Non-Traditional ETFs: Where Innovation Meets a Higher Compliance Bar & Risks

Exchange-traded funds (ETFs) are often marketed—and understood—as simple: low-cost, diversified, and easy to trade. But a subset of ETFs operates very differently. Leveraged and inverse ETFs, often grouped under the industry label “non-traditional ETFs,” are designed to deliver a multiple of an index’s daily return, the inverse of an index’s daily return, or both—typically over a single trading day, not over weeks or months. That “daily-reset” feature is the legal and regulatory pivot point: it’s why these products can behave in ways many investors (and, frankly, some advisors) do not expect—and why regulators have repeatedly told firms to treat them as complex products requiring heightened controls.

The compliance and litigation implications flow from that single design choice. Non-traditional ETFs are commonly structured to return a multiple of an index’s performance, the inverse of an index’s performance, or both, and the target is typically measured over the course of a single day.

That “daily reset” feature is not a technical detail; it is the core of the risk disclosure, the suitability analysis, and the “best interest” analysis under Regulation Best Interest. It is also why FINRA has repeatedly reminded firms that these products demand heightened attention in training, supervision, and surveillance.

The Product Reality FINRA and Regulators Keep Emphasizing

FINRA’s long-running concern is that investors tend to evaluate these instruments the way they evaluate ordinary index exposure: if the market goes up 10% over a month, then a 2x product should go up about 20%. With daily-reset leveraged and inverse exposure, that intuition can be wrong because of compounding and path dependency. FINRA cautioned as far back as 2009 that, due to compounding, performance over periods longer than a single trading session “can differ significantly” from the performance (or inverse performance) of the underlying benchmark over the same period. In that same guidance, FINRA stated that these products “typically are not suitable for retail investors who plan to hold them for more than one trading session.”

A decade and a half later, the regulatory theme has not changed; if anything, it has become more direct because Reg BI gives FINRA and the SEC a clearer framework for analyzing recommendations to retail customers. In the recent FINRA disciplinary action, Arkadios Capital, LLC, FINRA AWC No. 2023077131501 (Feb 5, 2026), while discussing the Reg BI adopting release, FINRA noted that the SEC cautioned that broker-dealers should understand that daily-reset inverse and leveraged exchange-traded products may not be suitable for, and therefore not in the best interest of, retail customers who plan to hold them longer than one trading session, particularly in volatile markets.  Indeed, these products may not be in a retail customer’s best interest absent an identified, short-term, customer-specific trading objective.

That language matters because it frames what the “right” conversation and documentation should look like when a daily-reset product is recommended to investors. For financial professionals or firms, it matters too because it signals what regulators expect your supervisory system to detect and prevent. Either way, the message is the same: when a product is designed for a short holding period, the recommendation and supervision have to be built for that reality.

Reg BI and FINRA Rule 3110

Reg BI applies when a broker-dealer or associated person makes a recommendation of a securities transaction or investment strategy to a retail customer. The Arkadios disciplinary action summarizes the basic standard in a way that is worth repeating: the recommendation must be made in the retail customer’s best interest at the time of the recommendation, without placing the financial or other interest of the broker, dealer, or associated person ahead of the retail customer’s interest.

From there, two Reg BI obligations become central for non-traditional ETFs, and the distinction between them is often where firms and financial professionals get tripped up. First, the Care Obligation requires reasonable diligence, care, and skill, including understanding the risks, rewards, and costs associated with the recommendation. In plain English, that means a representative cannot treat a daily-reset leveraged or inverse product as a generic ETF substitute, and a firm cannot pretend that “ETFs” are one homogeneous category. Secondly, the Compliance Obligation, in turn, requires a broker-dealer to establish, maintain, and enforce written policies and procedures reasonably designed to achieve compliance with Reg BI.

The Arkadios AWC emphasizes that firms should design policies and procedures to prevent violations, detect those that have occurred, and promptly correct them. FINRA’s supervision rule aligns with that concept. FINRA Rule 3110 requires member firms to establish, maintain, and enforce a supervisory system, including written procedures, that is reasonably designed to achieve compliance with applicable securities laws and FINRA rules.

For non-traditional ETFs, the practical implication is that regulators are not only evaluating whether a particular rep made a poor recommendation. They are evaluating whether the firm built a system capable of identifying recommendations that are inconsistent with the product’s intended use, the customer’s profile, and the required “short-term objective” rationale. That is not a hindsight exercise only; it is also a forward-looking test of whether the firm’s written procedures, training, and surveillance actually function and capture the relevant transactions for review and analysis.

What the Arkadios AWC Shows FINRA will Enforce

The Arkadios AWC is a useful teaching document precisely because it focuses on system design rather than a single dramatic bad act. FINRA found that, from September 2022 through March 2024, the firm failed to establish, maintain, and enforce a supervisory system, including written policies and procedures, reasonably designed to achieve compliance with Reg BI’s Care Obligation regarding recommendations of leveraged and inverse ETFs, described as non-traditional ETFs. As a result, FINRA found the firm failed to comply with Reg BI’s Compliance Obligation and therefore violated Exchange Act Rule 15l-1(a)(1), and also violated FINRA Rules 3110 and 2010.

