The US Securities and Exchange Commission has persuaded Morgan Stanley Smith Barney to pay an $8 million penalty and admit wrongdoing to settle charges related to single inverse exchange-traded fund investments that it recommended to advisory clients.

The SEC’s order finds that Morgan Stanley did not follow its policies and procedures adequately. It ought to have made its clients understand the risks that pertain to the purchase of inverse ETFs. Among the order’s findings, Morgan Stanley failed to obtain signed client disclosure notices from several hundred clients. Such notices state that single inverse ETFs are typically unsuitable for investors who plan to hold them for longer than one trading session unless they are used as part of a trading or hedging strategy. Morgan Stanley solicited clients to purchase single inverse ETFs in retirement and other accounts, the securities were held long-term, and many of the clients lost money.

The SEC’s order also finds that Morgan Stanley failed to 'follow through' on another key policy and procedure by requiring a supervisor to conduct risk reviews to evaluate the suitability of inverse ETFs for each advisory client. Among other compliance failures, the firm did not monitor the single-inverse ETF positions continually and did not ensure that certain financial advisors completed their single inverse ETF training. In short, it concludes that Morgan Stanley recommended securities with unique risks and failed to follow its policies and procedures to ensure that they were suitable for all clients.

ETFs are, typically, registered investment companies whose shares represent an interest in a portfolio of securities that track an underlying benchmark or index. Unlike traditional mutual funds, shares of ETFs typically trade throughout the day on a securities exchange at prices established by the market. ETFs have evolved over the years, becoming more complex. In the last few years, a number of "leveraged and inverse" ETFs have been introduced to the market that are very different from the traditional variety.