Losses in Low Volatility Investment Products Expected to Lead to Increase in Investor Unsuitability Claims

The Dow Jones Industrial Average went down more than 1000 points on each of February 5 and February 8, 2018. The drop in stock prices was marked by high volatility not seen in quite some time. While volatility spiked, investment products betting on low volatility, or stable stock prices, lost much of their value. For example, XIV, an inverse volatility exchange-traded note lost more than 96% of its value in one day, leading to the redemption of the notes and the shutting down of the product.

In 2012, FINRA had issued an investor alert pointing out the riskiness of exchange-traded notes. Also in 2012, a large brokerage firm agreed to pay more than $3.4 million in restitution to customers who purchased certain volatility base exchange-traded products as even their own brokers did not fully appreciate the risk of such investments. Yet, many investors who had made profits for years with low volatility products were wiped out in one day.

Brokers may have liability for making unsuitable investment recommendations to their customers. Whether a particular recommendation is suitable under the circumstances depends upon a whole host of factors, including, but not limited to, the customer’s age, other investments, financial situation and needs, tax status, investment objectives, investment experience, investment time horizon, liquidity needs, risk tolerance, and any other information that may be applicable. Given the large losses which low volatility investment products have already suffered, a surge in unsuitability claims against brokers, alleging that volatility linked exchange-traded notes were not suitable investments, would not be surprising.

Thomas J. McNamara is a Partner in the Commercial Litigation Practice Group at Certilman Balin.