Suit Slapped on Leveraged ETF Provider

ProShares denied the claim in Labaton Sucharow's class action suit that its ultralong and ultrashort products don't work as advertised.
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A lawsuit has been filed against the creators of

ProShares UltraShort Real Estate

(SRS) - Get Report

in what is the latest chapter in the war against leveraged ETFs. ProShares, creator of some of the first "ultralong" and "ultrashort" funds, is now facing a complaint filed by New York-based law firm

Labaton Sucharow LLP

in the U.S. District Court for the Southern District of New York.

The lawsuit claims that "as marketed by ProShares, Ultra ETFs are designed to go up when markets go up; UltraShort ETFs are designed to go up when markets go down." Anyone who has been following funds like

Direxion Shares Daily 3X Financial Bull

(FAS) - Get Report

and

Direxion Shares Daily 3X Financial Bear

(FAZ) - Get Report

(FAZ) or SRS for that matter, can claim that this statement

does not always hold true

.

According to

Morningstar

, in a one-year period ending July 23, the Dow Jones U.S. Real Estate Index dropped 38%, but the ProShares UltraShort Real Estate fund lost 82%. Year-to-date through July 23, SRS' index is down 3.5%, but the ETF has fallen 67%.

Direxion faced a similar challenge with FAS and FAZ as the funds dropped nearly 70% and 90% respectively from inception through July. The low price points and high volume prodded Direxion to

execute a reverse split

in both funds to defray transactional costs. Needless to say, both the bull and the bear strategy had moved in the same direction: down.

ProShares Advisors has issued a statement vehemently denying the claims. The rebuttal states: "The allegations reported in the complaint are wholly without merit. ProShares' registration statements have always been accurate and complete, contained all material information, and complied with all legal requirements. We plan to defend against this suit vigorously."

In the crusade against leveraged funds, everyone from the Massachusetts Attorney General to FINRA and brokerage firms like

UBS

(UBS) - Get Report

and

Wells Fargo

(WFC) - Get Report

are questioning the sales practices of leveraged-fund companies like ProShares, Direxion and

Rydex

. The issuers have responded to the encroaching regulation by beefing up disclosure on their Web sites and in their ads.

Where does advertising stop and responsibility begin? Investors should understand the risks involved in buying an ETF, which means probing beyond the surface. Issuers should not try to package a wolf in sheep's clothing.

As I have stated before, regulation should focus on

separating out traditional and non-traditional ETFs

. ETFs are broadly known for their transparency, low-cost structure and accessibility. As more complex strategies hit the marketplace -- and they inevitably will -- they should be characterized as such.

ETFs that passively track the

S&P 500

should not sit side-by-side with triple-down commodities funds on any Web site or in any ad. Equivocating the two vastly different strategies in any capacity is a dangerous disservice to investors. Both issuers and investors want to take advantage of the unique structure of ETFs, but they should do so responsibly.

At the time of publication, Dion had no positions in the funds or stocks mentioned.

Don Dion is the publisher of the Fidelity Independent Adviser family of newsletters, which provides to a broad range of investors his commentary on the financial markets, with a specific emphasis on mutual funds and exchange-traded funds. With more than 100,000 subscribers in the U.S. and 29 other countries, Fidelity Independent Adviser publishes six monthly newsletters and three weekly newsletters. Its flagship publication, Fidelity Independent Adviser, has been published monthly for 11 years and reaches 40,000 subscribers.

Dion is also president and founder of Dion Money Management, a fee-based investment advisory firm to affluent individuals, families and nonprofit organizations, where he is responsible for setting investment policy, creating custom portfolios and overseeing the performance of client accounts. Founded in 1996 and based in Williamstown, Mass., Dion Money Management manages assets for clients in 49 states and 11 countries. Dion is a licensed attorney in Massachusetts and Maine and has more than 25 years' experience working in the financial markets, having founded and run two publicly traded companies before establishing Dion Money Management.