On July 22, the 2nd U.S. Circuit Court of Appeals affirmed a ruling that had rejected a lawsuit by investors alleging that ProShares Advisors LLC did not properly disclose the risks for its leveraged exchange-traded fund products. Leveraged ETFs, also known as “ultra short” funds, are designed for short-term investors who target exponential gains and can bear the risks of large losses. ProShares’ leveraged ETFs were designed to double, move inversely to, or double the inverse performance of an underlying index on a daily basis.
According to a Reuter’s article, investors argued that between August 2006 and June 2009, at the height of the global financial crisis and a plunge in stock prices, ProShares “failed to disclose the risks that its ETFs might post substantial losses, and knew it could happen even if investors bet correctly on a market’s direction.” One example cited by investors occurred during a three-month period when the U.S. bank stock index fell 22.84 percent. The ProShares ETFs were supposed to double that index’s inverse performance, expecting a gain of approximately 45 percent, but instead it fell 17.3 percent.
The 2nd Circuit opinion said that ProShares disclosed the “speculative” nature of the ETF products and that the ETFs might move differently and contrary to what investors expected. His ruling also included that “no reasonable investor could read these prospectuses without realizing that volatility, combined with leveraging, subjected that investment to a great risk of long-term loss as market volatility increased.”