SEC Fails Investors on Leveraged ETFs

By now, most readers should know where I stand on the topic of leveraged and inverse ETFs. Last week, the Securities and Exchange Commission weighed in on the topic ... sort of:

While there may be trading and hedging strategies that justify holding these investments longer than a day, buy-and-hold investors with an intermediate or long-term time horizon should carefully consider whether these ETFs are appropriate for their portfolio.

I am not really sure what that statement says, and I have a hard time squaring it with what the SEC articulates on its own Web site:

The mission of the U.S. Securities and Exchange Commission is to protect investors, maintain fair, orderly, and efficient markets, and facilitate capital formation.

As more and more first-time investors turn to the markets to help secure their futures, pay for homes, and send children to college, our investor protection mission is more compelling than ever.

Obviously, there are a number of questions that pop up by their response. If the SEC knew then what it does now, would it have ever approved these products in the first place? Which strategies justify holding them for periods longer than a day for some people but not for others? And of course, how does the SEC justify the existence of these products within the context of the margin rules, over which the Fed has jurisdiction, not the SEC?

But really, such a wishy-washy statement just highlights how the SEC is failing its mission of investor protection. Furthermore, it raises questions as to how regulatory bodies should be operating more broadly. If all we need is a caveat emptor warning label, then the SEC would not exist, and as a result, capital formation would likely be hindered. Regulators, as I have mentioned before, have a place in the markets, because the capitalist incentive can lead to misbehavior by some participants in a pure laissez-faire environment. There is no "halfway" in the agency's mission of investor protection, yet it looks as though that is exactly what it is trying to do in this case and not make the tough decision -- a decision that is really quite simple.

Let me digress for just a moment and use an example from our criminal justice system. In our legal system, we have a presumption of innocence -- one is innocent unless proven beyond a shadow of a doubt to be guilty. The system is set up this way so that we do not send innocent people to jail unless we hold no reasonable doubt they have committed a crime. Obviously, it is a grievous error to send an innocent person to jail.

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Eric Oberg worked in fixed income, currencies and commodities for Goldman Sachs for 17 years before retiring as a managing director.