The carnage was bad for stocks, but even worse for ETFs and ETNs.  Much is being made about the Accenture (ACN) trade that took place at a penny.  However, of the 971 ETFs and ETNs with trading activity on May 6, twenty-two traded for a penny or less and 164 traded for less than a dollar.

By my count, 167 ETFs and ETNs experienced intraday drawdowns in excess of -90%. That translates to more than 17% of those that traded.  The NASDAQ and NYSE ARCA (the electronic trading arm of the NYSE) said they would cancel many trades.  The official notice from NASDAQ reads:

We have coordinated a process among U.S. Exchanges and therefore, pursuant to NASDAQ Rule 11890(b), NASDAQ, on its own motion, will cancel all trades executed between 14:40:00 and 15:00:00 greater than or less than 60% away from the consolidated last print in that security at 14:40:00 or immediately prior.

I do not have any easy way of determining all the ETF prices immediately prior to the panic, so the following analysis is based on moves from the prior day’s closing prices.

• 183 ETPs (18.8%) had trades in excess of -60%
• 25 ETPs (2.6%) had trades in excess of +60%
• 208 ETPs (21.4%) are therefore subject to having some of their trades cancelled
• 149 ETPs (15.3%) had trades from -15% to -60% which will not be cancelled
• 67 ETPs (0.7%) had trades from +15% to +60% which will not be cancelled
• 216 ETPs (22.2%) with extreme trades from +/-15% to +/60% had none of their trades cancelled

I think it is reasonable to assume that most of the ETPs that traded more than 60% away from the prior close also had trades that were in the 15% to 60% range.  Based on that assumption:  Approximately 424 ETPs (43.7%) had extreme trades from +/-15% to +/60% that will not be cancelled. There were participants on each side of those trades.  Some are happy, some are not so happy.

Most markets were already down more than 5% from their recent peaks prior to Thursday’s action.  Therefore, nearly every trailing stop on long unleveraged equity ETFs was triggered.  More regulation: coming soon to a stock exchange near you.

Every month I harp on ETF liquidity concerns, while others say there is nothing to worry about.  Ask the owners of the 424 ETPs mentioned above what they think.  Please refer to our Monthly ETF Statistics and ETF Deathwatch publications for the most accurate reports on new product listings, closures, and ETF liquidity.

Disclosure covering writer, editor, publisher, and affiliates: No positions in any of the securities mentioned. No positions in any of the companies or ETF sponsors mentioned.  No income, revenue, or other compensation (either directly or indirectly) received from, or on behalf of, any of the companies or ETF sponsors mentioned.

As we reported last month, the Securities & Exchange Commission is conducting a “review” of new filings for exchange-traded funds that use futures, options, swaps or other derivative instruments to implement their portfolio strategy.  This includes most of the ETFs offered by ProShares and Direxion, along with some smaller players.  Existing funds are not affected.  Nor, apparently, are new ETFs from sponsors that previously obtained exemptive relief from the SEC; subsequent to the March 25 SEC announcement, ProShares launched four new products covering biotechnology and regional banks.

The regulators say they want to make sure investors in these ETFs understand the risks they are taking.   This is a worthy goal but I’m not sure what else anyone can do.  The sponsors already provide abundant disclosures and educational materials.  Anyone who invests without bothering to inform themselves about what they are buying is unlikely to be stopped.

Read the article at Daily Finance for more detail.

Disclosure covering writer, editor, publisher, and affiliates: No positions in any of the securities mentioned. No positions in any of the companies or ETF sponsors mentioned. No income, revenue, or other compensation (either directly or indirectly) received from, or on behalf of, any of the companies or ETF sponsors mentioned.

This move is not directly related to last year’s decision by the Commodity Futures Trading Commission to enforce position limits on ETFs that use regulated futures contracts.  You may recall that turmoil in commodity-related ETFs followed the CFTC action.

The SEC move is unlikely to have such an immediate impact but could pose a long-term problem.  Sponsors who have built their business around leveraged, inverse, and commodity-based ETFs are particularly vulnerable since almost all such funds depend on various kinds of derivatives to execute their strategies.  This category includes Direxion, ProShares, Rydex, and several smaller firms.

