← Broker database 2021-11-23
McNally Financial Services Fined for Inadequate Supervision of Non-Traditional ETPs and Complex Options
According to FINRA, McNally Financial Services Corporation was censured, fined $35,000, and required to revise its written supervisory procedures for failing to establish adequate systems to supervise the sale of non-traditional exchange traded products (NT-ETPs) and complex options trading.
The firm's supervisory system and procedures were not reasonably designed to address the unique features and risks of NT-ETPs, including the significant risks associated with holding these products for extended periods. NT-ETPs, such as leveraged and inverse leveraged exchange traded funds, use derivatives and are designed to achieve their stated objectives on a daily basis. When held longer than one day, the effects of compounding can cause returns to deviate significantly from the underlying index, potentially resulting in substantial losses even if the index performs as expected over the holding period.
The firm's procedures provided no guidance on how supervisors should determine whether an NT-ETP was suitable for customers given these unique risks. The sole principal responsible for reviewing daily trades of 25 registered representatives had no tools for identifying NT-ETPs. The firm had no alerts, exception reports, restrictions, or approval processes that would detect when NT-ETPs were purchased, and no method for monitoring how long customers held these positions. Additionally, the firm failed to enforce what limited procedures it did have in place.
The supervisory failures extended to complex options trading. The firm was aware of red flags in a representative's risky options trading but failed to reasonably investigate whether the trading was suitable for customers. The firm did not detect that the representative was using the same options strategy for all customers regardless of their individual circumstances, including age, net worth, and investment experience. The firm never reviewed the frequency of options trading to determine whether the size and frequency of transactions were suitable for each customer.
Following these violations, the firm has effectively banned all sales of NT-ETPs and prohibited representatives from offering complex options trading strategies, demonstrating the seriousness of the previous supervisory gaps.
Investors should be aware that NT-ETPs are complex instruments unsuitable for buy-and-hold strategies, and complex options strategies carry significant risks. Before investing in these products, investors should ensure their broker fully explains the risks, verifies suitability based on their individual financial situation and objectives, and provides adequate ongoing monitoring.