Some sellsiders voice concerns, criticism of SEC's letter on disclosure

By Emma Trincal

New York, April 19 - The Securities and Exchange Commission caused some uproar when it sent to firms a letter asking them to improve document disclosure in their future structured notes offerings, according to sellside sources.

Sources said that the regulator raised irrelevant issues already addressed in existing documents or that it missed the key points that should be fixed. In addition, they judged that the agency's wording and recommendations were oftentimes vague and somewhat confusing.

"It seems to me that most of what the SEC is requesting is either done today in practice or will be very difficult to do because it asks for future commitments," said Michael Iver, founder of iVerit Consultancy and a former structurer at JPMorgan.

The letters were sent earlier in the month. The SEC released an illustrative letter on April 13.

Fair value

The No. 2 item in the letter pertaining to product pricing and value was seen as one of the most problematic.

The letter's author, Amy M. Starr, chief of the SEC's office of capital markets trends, asked issuers to "prominently disclose" the difference between the public offering price of a note and the issuer's estimate of the fair value.

"Tell us how much you're making. Good luck with that!" a New York structurer said.

"Do you require Apple to disclose how much they make on each computer?

"Fair value? Fair to who? What if your estimate is wrong?

"They write it in a way that makes no logical sense. What you get is the compliance officers running to their lawyers, who can't possibly figure out what this nonsense is all about."

Kenneth Lench, the agency' structured and new products unit chief, did not return a call seeking comment.

A sellsider agreed.

"It's a little bit misguided on the part of the SEC to think that people are going to divulge this," he said.

"From the issuer's point of view, they don't want for any product to be disclosing their profit margin.

"Everybody assumes that the firm issuing the notes is making money. Whether it's reasonable or not, who is to judge? If you ask 15 people if it's reasonable, you'll get 15 different answers."

For some, the issue of pricing disclosure was not even that clear. They wondered whether the SEC was trying to address the transparency concerns over commissions associated with distribution or if it was trying to force issuers to disclose how they price the embedded options and hedge the structure.

Deja vu

Market participants also expressed a sense of deja vu.

A source said that the letter brought up old issues "over and over again."

Another said that the SEC in its recommendations was attempting to fix what was already in place and working.

"Since the Lehman bankruptcy, all prospectuses clearly define issuer credit risk and the inapplicability of principal protection in regard to such risk," Iver said.

Liquidity risk also appears to be an old story to those sellsiders.

In its letter, the SEC wants issuers to "provide investors with a better understanding" of the potential illiquidity in the secondary market.

"Who defines what is 'better?'" asked Iver.

"Liquidity ... What else can you do? It's already disclosed in great detail. It's already being done," the structurer said. "All of this is kind of redundant."

Missing the point

Another criticism addressed to the regulator was that its recommendations may have unintended consequences.

"I think they're missing the point," the sellsider said.

"Salespeople want to see their clients read the documents. But the more information you put on the documents, the less it's going to happen. The majority of those clients will not understand what it means."

For the structurer, simplicity already exists in other documents, but clients rely too much on their advisers.

"We already have fact sheets, brochures, all of that regulated and approved by the SEC. There's really nothing they can do. If people choose to be stupid or not to read, you can't force them to act differently," he said.

Because the wording is already complex, even for the advisers who sell the products, the structurer predicted that the new measures, if adopted, would be hard to enforce.

"People don't read; you can't regulate that," he said.

"They're doing this so they can say 'We've done it!' It doesn't work. At least they can tell the politicians they've done it. They don't care if it slows down the business.

"None of this is enforceable. None of this will work."

Irrelevant

The notion that some of the items underlined in the letter have no significance for issuers and investors alike suggested for some a cultural gap between the firms and the agency.

"Our regulators, just by their choice of words, are always showing a disturbing, deep misunderstanding of the financial markets," the structurer said.

In its letter, the SEC asked the issuers to be more specific on how they intend to use the proceeds of their offerings.

"These notes are always issued to satisfy an investor's goal, so the use of proceeds looks to be not relevant to the investor," Iver said.

The structurer said that policing unsuitable sales practices or excessive concentrations should be the regulators' focus.

"But they're taking it on to the issuers while issuers are doing everything possible with the help of their lawyers who do everything they can to protect investors. Picking on issuers is stupid," he said.

The sellsider, echoing some of the concerns voiced by financial advisers as previously reported, said that one step in the right direction would have been to motivate issuers to make the prospectuses easier to read.

But the letter was not going in that direction, he said.

"Standardization would have helped. Everyone wants to see more simplicity," he said.

"But the SEC is not going to dictate a standard format for disclosure, so at the end, it's just going to be more wording and more confusion."

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

The Structured Products Association is reviewing the letter and expects to come up with a response "in the next few days," according to an email from its chairman, Keith Styrcula, who declined to comment.

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