Bloomberg News

SEC Seeking Fair Value Disclosure From Banks on Structured Notes

April 17, 2012

The U.S. Securities and Exchange Commission is asking banks that issue structured notes to boost disclosures to investors, including the banks’ own estimates for the securities’ market value at the time of sale.

The regulator sought the changes in a letter to banks it didn’t identify that was posted on its website April 13. The agency also asked the issuers to explain how they set up a secondary market for the notes, how they use the proceeds raised from sales and how important the business is to their funding needs.

The U.S. structured note industry, which sells bank bonds bundled with derivatives for customized bets, has come under scrutiny from regulators for the securities’ complexity and lack of transparency. Some notes have higher fees than their potential returns. Banks sold $45.9 billion of SEC-registered securities in 2011, down from a record $49.5 billion a year earlier, according to data compiled by Bloomberg.

“The SEC finally understands these products,” said Frank Partnoy, a University of San Diego law professor and former Morgan Stanley derivatives structurer. “I’m very encouraged by these questions that the SEC is asking.”

Florence Harmon, a spokeswoman for the SEC, declined to comment. The letter was sent by the Office of Capital Market Trends with a request for a written reply within 10 days. The office, created in July 2010 and headed by Amy Starr, is within the Division of Corporation Finance.

If banks included the disclosures that the SEC wants, demand for structured notes would suffer, Partnoy said.

‘Completely Opaque’

“The secondary market for structured notes is completely opaque, and people don’t have an accurate understanding how much they are worth the day after you buy them,” he said in a telephone interview.

In sale prospectuses for the securities, banks disclose certain fees, such as those paid to distributors, though they aren’t required to estimate the value of the products at issuance.

“We believe issuers should consider prominently disclosing the difference between the public offering price of the note and the issuer or its affiliate’s estimate of the fair value,” the SEC said in the letter.

The regulator also said it has observed that some banks have used inflated values of securities on account statements “for a limited period of time immediately following an offering.” It asked banks to explain how that affects pricing and trading.

The Financial Industry Regulatory Authority issued a notice in January to guide firms about the supervision of sales of “complex products,” citing some structured notes as examples. As many as 10 states are also investigating how some of the investments are being marketed, Ronak Patel, co-head of a working group for the North American Securities Administrators Association, said in a Feb. 2 e-mail.

Derivatives are contracts whose value is derived from stocks, bonds, currencies and commodities.

To contact the reporter on this story: Matt Robinson in New York at mrobinson55@bloomberg.net

To contact the editor responsible for this story: Alan Goldstein at agoldstein5@bloomberg.net.


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