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Leveraged ETFs: A Call for Coordination

WILLIAMSTOWN, MASS. ( TheStreet.com) -- Morgan Stanley (MS) (MS) Smith Barney is the latest firm to put the kibosh on leveraged ETFs. The wealth management division has noted that it will be making three major changes concerning the use of leveraged ETF products.

First, the firm will no longer solicit purchases of leveraged and inverse ETF products in traditional brokerage accounts. Second, advisory accounts will not be allowed to purchase leveraged funds. Finally, customer-driven purchases of leveraged ETF products will be more highly regulated.

Morgan Stanley Smith Barney's move to restrict leveraged ETFs comes in the wake of a widespread controversy surrounding the non-traditional funds. Edward Jones and UBS (UBS) were two of the first firms to curb the products with firms like Ameriprise (AMP) following soon after.

The Financial Industry Regulatory Authority's (FINRA) recent concern over the use of leveraged ETFs helped to spark the onslaught. In June, FINRA released a notice asserting that leveraged ETFs are "typically not suitable" for retail investors planning to invest for more than one day. FINRA later softened its statement by allowing that leveraged ETFs can be appropriate for short-term investors whose strategies are "closely monitored" by financial professionals.

Regulatory scrutiny has already proven to be a blow to the funds. Leveraged ETFs had net outflows of $1.56 billion in July, a strong reversal after a $1.8 billion gain the previous month, according to TrimTabs Investment Research. In the first seven months of 2009, leveraged ETFs attracted more than $7 billion.

Leveraged fund issuers like Direxion, ProShares and Rydex have responded to the regulatory squeeze by increasing disclosure on their websites and advertising. Direxion, creator of highly popular funds like Daily Financial Bull 3X (FAS), Daily Financial Bear (FAZ), Daily Emerging Markets Bull 3X (EDC) and Daily Emerging Markets Bear 3X (EDZ), has extensive disclaimers on its website.

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