ETF Providers Work Around SEC Hammer

NEW YORK (TheStreet) -- Although the public is focused on Washington's assault on Goldman Sachs(GS) and the Congressional debate over financial reform, these are not the only situations where the regulatory hammer has been brandished.

Prior to these headline grabbing events, the SEC began to actively examine the use of derivatives in leveraged and active ETFs.

As the ETF industry has grown and evolved over the years, products have become more and more advanced. Today, while the vast majority of funds like the SPDR S&P 500 ETF(SPY) and the PowerShares QQQ(QQQQ) passively track a broad index, investors can target increasingly complex slices of the market or magnify their returns using leveraged and alternative products.

Investors can also now choose from the growing collection of actively managed ETFs which promise stronger returns than a traditional index ETF.

While these new classes of exchange traded funds make promises of market beating returns, their use of derivatives make them increasingly risky. The dangers of holding these products have drawn the attention of the SEC which, in an effort to better grasp the use of derivatives in these products, placed a freeze on any new ETF which employs these instruments to achieve their goals.

The companies most affected by this freeze include Direxion, ProShares and Rydex: the three firms leading the leveraged ETF revolution.

While it may not have much to do directly with this regulatory development, since the SEC started its investigation, two of these providers have announced dramatic changes to their current and forecast leveraged ETF line-ups.

On Monday, investors learned that Rydex is planning to close nearly every leveraged exchange product in its lineup. Though well known for its leveraged mutual funds like the Rydex Dow 2X Strategy Fund(RYCVX), traditional ETFs like the Rydex S&P Equal Weight Index ETF(RSP), and CurrencyShares ETFs like the CurrencyShares Euro Trust(FXE), Rydex also commands a suite of fourteen 2X leveraged products that allow investors to take bullish and bearish bets a number of indexes and sectors.

For 12 of these products, May 21 will mark their final day of trading.

Products scheduled for execution include the Rydex 2X Russell 2000(RRY), the Rydex Inverse 2X S&P Midcap 400(RMS) and the Rydex 2X S&P Select Sector Health Care(REC). While these funds have been available for over two years, they have failed to gain much of a following.