What’s Hot? Leveraged ETF Lawsuits!

-“I took out all the Wheel of Fortune slots and put in a leveraged ETF machine. I’m tellin’ ya Nicky, the big guy in Kansas City’s gonna be real happy. The only problem is, sometimes these guys come and they lose it all. What do they want from me?

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So I did a Google (GOOG) News search for my favorite topic, Leveraged ETFs, and look at the headlines that popped up:

A Class Action Firms Looks at Eight B-Ds Over Leveraged ETFs

Notice From the Securities Law Firm of Klayman & Toskes to All Investors Who Invested in Leveraged and Inverse Exchange-Traded Funds

Dimond Kaplan & Rothstein, P.A. Investigating Leveraged and Short ETFs Sold by Merrill Lynch, Smith Barney, LPL Financial, Ameriprise, Edwards Jones, UBS, and Morgan Stanley Smith Barney

As I predicted in my recent article on Leveraged ETF’s for Minyanville, lawsuits were inevitable. When you mix complex investments with a public too lazy to do their own homework, you simply create havoc.

Do these lawsuits make sense? Let’s look at the ProShares FAQ:

No. Nevertheless, although no one can predict future performance, an empirical study of historical data demonstrates that over relatively short periods that are longer than a day, there can be a high probability that a leveraged fund can approximate its daily target. The longer the time period that a leveraged fund is held and the more volatile the underlying benchmark, the greater chance that the impact of compounding will cause the performance of a leveraged fund to deviate from the daily objective over time. This deviation may be significant.

And a quick reminder of what Direxion, manager of the FAS and FAS 3X Leveraged ETFs, has on its homepage:

Direxion Shares ETFs seek daily investment goals and should be used strictly as short term trading vehicles. Please read the prospectus and visit our Education Center before investing.

These companies never made promises they couldn’t keep. They never hid the risks of these wild instruments. Any reasonable person who took 5 minutes to glance at a prospectus before laying down their bets would know they were playing with fire, and that they were gambling. Sometimes you win, and sometimes you lose.

Making highly leveraged bets on market direction during periods of extreme volatility is incredibly dangerous.

Is it a surprise that things didn’t work out perfectly?

In related news, media outlets are reporting that Wells Fargo (WFC) is laying down restrictions on client activity in leveraged ETFs, including higher margin requirements. This is a good idea -- we don’t need brokers exposed to self-destructing gamblers who fail to make good on what they owe.

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