, then they are not going to do what you think,” said Ben Johnson, director of ETF research at Morningstar Inc.

Rowe and Focus, which managed $23.9 million in assets at the end of 2011, according to regulatory filings, are also the subjects of a civil enforcement proceeding by the New Hampshire Bureau of Securities Regulation. The Bureau has been trying to revoke the licenses for Rowe and Focus since August, a process that can take months. The Bureau received complaints from some of Rowe’s customers about heavy losses caused by trading in the leveraged and inverse ETFs, New Hampshire regulators said.

Separately, a New Hampshire court last week issued a temporary order prohibiting Rowe and Focus from conducting business, other than to transfer or liquidate accounts, according to Jeff Spill, deputy director of the New Hampshire Securities Bureau.

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