More ETFs Get Sued

NEW YORK ( TheStreet) -- New lawsuits are adding to leveraged ETF woes, putting ProShares' UltraShort MSCI Emerging Markets ( EEV) and UltraShort Financials ETF ( SKF) under fire. The new lawsuits, which criticize ProShares' disclosure about these ETFs, come in the wake of a lawsuit against the ProShares UltraShort Real Estate ( SRS) and criticism of leveraged funds at large.

Both complaints allege similar misleading practices on the part of ETF issuer ProShares. While Direxion and Rydex also offer leveraged ETF products, ProShares is widely regarded as a pioneer in the leveraged ETF business, offering a range of sector and international leveraged funds.

The complaint against EEV, filed by U.S. firm Gilman and Pastor, notes that the fund was designed to track twice the inverse of the MSCI Emerging Markets index. From Jan. 2, 2008 to Dec. 17, 2008, the MSCI Emerging Markets index fell by 52%, while EEV fell approximately 30%. If the fund tracked twice the inverse of the index for this period, EEV should have risen 104%. (Emphasis mine.)

SKF and SRS have also deviated enormously from their perceived stated objectives, along with other popular leveraged funds like Direxion Daily Financial Bull ( FAS) and Direxion Daily Financial Bear ( FAZ). The reason for this deviation, the daily tracking objectives of the funds, was evidently not clear to the investors initiating the lawsuits.

It is of no surprise that these lawsuits are cropping up now, in the midst of a spate of new financial regulations for the ETF industry. FINRA reminded investors back in June that leveraged ETFs had daily tracking objectives, and were not appropriate for long-term buy-and-hold investors.

A more recent notice from FINRA alerts investors that the margin requirements for leveraged ETFs will be changing to be commensurate with their degree of leverage. ( Leveraged ETF Margin Rules to Change)

As criticism of leveraged ETF funds comes to a boil, issuers like ProShares, Rydex and Direxion have responded with increased disclosure and explanation of objectives. Rather than explaining the daily-resetting strategy in the prospectus, these issuers now alert investors aggressively on their Web sites and in their advertising.

Do these lawsuits have any merit? Probably not. It is the job of each and every investor to understand what the investment objectives of their funds are, and how the funds achieve their investment objectives.

It is one thing to drop your money manager for getting you involved in an unsuitable investment. Suing a fund issuer for not warning you about losses is less likely to be successful.

Angry investors will likely continue to try and exact revenge on leveraged funds as financial regulation stays in the news. Regulatory agencies like FINRA and the Commodities Futures Trading Commission are beginning to team up in their oversight of the ETF industry, and fundamental changes could help to better inform investors in the future. ( ETFs: Cry Transparency)

In the meantime, investors who are not using leveraged ETFs for their daily tracking strategies should stay away from these funds. A storm is brewing for leveraged ETFs on multiple fronts, and investors should avoid the downpour. ( Regulatory Storm Brews for ETFs)

-- Written by Don Dion in Williamstown, Mass.

Don Dion is 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.

Dion also is 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.

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