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Oil-Linked Exchange-Traded Products Investment Loss Options

Posted on Wednesday, May 27th, 2020 at 8:57 am    

Oil-Linked Exchange-Traded Products

Did your broker recommend you invest in Oil-Linked Exchange-Traded Products (ETPs) and you suffered investment losses? Brokers across the country recommended their clients invest in unsuitable oil, gas, and energy investments, which suffered significant declines when the market crashed due to the COVID-19 pandemic (the coronavirus of the winter and spring of 2020). 

In May 2020, FINRA made an announcement cautioning investors who may have suffered investment losses due to recommendations by their broker to invest in oil-linked ETPs. According to the announcement, “Exchange-traded products (ETPs) provide different types of exposure to the oil market through several product structures, which some investors or investment professionals might not understand. Moreover, the performance of such products may be linked to unfamiliar indices or reference benchmarks, making them difficult for the average investor to comprehend. In particular, a number of these ETPs are designed to track daily price movements of specified crude oil futures contracts, such as those on West Texas Intermediate (WTI) light, and sweet crude oil.” 

Oil-linked ETPs are complex products that may not be suitable for some investors, such as those with conservative investment objectives and those looking to live off of their investments for many years down the road. Due to the heightened risk that ETPs may cause to investors, broker-dealers must be diligent to ensure that the sale of these investments is suitable for the investor. Oil-linked ETNs are debt obligations that do not hold any underlying portfolio; they promise to pay the note holder a return linked to the performance of an index at note maturity. Additionally, ETNs vary in terms of the discretion in the creation (issuance) of new notes and redemption of notes, both of which can impact the performance and the extent to which the market price of the note reflects its value.

An ETP is a security that seeks to provide exposure to the performance of an index, benchmark, or actively-managed strategy. ETPs are listed on an exchange and publicly traded. The most common ETP is an exchange-traded fund (ETF). All ETPs are registered, but the various types of ETPs may be subject to varying regulatory requirements and oversight by the Securities and Exchange Commission (SEC) or the Commodity Futures Trading Commission. 

Some investment brokers and the clients to which they recommended investment in ETPs may not have understood the oil-linked ETPs’ investment objectives, how their performance relates to the cash price of oil, or how the different product structures can impact their performance and the investor experience.

Several oil-linked ETPs have experienced significant volatility and lost a substantial percentage of their value due to recent conditions in the crude oil markets, as well as the manners in which the products are structured. 

In May 2020, two months into the global pandemic due to COVID-19, oil prices continued to drop to the low $20s per barrel as demand for oil has dwindled due to worldwide lockdowns, declined use, and excessive storage capacity declines. Predictions are surfacing that many oil companies will be declaring bankruptcy soon. The Exploration & Production (E&P) Industry, including oil companies, had $2.47 trillion in revenues in 2019. In 2020, the industry is predicting to see $1.47 trillion in revenue, a 40% decline from the previous year, according to CNBC

For example on May 9, 2020, West Texas Intermediate (WTI Crude) prices were at $23.26 per barrel, which is a 59% decline from a year earlier. According to the FINRA announcement, “Recently the June 2020 WTI crude oil futures contract fell 43 percent to close at $11.57 per barrel—only one day after the expiring May 2020 WTI contract price dropped below zero and settled at minus $37.63 per barrel.6 This plunge in market value has significantly impacted ETPs tracking WTI futures… For example, as of April 22, 2020, the largest oil-related ETP had lost 41 percent of its value in one week. This ETP also subsequently adjusted its investment focus from near-dated futures to longer-dated contracts.” The announcement went on to say, “Surging investor demand for this oil-linked ETP in particular led to a dramatic increase in new share issuance, which ultimately exhausted the number of available shares permitted to be issued under the ETP’s existing registration statement.”

Brent Crude dropped to $31 per barrel during this same period; Brent Crude saw a low of $19.33 on April 21, 2020, compared to $70.23 on May 13, 2019, which is a 70% decrease. During this time, at least one ETP liquidated and another was forced to halt the issuance of new shares and to adjust its investment objectives. According to FINRA, “Leveraged and inverse oil-linked ETPs that seek to deliver multiples or the opposite of the return of an oil-linked index likewise have been extremely volatile during these market conditions.”

Broker-dealers and their brokers are obligated to make recommendations to customers that must be based on a full understanding of the terms, features, and risks of the product recommended. Furthermore, firms must have reasonably designed supervisory procedures in place to ensure that these obligations are met, and the firms must train registered representatives who sell these products about the terms, features and risks of these products.

Pursuant to FINRA Rules, member firms are responsible for supervising a broker’s activities during the time the broker is registered with the firm. Therefore, brokerage firms across the country may be liable for investment or other losses suffered by its customers.

Erez Law represents investors in the United States for claims against brokers and brokerage firms for wrongdoing. If and have experienced investment losses, please call us at 888-840-1571 or complete our contact form for a free consultation. Erez Law is a nationally recognized law firm representing individuals, trusts, corporations and institutions in claims against brokerage firms, banks and insurance companies on a contingency fee basis.