A Raft of Risks: Assessing FINRA’s New Alert on Exchange Traded Notes

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Headline news charting the dramatic peaks and valleys of select Credit Suisse and Barclays properties prompted the Financial Industry Regulatory Authority Inc. (FINRA) to issue a July warning to investors detailing the potential risks inherent to exchange-traded notes (or ETNs). The investor alert, entitled “Exchange Traded Notes – Avoid Unpleasant Surprises“, details vital notices to consumers on the nature of such properties.

“ETNs are complex products and can carry a raft of risks,” said Gerri Walsh, FINRA’s Vice President of Investor Education in a July 15th statement to Investment News. “Investors considering ETNs should only invest if they are confident the ETN can help them meet their investment objectives, and they fully understand and are comfortable with the risks.” Unfortunately, all too often these risks can be hidden from investors by their financial advisor.

Many investors may believe that ETNs are just like exchange-traded funds (or ETFs). However, despite their similar naming and being commonly categorized together, ETNs are quite different than ETFs. ETFs can be essentially characterized as a grouping of bonds or stocks that trade within the same day on an exchange. ETNs meanwhile, do not in fact hold anything, but rather are bank-drafted promissory notes intended to deliver the returns of an index. Unlike an ETF, an ETN in many respects is an uncollateralized loan to a bank, albeit one that offers theoretically great rewards to an index’s return. The value of an ETN is largely dependent on the given day’s market value of the index it tracks.

The risk within ETNs comes when that bank is no longer able to issue new shares. This moment can arise either when the bank can no longer practically hedge against the index, or when the peak number of shares has been reached. When the peak has been reached and there are no new shares to offer, continued demand for them can force shares to a premium over the total asset value. In addition, there is also the potential that the issuer can default on the note, or otherwise prove a detriment to its value.

In addition, ETNs are not under the confines of the Investment Company Act of 1940, which requires funds to have a board of directors and issue standard disclosures. For banks and other issuers, an ETN is a win-win situation: inexpensive to run and inclined to shift risk to the consumer. Yet many investors may be left bearing heavy losses when the ETN market goes against them.

It is the right of any and all investors who believe they may have suffered losses as a result of recommendations of their financial advisor to contact our offices to explore their legal rights and options. If you or a family member suffered losses through an investment in exchange traded notes, contact the securities fraud lawyers at Malecki Law for a free consultation and case evaluation at (212) 943-1233.