What makes the case especially instructive is the gap between what the firm said and what the firm built. FINRA noted that the firm cautioned representatives to consider intended holding periods when recommending these products, but lacked a system to supervise whether representatives actually considered holding periods before making recommendations. That is a classic compliance failure mode: an advisory statement in a policy manual without a mechanism to test adherence. FINRA also found that while the firm’s written policies and procedures addressed Reg BI generally, they were not tailored to supervising recommendations of non-traditional ETFs, including because they did not describe methods for supervisors to identify and address recommendations that potentially were not in customers’ best interests.

FINRA then identified the types of controls it expected to see by describing what was missing. The firm did not implement supervisory tools such as alerts or exception reports to detect recommendations that potentially were not in customers’ best interests, and it did not provide training to representatives or supervisors regarding the terms, features, and risks of non-traditional ETFs. Those observations tie directly back to FINRA’s earlier guidance. Regulatory Notice 09-31 reminded firms not only about compounding risk but also about the need to train registered persons on the terms, features, and risks of ETFs they sell, and specifically emphasized understanding and considering the risks of leveraged and inverse ETFs. Regulatory Notice 12-03, as described in the AWC, reminded firms of heightened supervisory obligations for complex products and encouraged periodic reassessment and procedures to monitor how products performed after approval.

The customer-impact section is equally revealing because it shows what FINRA considered a red flag. FINRA found that the firm failed to detect and address 47 instances in which a representative recommended daily-reset non-traditional ETFs to 36 retail customers in situations that potentially were not in the customers’ best interests, and that these customers, including seniors, had investment objectives other than speculation and held positions beyond intended holding periods. FINRA then gave concrete examples that, from a best-interest perspective, practically read like a checklist of what not to allow to happen unnoticed: one senior customer with a moderately conservative risk tolerance held a daily-reset position for 630 days and realized a loss of $5,935.72, while another customer with a moderate risk tolerance held a daily-reset position for 82 days and realized a loss of $14,635.57.

FINRA censured the firm, imposed a $25,000 fine, and ordered restitution of $20,571.29 plus interest. The AWC also notes that, in March 2024, the firm adopted procedures prohibiting its representatives from recommending non-traditional ETF purchases to firm customers, which underscores a point practitioners see repeatedly: after enforcement, firms often decide that restricting a complex product is less costly than supervising it properly.

Lessons for Investors and Financial Professionals

For investors, the Arkadios matter reinforces an uncomfortable truth: harm does not always come from a product that is fraudulent or a strategy that is exotic. Harm can come from a product that is widely available but widely misunderstood, especially when the recommendation is treated like a routine portfolio allocation rather than a short-term trading tool. When a daily-reset product is held for months, the question is not simply whether the market moved against the investor. The question is whether the investor was ever told, in a way that was understandable and candid, that the product is typically designed for a one-day objective and may behave unpredictably over longer periods because of compounding.

If the investor’s objective was income, capital preservation, or even growth with moderate risk tolerance (not speculation), the mismatch between the objectives and the product’s risk profile becomes harder to justify, and FINRA’s description of the affected customers highlights exactly that kind of mismatch.

For financial professionals and their firms, the case is a reminder that Reg BI is enforced not only through post-trade reconstruction of a rep’s recommendation but also through a firm’s ability to demonstrate a real compliance architecture. The AWC’s critique is telling: it does not say the firm had no policies; it says the firm’s policies were general, not tailored, and not supported by tools and training capable of detecting and addressing recommendations that potentially were not in customers’ best interests. In other words, “we told reps to be careful” is not the same as “we built a supervisory system reasonably designed to prevent, detect, and correct.”

This is also where the investor’s perspective and the financial professional’s perspective converge—and where the firm’s role comes into sharper focus. Investors want recommendations that actually fit their objectives and time horizon, not just products that sound like they will. Financial professionals, in turn, need to be able to explain and support the recommendation under Reg BI’s Care Obligation, particularly when the product’s design is tied to a one-day objective. Those two aims align: if a daily-reset leveraged or inverse ETF is recommended, it should be tied to a truly short-term, customer-specific trading purpose. But it cannot end with a well-intentioned conversation at the rep level. The firm must also be able to show that it built the infrastructure to support that standard—through meaningful training on product mechanics and supervision designed to detect when these instruments are being held or used in ways regulators have repeatedly warned can undermine a retail customer’s best interest.

The practical takeaway is not that non-traditional ETFs can never be appropriate. The point is that the bar for recommending them to retail customers is higher because the product design is different, the risks are not intuitive, and regulators have been explicit for years about what they expect firms to do. FINRA’s emphasis on training, risk understanding, and heightened supervision for complex products, and the SEC’s emphasis on short-term objectives for daily-reset products under Reg BI, are not abstract principles. They are the basis on which enforcement actions are brought and supervised systems are judged.

If you are an investor, it is reasonable to insist on clarity before agreeing to a recommendation that depends on daily-reset mechanics. If you are a financial professional or a firm, it is equally reasonable to assume that FINRA will ask not only what the rep believed, but what the firm did—on paper and in practice—to ensure that the recommendation was in the customer’s best interest and that the risk of predictable misuse was actually supervised.

If you have questions about a leveraged or inverse ETF recommendation—whether you’re an investor trying to understand losses that don’t seem to match the market, or a financial professional navigating Reg BI documentation and supervisory expectations—AMW Law PLLC can help you evaluate what happened and what options may be available. We represent individual investors in securities arbitration and related claims, and we also counsel and defend financial professionals and firms in FINRA matters, regulatory inquiries, and compliance-driven disputes.