Here is what investors get told, before investing in one set of exchange-traded notes:

* You may lose all or a significant part of your investment in the ETNs if the index decreases or does not increase by an amount sufficient to offset the applicable fees and charges;

* The ETNs are intended to be trading tools for sophisticated investors and should be purchased only by knowledgeable investors who understand the potential consequences of investing in a volatility index and of seeking leveraged investment results;

* The ETNs are not linked to the VIX;

* If you hold your ETN as a long term investment, it is likely that you will lose all or a substantial portion of your investment;

* The market price of your ETNs may be influenced by many unpredictable factors;

If you don't understand what you're buying and you don't understand what you're getting into, avoid this investment like paying off your home mortgage depends on it. Right?

"That says it right there,'' said research analyst Henry Chien. "I don't know what more you can do,'' if you're an issuer like Credit Suisse of heavily structured exchange-traded products, like exchange-traded notes.

The notes in question here are the VelocityShares Daily 2x VIX Short-Term exchange-traded notes, which became a cause celebre in March.

That's because the shares, for a time, traded at an 80 percent premium to their net asset value, by Chien's reckoning, then plunged. Retail investors, trying to capitalize on market volatility, instead got caught in it. The Securities and Exchange Commission says it's investigating, as does the Financial Industry Regulatory Authority, the overseer of broker-dealers.

Credit Suisse, for its part, says it's cooperating with investigators. But otherwise is not commenting.

But those warnings that start on the first page are in the product pages that summarize the characteristics of these particular VelocityShares notes, in the registration statement filed in December 2010 with the SEC. And sitting in plain sight on the Credit Suisse site, for any investor that wants to see what the characteristics of the investment in these notes involves.

A good warning flag, for instance, might just be that the very first risk listed is that an investor "may lose all or a significant part" of an investment if the index on which it is based drops.

A second strong flag would be that a note that actually bases its drawing power on the fact that it is a "Daily 2x VIX Short-Term ETN" and in the same breath notes that is "not linked to the VIX" is probably worth stopping an investment in its tracks, if the investor thinks that somehow the note actually has a direct link to the VIX. Or, more pointedly, generates a return that is "2X' the movement of the VIX.

The VIX, of course, is the Chicago Board Options Exchange's index of the swings of stock markets. The Volatility Index. The Fear Index. The thing that has pretty much made the CBOE a hot venue for contracts that bet on future movements of the Standard & Poor's 500 stock index.

But the VelocityShares Daily 2x VIX Short-Term ETN instead is an investment in a debt obligation of a bank. These notes are "senior, unsecured obligations of Credit Suisse AG acting through its Nassau branch. The return on the ETNs is linked to twice the daily performance of the S&P 500 VIX Short-Term Futures Index less the investor fee.''

Translate: If something goes wrong, your investment is "unsecured," or probably worthless. The investment is "linked" to some sort of short-term index of future movements of the VIX. But not the VIX itself.

Buyer beware.

The nut nut: Only professionals need apply for these exchange-traded notes.

And even they could get caught in the damage, when unexpected events actually do come about.

On February 21, Credit Suisse, as it notes in its amended prospectus for these notes, "temporarily suspended further issuances of the 2x Long VIX Short Term

ETNs due to internal limits on the size of ETNs." The apparent meaning: That it could not issue more shares, without crossing its own 'internal limits' on holdings of a particular security or affecting the underlying value of the obligations themselves.

That drove up the value of the notes, to the surprise of Morningstar exchange-traded product analyst Timothy Strauts.

"Logic would tell you it would go to a discount,'' he said, because the amount of shares being created did not meet demand. "Unfortunately, that was not the case.''

Instead, demand for a scarce product pushed up the price far beyond its asset value, Chien noted. Which reflects basis supply-and-demand economics.

That led to the bubble that burst, in fairly short order in March. And the investigations of how investors got hurt.

On March 23, Credit Suisse began to issue more notes into inventory. And said it made issue more notes to market makers, starting March 28. But on April 2, the company would not confirm if that second step had started to take place.

Meanwhile, market analysts like those at Morningstar sent flares out that ETNs should be avoided, except by the most sophisticated market participants.

Analyst Samuel Lee sent out a report that " Exchange-Traded Notes Are Worse Than You Think.''

In it, he argued and Strauts concurred that exchange-traded notes are vastly different from exchange-traded funds. And have greater risks, since they trade, to a significant degree, on the reputation of exchange-traded funds for low costs, transparency and ease of understanding of what they are about.

On the cost front, Morningstar notes that many exchange-traded notes do not calculate their fees the same way that exchange-traded funds do.

For instance, Strauts says, many ETNs calculate their fees on the average of the value of the assets they have held, since inception.

So, if the value of a batch of ETNs was to suddenly plunge, as occurred in the wake of the credit crisis of 2008, the fee that would be charged to investors was not 1 percent of the current value of the fund, but 1 percent of the value of the fund since inception.

Which would mean a charge of much more than 1 percent on the current value of the notes, at the very time the notes had hit new lows.

Other examples of 'investor unfriendliness,' Lee would say, are index calculation, futures execution and event risk hedge fees, not found with ETFs.

Unlike mutual funds and most exchange-traded funds, ETNs are not registered under the Investment Company Act of 1940, or the '40 Act, which obliges funds to have a board of directors with fiduciary responsibility and to standardize their disclosures.

ETNs, on the other hand, are what Morningstar calls "weakly standardized contracts, presumably between two sophisticated parties."

Yet many investors conflate the two. Where an ETN investor should fear what he doesn't know, he instead is gulled into thinking he understands the risks and costs he bears, Lee said.

Tom Steinert-Threlkeld writes for Securities Technology Monitor.


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