SEC tells some structured product issuers to improve disclosure

By Angela McDaniels

Tacoma, Wash., April 13 - The Securities and Exchange Commission said it sent letters to some financial institutions in April in an effort to improve disclosure in their future structured note offerings.

The letter recipients were asked to submit written responses within 10 business days from the date of the letter.

The SEC released an illustrative letter on Friday. The letters were sent by the corporation finance division's office of capital markets trends.

"We are writing this letter in connection with our review of takedowns of structured notes from shelf registration statements by financial institutions and have identified a number of areas in which we believe there could be disclosure improvements," the letter began.

The letter covered 10 areas: product names, product pricing and value, use of proceeds and reasons for offerings, plan of distribution, liquidity, issuer credit risk, tax consequences, reference asset or index disclosure, disclosure format and exhibits.

The letter recipients also were asked to provide written statements acknowledging that they are responsible for the adequacy and accuracy of the disclosure in their filings.

Product names

The SEC said note titles should describe the product in a balanced manner and issuers should avoid titles that stress positive features without also identifying limiting or negative features. Note titles using the term "principal protected" should also include balanced information about limitations to the principal-protection feature.

Product pricing and value

The SEC wants issuers to prominently disclose the difference between the public offering price of a note and the issuer's estimate of the fair value of the note.

In addition, the SEC has observed that some issuers will, for a limited period immediately following an offering, use values on account statements or provide repurchase prices to customers at levels that temporarily exceed the issuer's estimate of the fair value of the product. If applicable, the SEC wants issuers to disclose their usage of different values and prices in this manner and explain the potential impacts.

Use of proceeds

Issuers often provide disclosure explaining that they will use the proceeds of an offering for general corporate purposes and may use an unquantified portion for hedging transactions, the letter noted.

The SEC reminded issuers that regulations require them to disclose the approximate amount of the proceeds to be used for each purpose and, if the issuer does not have specific plans for a significant portion of the proceeds, to note the reasons for the offering.

In their response letters, issuers were asked to tell the SEC about trends or changes in their reliance on structured notes as a liquidity source.

Plan of distribution

The SEC said some issuers disclose that their affiliates might change the price and selling terms if all notes are not sold at the public offering price disclosed on the cover page.

Letter recipients were asked to explain the manner in which they conduct structured note offerings and whether any notes are sold to broker-dealers and not immediately resold to investors or are resold to investors at differing prices. In this situation, they were asked to explain why there may be different prices and what type of investor may receive a "better" price.

In some preliminary pricing supplements, issuers offer a range for certain terms such as the maximum return. Letter recipients who do this were asked to explain how the size of the range is determined, how the actual terms are established and when and how the actual terms are communicated to investors.

Liquidity

The SEC said an offering's disclosure should provide investors with a better understanding of the potential liquidity or lack of liquidity of any secondary market.

Issuer credit risk

The SEC said the risk that an investor is exposed to an issuer's credit should be disclosed on the prospectus supplement cover page in a "clear, consistent, and prominent manner."

Tax consequences

The SEC asked the letter recipients to explain their approaches to providing tax disclosures for the different types of notes offered and how they determine whether these disclosures must be based on the opinion of counsel.

Reference asset disclosure

The SEC said its view is that an issuer may not disclaim liability or responsibility for the information it discloses about the note's underlying asset or index. Issuers may, however, state that they have not undertaken any independent review or due diligence of publicly available information about the underlying asset or index. If needed, letter recipients were asked to revise their disclosure to be consistent with this standard.

Letter recipients were also asked whether they have ever disclosed hypothetical historical price information, for example in the case of a new index. If so, they were asked to explain what information was provided and how it was presented in a balanced manner.

Disclosure format

Usually, disclosures in structured note offerings are made through combinations of base prospectuses, underlying prospectus supplements and preliminary and final pricing supplements, which may make it difficult for investors to locate information. The SEC asked the letter recipients to explain what constitutes their disclosure packages for structured note offerings.

Exhibits

Each time an issuer conducts an offering, it may need to file certain exhibits if it has not already done so. Letter recipients were asked to explain their approaches to filing these and any other applicable exhibits.

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