In June 2014, the U.S. District Court for the Southern District of New York granted Credit Suisse’s motion to dismiss a class action arising out of the Velocity Shares Daily 2x VIX Short Term ETN.9 As many readers of this publication know, the value of this ETN decreased significantly in 2012 when the issuer temporarily suspended the issuance of new ETNs.
The decision is a useful reminder of the importance of careful drafting of prospectus and pricing supplement risk factors. The following table identifies some of the plaintiffs’ claims, and the relevant prospectus language or analysis that helped to overcome the claims:
Click here to view table.
The decision relies to a significant degree on the risk factor disclosures set forth in the prospectus. However, the decision also includes cautionary language that reminds practitioners that there are limits on what risk factors they can reasonably expect to anticipate:
Whatever formula is used to determine an investor’s return, to the extent that it relies on future values of an underlying index, which cannot be known in advance, it is not a material omission to fail to predict future market performance.
The liability provisions of the 1933 Act do not require the disclosure of publicly available information, such as historical volatility trends.10
Detailed computations are not necessary in order to describe the fundamental risk associated with volatility and daily rebalancing; when the prospectus warns of a risk that later materializes, investors will not have a Section 11 claim.
Once a risk has been properly disclosed, the prospectus is not necessarily required to predict the precise effect that will follow from a manifestation of that risk.
The Southern District’s decision is a useful reminder to issuers, underwriters and their lawyers to consider carefully the nature of the risks inherent in the products they are offering and to tailor the disclosures to address them.11