A court in the Southern District of New York recently dismissed a case brought by investors against Credit Suisse related to the VelocityShares Daily Inverse VIX Medium-Term Exchange Traded Notes ("ZIV ETNs") and the sufficiency of the disclosure in the ZIV ETN offering documents. While this case was specific to the ZIV ETNs, the opinion highlights the disclosure expectations regarding volatility-linked exchange traded products that issuers should consider (in addition to the FINRA guidance regarding sales of volatility products, which we have previously discussed here).

As a result of a spike in market volatility, Credit Suisse hedged its exposure as the issuer of the ZIV ETNs in the market using, among other thing, the same futures contracts used to determine the level of the S&P 500 MidTerm VIX Index, the index underlying the ZIV ETNs. As volatility continued to increase, this hedging activity contributed to the trading volume and adversely affected the market price of the relevant futures contracts – effects that were exacerbated by thin liquidity. Investors, as a result of the volatility spike, suffered significant losses on the ZIV ETNs.

The ZIV ETN plaintiffs brought claims under both Section 11 of, and Regulation S-K under, the Securities Act of 1933, alleging that there were material omissions in the ZIV ETN disclosure regarding key risks, including Credit Suisse's hedging activity and its effects on market levels, liquidity in futures markets for VIX contracts and investor suitability.

The court, in its review of the offering package, recognized that the ZIV ETN offering documents provided extensive disclosure regarding potential hedging activity, making clear that Credit Suisse intended to hedge its obligations through one or more affiliates and that such activity could contribute to the trading volume of the underlying futures contracts and affect the market price. Credit Suisse also made clear that it could receive positive returns on its hedging activities while the value of the ZIV ETNs declined. The disclosure also included warnings that the market price of the ZIV ETNs may be influenced by the liquidity of the underlying futures contracts or related futures and derivatives contracts and that futures markets are subject to temporary distortions due to factors including lack of liquidity. The court was clear that it viewed these disclosures as sufficient, and that it was unnecessary for Credit Suisse to state the risks with certainty (i.e., "would" rather than "could" or "may") or for it to describe prior spikes in the VIX futures market given that this information was otherwise publicly available. The lack of disclosure regarding historical performance (and forecasts of future performance based on historical performance) where that information is otherwise publicly available has been consistently supported for volatility products and, more generally, for other types of structured products.

The ZIV ETN disclosure also warned that the ZIV ETNs were inappropriate for certain investors and outlined suitability considerations. Credit Suisse specifically disclosed that the ZIV ETNs were appropriate only for sophisticated, knowledgeable investors that were willing to sustain significant or even total losses on the investment. The disclosure also specifically warned that the ZIV ETNs were only suitable for very short investment horizons and warned against long holding periods even within the course of a single day. As a result, the court dismissed plaintiffs' claim.

The opinion also specifically referenced the extensive warnings that an investor may lose a significant portion or all of its investment in the notes in addition to the more detailed risk discussion described above. The opinion also emphasized the prominence, based both on repetition and formatting, of this disclosure, making clear to investors that there was a potential of large or even total losses. Ultimately, due to the warnings regarding potential losses, in combination with the disclosures regarding hedging and market liquidity and investor suitability, the court dismissed the plaintiffs' claims.

Originally published in REVERSEinquiries: Volume 3, Issue 7.
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Originally published 22 July, 2020

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