Authorities are finally cracking down on exchange-traded funds. Massachusetts securities regulators announced today that there will be an inquiry into the sales practices of popular leveraged ETFs.

Secretary of State William F. Galvin's office has sent letters to Rydex Investments, Direxion Funds, and ProShares in order to learn more about the issuers' marketing methods.

As I have noted extensively on both TheStreet.com and RealMoney.com, leveraged ETF funds are intended only for professional investors and can erode an average investor's position over time.

ProShares is perhaps most famous for introducing single sector leveraged bets, but Direxion and Rydex have also built substantial lines over time. Most recently, Direxion performed a reverse split in both Direxion Shares Daily Financial Bull ( FAS) ETF and Direxion Shares Daily Financial Bear ( FAZ).

FAZ and FAS had plummeted 86% and 67% year to date as the volatility of the market has combined with the funds' methodology to erode the share price.

The Financial Industry Regulatory Authority (FINRA) posted a notice about leveraged funds on its site in early June. The notice was intended to remind brokers and registered investment advisers about their fiduciary duties when selling ETFs that offer leverage. The site urged that "these instruments are complex and typically unsuitable for retail investors who plan to hold them longer than one trading session."

High trading volume undoubtedly draws attention, and Direxion's reverse split might help to calm some watchdogs. The popularity of leveraged funds continues to grow, however, and the biggest concern is that the wrong kind of investors will get swept up with the crowd.

ETF issuers are pumping out leveraged products to meet investor demand. Regulators must examine the methodology and advertising of exchange traded funds before another wave of leveraged funds hit the market.
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.