SEC's letter on disclosure may be counterproductive, buysiders say

By Emma Trincal

New York, April 16 - Some financial advisers reacting to the Securities and Exchange Commission's letter recently sent to some financial institutions regarding structured note offerings disclosure said they were disappointed by the agency's efforts to improve disclosure.

In its letter released Friday, the SEC asked the letter recipients to submit written responses within 10 business days from the date of the letter.

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.

Among some of the key points issuers are being asked to disclose are the difference between the public offering price and the estimate of the fair value of the note. Issuers were also told that product names should be more balanced and not simply stress the positive features, secondary pricing should be more transparent, the liquidity or absence of liquidity should be better explained, plans of distribution to brokers and to clients should be explained, the issuer should disclose if it has not undertaken any independent review or due diligence of publicly available information about the underlying asset or index, and firms should also explain how they came up with tax opinions.

They don't read!

"I think it is good for the industry," a sellsider said.

But financial advisers who are in direct contact with clients were not that impressed.

"It seems to me that the SEC letter does nothing but add more information, more complexity," a financial planner said.

"The problem with these offerings in general is the complexity. It's not always written in plain English, and you have this half-an-inch document as if you were signing up for a limited partnership.

"You'd be better off with a two-page fact sheet. It would help the adviser understand the big picture first and see if it has any value to the client. Then you can read the details.

"Right now, the main problem is that investors don't understand all this information. The client's responsibility is to read the offering documents, which they don't do. Nobody wants to read 65 pages written by lawyers. And they don't.

"Myself, I want to be able to find out quickly whether the product makes sense in my portfolio and whether I should recommend it to my client. Then I can go to the offering document."

Another issue, this planner noted, is that the SEC's letter seemed to focus on the same points already covered in the existing language.

"It's going to be irrelevant. A lot of what they're asking is already there," he said, pointing to the letter's liquidity paragraph, or item No. 8, in which the SEC asks issuers to provide investors with a "better understanding" of the "potential liquidity or lack of liquidity" of any secondary market.

"They already do that," he said.

This planner agreed that the regulator has a role to play. But he said that the general aspect of the letter indicates that the agency may be missing the point.

"It's true that structured notes are more complex than traditional investments, which is OK. What's not OK is that you have many brokers who offer them as if they were ETFs or mutual funds. There must be a policeman on the beat. But I don't think they're doing anything really helpful with this letter. This looks to me like a lawyer's job security act," he said.

Another buysider, a registered financial adviser, also said that the letter's recommendations may not encourage his customers to read the prospectus.

"When the SEC comes in and says they want more disclosure, I actually think it hurts the end client. Those offerings documents are huge; they're hard to read, not to say to understand. The client ends up not reading it because it's too long and too complex," he said.

"What you need is less disclosure but clear, concise and consistent disclosure of information. They're going in the wrong direction."

Comparing products

In addition, this adviser said that the SEC failed to address an ongoing problem for the buyside as a whole, which is the lack of categorization for the products. Many have advocated the use of a nomenclature of products as a tool to better evaluate them, as it is the case in other countries, notably in Switzerland.

"We should have an executive summary on page one. Five things on the front page. You should be able to hand the client a simple piece of paper," he said.

"The information should be more structured. You've got to be able to compare apples to apples easily.

"Sometimes, more information is less useful. I'm not saying that the issuer should not disclose the information. There are some items that are not in the documents right now and should be.

"For instance, we shouldn't have to look up the credit rating or the CDS spreads of an issuer. We shouldn't have to look up for the annualized standard deviation of the underlying index this thing is going to be invested in."

This adviser, however, noted a few positive aspects in the letter. For instance, he liked the paragraph on credit risk.

"I agree with their item number nine when they ask that issuer's credit risk be disclosed on the cover page in a clear, consistent and prominent manner. I applaud. I don't mind if they hit people over the head with the right requirement," he said.

The aspect on pricing is likely to be unwelcome by issuers, he guessed.

"But really, I'm not sure it means much for the investor. They ask the issuer to explain in the document the difference between the offering price and the fair value of the note. An option is going to cost more when the asset is more volatile. Nobody would ever think of saying that a Bentley is not a good car because it's expensive," he said.

Overall, the adviser said that he was pessimistic about the impact of the letter on industry practices.

"These new requirements add more layers of information, which may not necessarily help the investor. The SEC feels better, but you're not accomplishing the main goal, which is to protect investors. You need to give the relevant information that they can understand. Just adding 10 pages of disclosure is not going to help," he said.

Asked to comment about the recent letter, Keith Styrcula, chairman of the Structured Products Association, said, "My only comment is that we're reviewing the letter with SPA's legal and compliance committee and expect to have some reaction in the next few days."

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