We conducted an informal analysis about cover page disclosures for structured notes. We looked at the pricing supplements for offerings from two different issuers that each had a fairly common structure:
- 3x upside to a cap.
- 1-1 downside.
- No interest payments.
One pricing supplement expressed this structure with 1,133 words on the cover page. The other, did so with only 424 words.
Industry participants would read these cover pages and quickly realize how similar these two products are. But if a retail investor had each pricing supplement in hand, that investor might not realize so quickly how similar these offerings are. At least at a superficial level, these two offerings might seem somewhat different.
Of course, this quick study simply reveals what readers of this publication already know: disclosure documents and styles can vary significantly from issuer to issuer, and underwriter to underwriter. But what are the actual requirements of a structured note cover page? This article attempts to discuss that question.
Of course, in the context of a registered public offering, we look first to Regulation S-K under the Securities Act of 1933 to tell us the black letter law of cover page disclosures. These requirements are set forth in Item 501(b). The cover page must:
- set forth the issuer’s name;
- set forth the title of the securities,1 and the amount being offered;
- provide a brief description of the terms of the securities;
- set forth the public offering price2 and the underwriting discount;
- indicate whether the securities will be listed on a stock exchange, providing the trading symbol (if applicable);
- set forth a cross-reference to the risk factors section;
- set forth a legend that the SEC has not approved of the securities or the offering;
- identify the underwriters,3 and, if the offering is not a “firm commitment underwriting”, describe the nature of the plan of distribution; and
- set forth the date of the prospectus.
Item 501(b) requires the cover page to be limited to just that—the cover page. Of course, this can be a bit of a challenge in the case of complex products or complex underliers.
The SEC Weighs In
As you know, the SEC has taken an active interest in cover page disclosures. As a result of the SEC’s 2012 sweep letter and its aftermath, pricing supplement cover pages for structured notes now include:
- estimated value disclosures.
- a reminder that payments on the notes are subject to issuer credit risk.
In addition, where the issuer is a bank holding company (and not a bank), the SEC has historically encouraged issuers to remind investors that these debt securities are not bank deposits, and are not insured by the FDIC.
FINRA Corporate Financing Rule
One additional small requirement emanates from the FINRA rules. Where the underwriter is affiliated with the issuer, in order to obtain the exemption from FINRA filing for investment grade securities, the cover page of the offering documents for a non-registered offering must indicate that the conflict exists, and cross-reference the “Conflicts of Interest” subsection of the “Plan of Distribution” section. (FINRA Rule 5121(a).) Many registered offerings follow this approach as well (in addition to the separate, but related, “table of contents” requirement that does apply under the FINRA rules to registered offerings).
In addition to the required disclosures, some market participants have added a variety of additional provisions to their cover pages:
- suitability considerations;
- key risk factors, particularly the potential loss of principal (for “non-principal protected” notes);
- “structuring costs” and similar amounts; and
- explanations of the compensation that “selected dealers” will receive from underwriters
Regulatory capital changes in Europe (and expected ones in the U.S.) will potentially cause some types of structured notes to convert into equity securities in the event of a failure. This feature also has been added to cover pages.
Additional Marketing Materials?
Needless to say, different market participants have different views as to the best way to present all of the above information, and which of the “optional” information is best suited for a cover page. (The answer may depend upon the nature and sophistication of the investors.) That being said, the combination of regulatory requirements, and occasional complexity of structured notes, often leads to cover pages that not everyone will agree are the optimal solution. Accordingly, many market participants also rely on additional marketing materials, such as term sheets and offering summaries, to help present information in the manner that they believe is most helpful.