Controversial ETFs that would have delivered four times the market hit a snag

Key Points
  • The SEC has decided to review a previous staff approval of highly levered funds that had come under criticism, according to a report.
  • The ForceShares UP and DOWN funds were designed to replicate four times the directional moves of the S&P 500.
The new risky ETF: Quadruple-leveraged fund

An unprecedented effort to create funds that would have delivered four times the return of the S&P 500 has run into a regulatory roadblock.

The Securities and Exchange Commission earlier this month approved an application from ForceShares that would have created the two exchange-traded offerings — the ForceShares Daily 4X US Market Futures Long Fund and ForceShares Daily 4X US Market Futures Short Fund.

The funds would use derivatives to represent four times the gains or losses of the futures contract, and the respective tickers were to be UP and DOWN.

However, some market participants complained that the funds were risky and could cause unwitting buyers to sustain major losses.

In an unusual move, the SEC commissioners are reviewing the approval that came from staff members and could shoot down the funds, according to a report in The Wall Street Journal. The three-member commission also could uphold the decision, though the move to review the staff approval could signal trouble for the funds.

An SEC official declined further comment to CNBC.

The Securities and Exchange Commission in Washington.
Jim Bourg | Reuters

"It's unusual for them to come out and say all of a sudden that they're going to review something that was approved," Joe Saluzzi, a principal at Themis Trading, told CNBC. "I think it was the public reaction to the approval. Everyone was like, 'Are you kidding me?' The SEC is saying, 'let's put this out to comment.'"

Themis has been vocal in its opposition to the funds on the grounds that they add risk to the market and could give rise to other products that use even more leverage.

"Hopefully, people will comment," Saluzzi said. "It's a good thing that they stopped it. You can bet there were probably a dozen more in the queue ready to go."

The ForceShares application has come under fire for other reasons, including regulatory disclosures that the managers of the fund have little experience and have a small staff for operating complicated funds. Representatives of the company could not be reached for comment.

Leveraged ETFs are not unusual, with some 273 in the market that offer two and three times the moves of various indexes and asset classes, according to XTF data cited by the Journal.

The best performer of the past 12 months, in fact, has been the Direxion Daily Semiconductor Bull 3X Shares, which provides three times the gains of the semiconductor sector and is up 328 percent.