The SEC seems to be concerned that investors in these funds do not understand the additional risks.  They are perfectly correct: plenty of investors obviously don’t know what they are getting into.  That’s why they get angry and file lawsuits after they lose money, despite the many warnings and disclosures they apparently ignore.

My best guess is that the SEC will, following its review, allow ETFs to continue using derivatives, though maybe with some new restrictions and additional disclosures.   Meanwhile, we probably won’t see any new leveraged, inverse, or commodity-based ETF launches.  Exchange-Traded Notes (ETNs) fall into a different category, so we may see sponsors switch to that format in some cases.

Disclosure covering writer, editor, publisher, and affiliates: No positions in any of the securities mentioned. No positions in any of the companies or ETF sponsors mentioned. No income, revenue, or other compensation (either directly or indirectly) received from, or on behalf of, any of the companies or ETF sponsors mentioned.

Arresting a billionaire or two must have seemed like a good way to get started.  Earlier this year the SEC went after Allen Stanford, who like Madoff operated unmolested for years.  Now they have Raj Rajaratnam in handcuffs for alleged insider trading.

Rajaratnam, if you haven’t heard of him, is the founder and head of a large hedge fund firm called Galleon Group.  (In hindsight, the pirate-looking ship photos on their web site might have been a clue something was up.)  He was recently listed in Forbes magazine as the 559th richest person in the world with a net worth of $1.3 billion.  He is charged along with several others, including executives at Intel, IBM and McKinsey & Company.

I realize the wheels of justice turn slowly.  However the fact that the SEC has been wiretapping Rajaratnam’s cell phone since March 2008 and has only just now arrested him makes me wonder what they’ve been doing all this time.  I also wonder why someone who is already a billionaire would get involved in a criminal scheme worth only $20 million.

Meanwhile, on a surely unrelated note, the SEC has hired a 29-year-old former Goldman Sachs employee to be the Chief Operating Officer of its Enforcement division.  According to a Bloomberg story, Adam Storch will be charged with making the unit more efficient.

Some will decry the ever-revolving door between Washington and Goldman Sachs, but I will give Mr. Storch the benefit of the doubt along with this suggestion:  When one of your staff attorneys investigates Bernie Madoff and finds nothing wrong, don’t give her the highest possible performance rating and don’t promote her to New York branch chief.  Neither act made the SEC’s enforcement efforts any more efficient.

Today the Labor Department reported that the Consumer Price Index rose 0.2% in September and fell -1.3% in the last twelve months.  This was no great surprise, since it was the seventh consecutive month of negative year-over-year CPI.  September is a special month, however, because it is the end of the federal government’s fiscal year and is used to determine inflation adjustments for the next year.

By law, Social Security payments cannot go down – but they don’t have to go up, and this year they won’t.  This may come as a surprise to retirees who have grown accustomed to getting a “raise” each year.  The last year without a COLA was 1975.

Even more aggravating, health care was one of the few CPI categories to actually go up in the last year while much of the decline was related to energy costs.  Retired people, of course, are often above-average consumers of health care and below-average consumers of energy.  Their cost of living hasn’t dropped, negative CPI notwithstanding.

President Obama and members of Congress are keenly aware that senior citizens won’t like this development at all.  They are therefore seeking to defuse the political explosive environment with a one-time $250 payment to all Social Security recipients.  This would be in addition to the $250 “economic stimulus” payments sent to the same group earlier this year.

These payments will largely offset the lack of a Social Security COLA this year, and some seniors may actually come out ahead.  Nonetheless, at least one lobbying group is already whining that it’s not enough.  The younger workers who pay the bills are, apparently, not their concern.

With many new media (blogs, twitter, content aggregation sites) outlets operating in unregulated wild frontier mode, the FTC saw fit to try to restore some sense of order. FTC 16 CFR Part 255 says that effective December 1, those that review products must disclose any connection with advertisers.

