Exchange-traded funds have become the latest investment product to fall under the SEC's radar.

The SEC said it will review the ETF market to ensure it is “transparent” and not generating market volatility. The decision, announced at a Senate Banking subcommittee hearing on Wednesday, marks the second time the regulator has investigated investment companies.

In August the SEC sought industry comment on how it should oversee the use of derivatives by mutual funds and ETFs. In March, the SEC suspended requests from exchange traded funds that wanted to invest in derivatives pendng the outcome of its review into derivatives by investment companies.

"Commission staff is currently engaged in a general review of exchange-traded products in connection with, among others, the adequacy of investor disclosure, liquidity levels and transparency of underlying instruments in which ETFs invest, fair valuations, efficiency in the arbitrage process and the relationship between market volatility and ETFs," said SEC Investment Management Director Eileen Rominger in prepared remarks for the Senate Banking subcommittee.

Exchange-traded funds track market indexes and trade on exchanges. The $1 trillion market has generated plenty of interest as a result of the flash crash in May when ETFs experienced massive intraday price swings and made up a large percentage of cancelled trades. Since then the SEC has implemented circuit breakers to help prevent another major market drop. The SEC has also warned investors about using so-called leveraged ETFs and inverse ETFs.

While ETF experts praise the SEC for its formal review of the ETF market, they also believe that investors and financial advisers should do their part. There is plenty of information readily available.

“They [investors and advisers] should wade through the most intensive document an ETF publishes – either part B of its prospectus or its statement of additional information,” recommends Gary Gastineau, director of ETF Consultants, an ETF consultancy in Summit, N.J. “Reading the prospectus is sufficient about 90% of the time but for an extra precautionary measure, investors and advisers should review the statement of additional information to provide more details on the product and the investment risks.”

-- This article first appeared on Securities Technology Monitor.



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