Wells Fargo & Co. agreed to compensate customers after recommending complex exchange-traded products linked to stock market volatility, without fully understanding the securities' risks.
The Financial Industry Regulatory Authority ordered a brokerage division of Wells Fargo that has financial advisers around the country to pay $3.4 million for recommending the volatility ETPs between July 2010 and May 2012.
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"Certain Wells Fargo representatives mistakenly believed that the products could be used as a long-term hedge on their customers' equity positions in the event of a market downturn," Finra said in a release Monday.
In fact, the volatility ETPs are for short-term trades and their value can erode significantly over time, said Finra. The ETPs should not be used as part of a long-term buy-and-hold investment strategy, according to the regulator.
The Wells Fargo charge marks the first time that Finra has made a case related to volatility ETPs, a spokeswoman for the regulator said. The first volatility ETP launched in 2009, and they've surged in popularity among both sophisticated institutional investors and retail traders. The products are linked to the widely watched measure of volatility for equities, the CBOE Volatility Index, or VIX.
The iPath S&P 500 VIX Short-Term Futures Exchange-Traded Note, or VXX, was one of the first and is among the most traded securities in the U.S. stock market, according to WSJ's Market Data Group.
Wells Fargo has settled the claims with Finra and will no longer offer the three ETPs in retail brokerage accounts, a spokeswoman for the firm said in an email.
"We are committed to helping our clients achieve their investment goals through advice that is regularly reviewed and aligned to their objectives and risk tolerances," the spokeswoman said.
Besides VXX, other products that Wells Fargo doesn't offer include the iPath S&P 500 VIX Mid-Term futures Exchange-Traded Note, or VXZ, which has plunged more than 40% this year, and the ProShares VIX Short-Term Futures Exchange-Traded Fund, or VIXY, which is down about 65% in 2017.
Wells Fargo didn't give its representatives the adequate training regarding volatility ETP's, violating Finra rules, according to the regulatory body.
This isn't the first time Wells Fargo has been ordered to compensate customers regarding ETPs. In 2012, Finra fined the firm more than $2 million for violations related to leveraged, inverse, and inverse leveraged products, and ordered it to pay over $600,000 in restitution to customers.
Wells Fargo is also facing $1 billion in charges over a regulatory investigation into its crisis-era mortgage practices.
An ETP such as VXX is designed to wager on stock market volatility by tracking near-term futures contracts tied to the VIX. They tend to lose money over time -- a process often referred to as "decay"--because of the cost of selling futures that expire and buying futures further out in time.
VIX futures also diverge from the VIX index itself, wrote Finra executives in an October regulatory notice regarding the products. Moves in the futures contracts are often smaller than those in the VIX, according to Finra.
Write to Gunjan Banerji at Gunjan.Banerji@wsj.com
(END) Dow Jones Newswires
October 16, 2017 16:49 ET (20:49 GMT)