This has been a long standing policy with many in the financial world. For example, Seeking Alpha requires that contributors with Gold Standard Certification “… must disclose if they are employed by a company whose stock they are writing about; perform consulting for a company they write about; receive paid advertising revenue or any other form of sponsorship fee from a company they write about.” However, this policy is “self-enforced by contributors” and Seeking Alpha does not have any mechanism to ensure contributors are making such disclosures. Nor is there any penalty for failing to do so, other than having future contributions potentially rejected by Seeking Alpha.

I have yet to see a financial website article or blog post disclose the receipt of advertising revenue from the firms behind the products they are writing about. To me, this is a blatant conflict of interest. I’d like to think that somebody, somewhere has done it, but to my knowledge, no author/contributor has ever disclosed the receipt of advertising revenue (either directly or indirectly) from iShares, WisdomTree, or other ETF sponsors when writing a review of one of those products.

Perhaps this will change on December 1. In the mean time, everyone should be aware that proper disclosures are not being made and those glowing reviews may not be truly independent.

Disclosure (as required by FTC 16 CFR Part 255): I have no positions in any individual securities mentioned. I have no positions in any of the companies or ETF sponsors mentioned. I have never received any income, revenue, or fees from, or on behalf of, any of the companies or ETF sponsors mentioned.

According to data published in USA Today, the government gave a total of $365 billion to 700 different banks under the TARP program.  The Treasury received preferrred stock from these banks which is supposed to pay a quarterly dividend.   Now we learn that 33 of these banks simply decided not to pay dividends this quarter.  American International Group (AIG), which also received TARP money but is not technically a bank, also failed to pay its dividend.

A Treasury spokesperson claims that the banks are contractually permitted to skip these payments – and of course the federal government respects their rights.  This is laughable.  The federal government is probably the least contract-respecting institution in the world today.   The rights that need to be respected are those of the taxpayers whose capital is being used to prop up institutions that would otherwise have collapsed. 

Why are these institutions stiffing us?  From their point of view, why not?  They were handed free cash at a time when their very existence was being threatened.  Of course they took it.  Maybe now their existence is threatened again due to loan losses and they need to conserve cash.  Or maybe they would just rather use the TARP money for other things.  We don’t know.  What we do know is that the odds the government will  make a “profit” from TARP are not high.

AIG alone owes the Treasury $69.8 billion, according to Reuters.  The automotive industry owes $80 billion.  The 600 banks that haven’t yet repaid their TARP money owe a total of $134 billion.  I, for one, feel sure that the AIG and automotive “investments” will be near-total losses.  One of the dividend-skippers is CIT Group (CIT), which owes $2.3 billion and is probably going to file bankruptcy soon.   This will wipe out preferred shareholders like TARP. 

None of these numbers include the various other bail-out programs and Federal Reserve lending facilities.   The bottom line is that billions (and probably trillions of dollars) have been transferred from the public to politically favored industries like banks.  Most of it is probably never coming back.  A shocking number of people appear to be okay with this.  They say it is distasteful but necessary to save our capitalist system.

No, no, no.  This is not capitalism.  If it were capitalism, incompetent and unprofitable businesses would cease to exist.  Their directors, managers and employees would lose their jobs.  Investors would lose their investments.   This is what happens in industries that lack the ability to extract capital from the public with the government as intermediary/collection agency.  Call it whatever you like, but it’s not capitalism.

The final insult: if you happen to owe money to one of these deadbeat banks, do you get the right to skip payments?  Does your lender simply shrug and tell you to pay when you feel like it?  I didn’t think so.

The G-20 promotes global cooperation between the largest economies in the world. Although decisions are officially non-binding on the member states, members consult each other on major economic decisions. The group has loose ties to the World Bank, the International Monetary and Finance Committee, the Financial Stability Forum, and other international institutions.

G-20 economies comprise 85% of global production, 80% of world trade, and two-thirds of the world’s population. Current member states are Argentina, Australia, Brazil, Canada, China, France, Germany, India, Indonesia, Italy, Japan, Mexico, Russia, Saudi Arabia, South Africa, South Korea, Turkey, United Kingdom, United States, and the European Union.

