Bemoaning the "volatility virus" known as XIV—or Credit Suisse's VelocityShares Daily Inverse VIX Short-Term Exchange-Traded Note—the Financial Times shed the spotlight on an investor who held XIV in his trading account, buying several thousands-of-dollars worth of the security in late January 2018, only to see XIV lose 94% of its value by the following week. In all, brokers may have subjected clients to far too much risk, unsuitably recommending XIV and related volatility products because of many brokerages' cultural over-reliance on volatility and risk.
For instance, FINRA has sanctioned a handful of registered representatives and firms related to unsuitable recommendations of volatility products, such as a $3.4 million sanction levied against Wells Fargo for unsuitably recommending customers purchase volatility-linked exchange-traded products, including sales of ETPs and ETNs by Wells Fargo reps who did not fully understand the products they were selling.
Also in 2017, FINRA suspended ex-Global Arena Capital broker James Flower for unsuitably recommending the highly volatile iPath S&P 500 VIX Short Term Futures ETN (VXX) offered by Barclays, causing 13 clients to lose more than $249,000. As it found in the Wells Fargo action, FINRA cited Flowers for failing to fully understand the risky VXX product he sold.
In 2016, FINRA found that former Newport Coast Securities brokers David M Levy, Antonio Costanzo, and Donald A Bartelt recommended quantitively unsuitable investments to customers, including the iPath S&P 500 VIX Short Term Futures ETN (VXX). FINRA also charged the trio with churning the accounts of 24 Newport Coast Securities customers, ultimately causing more than $1 million in damages to the affected investors. Newport Coast Securities is now defunct, having left behind a string of devastated clients.
Former Craig Scott Capital broker Edward Beyn is yet another representative FINRA punished for unsuitably recommending a customer invest in VXX.
A common theme amongst the victimized investors is: a conservatively low-to-medium risk tolerance preference and a long-term investment horizon. For instance, many of these volatility-linked products are designed for shorter holding periods, such as day-trading, and many of the harmed investors unsuitably held these products in their accounts for a much longer period of time, having received improper instructions from their brokers that long-term holding was appropriate for those products.
Describing XIV as a story of "financial engineers creating something new, lucrative, [and] potentially dangerous for hedge funds, insurers, banks, and ordinary investors—arguably making the global financial system more fragile in the process," FT wrote that the abrupt rise of volatility trading and ETPs like XIV (from nary 1,000 VIX futures contracts traded per month in the mid-2000s to upwards of 6 million per month by late 2017) helped contribute to an unsustainable product that led to a greater dollar loss on Wall Street than what occurred on NASDAQ when the dotcom bubble burst.
Said one fund manager, volatility-linked securities, such as XIV, are akin to viruses. XIV specifically became the "virus that has infected the entire finance industry and gradually 'corrupted' its behavior."
Economist and Nobel prize recipient Harry Markowitz referred to volatility as a shorthand for risk, with the virus analogy accordingly suggesting that by relying on volatility so heavily, what brokers are really doing is subjecting clients to excessive levels of risk.
With all manners of brokers, advisers, firms, and investors betting on volatility, the market inherently became unsustainably volatile.
One theory posits that banks' and investment firms' value-at-risk calculations—such as JPMorgan's RiskMetrics—systemically underrepresented potential losses in a crisis, which spurred more interest in the risk-underrepresented XIV. Another stressed the over reliance on volatility and risk in recommending unsuitable investments to customers who by all accounts are adamantly risk averse, as indicated by their objective preferences and risk tolerance paperwork.
If you have invested with a full-service brokerage firm in a volatility-linked product such as Credit Suisse's VelocityShares Daily Inverse VIX Short-Term Exchange-Traded Note (XIV) that was unsuitable given your investment objectives and risk tolerance preferences, and your broker's failure to disclose the significant risk factors involved in such an investment, such as its unsuitability for longer-term holding periods, has proven harmful to your interests, please call The Law Offices of Jonathan W. Evans & Associates at (800) 699-1881 for an investigation and consultation.