October 6, 2011
Dear Friends at the SEC.
I meet the definition of "accredited investor".
Nevertheless, I see myself as a retail investor, who purchases bonds, shares of stock and shares of mutual funds. I have not purchased shares in any ETF and I have not invested in any "hedge fund" or "limited partnership".
I understand that placing such limits on my investments reduces the potential income from my investments. I accept that potential cost. It is a price I am willing to pay to reduce "risk" in the value of my investments.
I understand that the first ETFs sought to reproduce the performance of particular indexes. For example, an "SP 500 Indes ETF" would seek to buy assets whose aggregage value would closely follow movements in the "SP 500 Index".
Obviously, "closely follow" is different from "identically follow. I think it would be impossible to create a portfolio of investments, whose financial performance was identical to the financial performance of another, different portfolio. In my opinion, that unavoidable difference creates opportunities for gross error and for fraud.
As I see it, the SEC's mission is to protect retail investors from being misled by over-aggressive promoters. But the tools the SEC has available are themselves limited. The SEC can require "disclosure". In the case of mutual funds, that "disclosure" is a daily event. In my opinion, this tool has allowed the SEC to do an exellent job overseeing mutual funds.
Now consider UBS' loss of $2 billion. That loss makes me wonder how any investment fund could have gone so far wrong. It seems obvious that whatever "disclosure" UBS relied upon to protect itself from "rogue traders" was insufficient. And that weakness implies that the process by which "values" are assigned to derivatives is not an objective, market-determined process.
It follows that any ETF that seeks permission to invest in derivatives cannot provide the degree of "disclosure" for those derivatives that the SEC must demand if the retail investors in that ETF are to be protected.
In a way, allowing ETFs to invest in derivatives, is to allow those EFTs to become publicly traded "hedge funds" with a competitive advantage: they will be exempt from the SEC's requirement to only sell their securities to "accredited investors".
Please do not allow this to happen.