One of the more significant results of the Pittsburgh meeting was the announcement that the G-8 is no longer the primary international economic forum. On Friday, G-20 leaders declared the G-8 has been superseded by the G-20 as the main economic council of wealthy nations. This illustrates the ascent of emerging markets. China will soon overtake Japan as the world’s 2^nd largest economy while Russia, Brazil, India, and other ‘2^nd tier’ economies are growing quickly.

Another event relates to a two-word declaration in the event’s final statement. Speaking on the global financial crisis and how the G-20 responded to it, leaders inserted a blunt “it worked.” They may have spoken too soon. Continued high unemployment, banking sector instability, and the injection of trillions in economic stimulus into the global economy could create more problems.  Of their seemingly premature conclusion, one former chief economist of the International Monetary Fund said, “it’s hubris.”

Finally, the G-20 wanted to be seen as moving past the global recession. They addressed global climate change. President Obama spoke about a “transition to a 21st-century clean energy economy.” No timetables were set and no decisions made. However, the fact that G-20 leaders addressed the topic underscored current momentum for action on cap-and-trade, carbon restrictions, and other green initiatives. Worldwide action on these goals, for better or worse, is gaining momentum

In reading the UNG 8-K filing, the fund makes no promise to resume share creation.  In fact, it spells out four conditions where new share creation may take place:

1. At its sole discretion, UNG may accept “specified  investments that meet UNG’s investment objective”  from Authorized Participants in exchange for newly created shares.  The “specified investments” are to be an over-the-counter swap contract between UNG and the Authorized Participant.
2. UNG’s management may decide to limit the number of new shares to any single Authorized Participant.
3. UNG’s management may vary the terms and conditions of the investments to be delivered.
4. UNG’s management may decide to offer new shares only on particular days.

The core of the filing is the first condition listed above.  Namely, UNG intends to circumvent exchange-imposed position limits by having the Authorized Participants be responsible for hedging their positions with futures contracts.  The use of swaps relieves UNG from the need to buy additional natural gas contracts while causing Authorized Participants to shoulder that burden.

UNG also makes two new disclosures that investors should be aware of.  First is that UNG’s expenses are expected to increase with these proposed swap arrangements and therefore the fund’s expense ratio will likely increase, as will its tracking error.

The second disclosure involves UNG’s current premium and is repeated here:

“At present, UNG’s units are trading at a premium to its net asset value (“NAV”).  UNG’s management cannot predict what impact, if any, the resumption of creation activity will have on the price of the UNG units on NYSE Arca.  It is possible that the resumption of creation activity, even on a limited basis, could reduce or remove any premium over NAV.  Investors are cautioned that paying a premium over the NAV for UNG units can lead to additional losses for the investor in the event that the investor sells such units at a time when the premium is no longer present in the market price.”

Investors should be aware that this filing may also reduce the premium.  The premium is constantly changing.  Around an hour before the close today, UNG was trading at $10.94 while its underlying value was $10.32, a premium of about 6%.  At the same time, competitor iPath DJ-UBS Natural Gas Total Return ETN (GAZ), another fund that has halted share creation, was trading at an 11% premium (price of $15.18 and underlying value of $13.67).

Links to UNG website and GAZ website.

Disclosure: no positions

Unlike many other ETF and ETN closures that result from the failure of the products to gain traction in the market, DXO has attracted more than $600 million in assets since its launch in June 2008.  In fact, it may have become too successful.

Deutsche Bank did not directly mention the CFTC in its announcement but said this redemption is the result of “limitations imposed by the exchange” causing a “regulatory event” as defined in the terms of the Notes.  Exchange-traded notes (ETNs) are different than typical ETFs, but that does not appear to be a root-cause of this closure.  See our open letter to ETN sponsors and our article on ETN risk for additional information.

Daily share creations of DXO have been suspended, and it closed today at a 4.5% premium to its underlying value.  Additional information can be found on the PowerShares ETN website, including the prospectus for the DXO Notes.

No other DB ETNs are affected at this time, including PowerShares DB Crude Oil Long ETN (OLO), PowerShares DB Crude Oil Short ETN (SZO), and PowerShares DB Crude Oil Double Short ETN (DTO).  DTO was the best new exchange-traded product of 2008.

Disclosure: no positions