The crash of an exchange-traded note (“ETN”) backed by Credit Suisse Group shows the increasing risks for investors in Wall Street’s highly complex exchange-traded products. The VelocityShares Daily 2x VIX Short-Terms ETN (TVIX), which is supposed to provide twice the daily return of the VIX volatility index, fell 30 percent on March 23 after Credit Suisse said it would be issuing new shares. Credit Suisse had stopped creating shares a month ago, unhinging the fund’s price from the index and leading to a premium over the indicative value that reached as high as 89% on March 21 before plunging to roughly 7% two days later.

As investors have sought to track the performance of indexes with lower fees than active funds, exchange-traded products have grown into a $1.7 trillion industry. More than one-half of all U.S. fund deposits over the past five years have been placed in exchange-traded products. The exchange-traded funds have generated scrutiny over whether they bring undue risks to financial markets, and whether investors understand how these funds work in employing derivatives to produce returns. These complicated, high-risk products are being sold not only to institutional investors, but also increasingly to unsophisticated retail investors.

The majority of exchange-traded products are exchange-traded funds, which track an index by holding the underlying securities. ETFs issue shares that trade on an exchange like stocks, and can issue new shares or redeem existing ones. By comparison, exchange-traded notes, or ETNs, like the one backed by Credit Suisse, issue unsecured securities that are supposed to deliver the return of an index. The issuer typically uses derivatives linked to the index to cover its obligations to shareholders. If the issuer cannot repay the notes, investors lose money. Issuers also may stop issuing or redeeming shares, separating the ETN from the security or index it was intended to track.

Investors in Credit Suisse’s VelocityShares Daily 2x VIX Short-Terms ETN lost approximately $340 million when the ETN dropped more than 50% over two days.

Exchange-traded products have come under regulatory scrutiny since 2009. The SEC examined whether they contributed to market volatility in 2010 and the infamous May 6, 2010 “flash crash.” But, we all are aware of the sluggish pace at which the SEC proceeds, so we don’t expect the regulators to take meaningful action any time soon. Investors who lost money in this ETN and other exchange-traded products may have been misled about the nature of the products. Investors should contact a lawyer who is well-versed in securities arbitration to discuss whether a claim exists to recover ETF or ETN investment losses from the brokerage firm that recommended the investment.

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