As market participants prepare for the effective date of the European Union's "key information document" ("KID") requirements, they must address a variety of drafting and operational issues.9 In this article, we discuss some of the aspects as to the interplay between the contents of KIDs and the U.S. federal securities laws, particularly where a KID is used in an offering registered under the Securities Act of 1933 (the "Securities Act"). For example, in the context of a U.S. registered offering, there may be sales of a particular structured note to retail investors in the EU, as to whom there is an obligation to deliver a KID. That is, while the offering is principally designed for U.S. investors, the relevant broker-dealers may wish to distribute a portion of the offering to selected European retail investors.
Summary of KID Requirements
In many respects, the contents of a KID will resemble the contents of a summary term sheet prepared for a U.S. registered offering. For example, both types of documents will identify the key terms and the key risks arising from the relevant product.
However, the form and content requirements for the KID are highly prescriptive, including the title headings and order in which information is presented. These requirements mean that a KID would contain a number of significant disclosures that are not currently included in typical U.S. structured note offering documents:
· a summary risk indicator for the product (numbered from 1 (least risky) to 7 (most risky)), supplemented by a narrative explanation of this indicator; and
· a section entitled "How long should I hold it and can I take money out early?", which is designed to indicate the potential consequences (and payments) from selling the product before the end of the term.
We specifically have identified these items, as they potentially raise disclosure issues for offerings regulated by the U.S. securities laws. For example, especially in the context of a short-form document such as a KID (which is not allowed to exceed three pages of A4 paper10 in length), that provides only limited room for qualifications and explanations, these types of disclosures may, to a U.S. practitioner, seem potentially inadequate or speculative, unless accompanied by a somewhat longer explanation of factors that describe the underlying assumptions and the limitations of the information shown. Put another way, while the disclosures will be required under EU regulations, they may create significant additional liability concerns when used in the context of an SEC-registered offering.
Analyzing a KID Under the SEC Rules
To understand the use of such a document in an SEC-registered offering, we turn to the SEC's rules relating to free writing prospectuses. After all, in one sense, these are offering documents that do not take the form of an SEC statutory prospectus.11 Because they would be delivered to an investor after the final terms are determined for an offering, they could be considered a "final terms" free writing prospectus, requiring filing via EDGAR within two business days, per Rule 433(d)(1)(i)(C).
Taking such an approach may not be very desirable in the context of a public offering:
· the disclosures in the KID, such as the new ones discussed below, would not (at least under current practice) be provided to U.S. investors in the offering, potentially creating a question as to whether all investors were fairly treated and received the full disclosures;
· the issuer and other parties could be subject to U.S. securities law liabilities for the content of these documents, which differ in some respects from those of typical U.S. offering documents; and
· in the case of "ineligible issuers," some of these disclosures may appear to go beyond the permitted disclosures under Rule 164.
How can participants in U.S. registered offerings address these issues? We discuss in this section a few possibilities that have been considered by market participants.
Adding Disclosures to U.S. Offering Documents. One approach would be to take the new disclosures and add them to the U.S. offering documents for the relevant offerings, such as red herrings. Doing so would ensure that all investors in an offering have comparable access to them before making an investment decision. However, as discussed above, these types of disclosures might be viewed as problematic in the context of a U.S. offering and could expose the issuer and other parties to potential liabilities.
Provide the New Disclosures Solely in the Context of a KID. This approach is the exact opposite to the approach in the prior paragraph. It would mirror the approach that was followed for many years in the context of debt offerings that involved a "Canadian wrapper." In these offerings, relevant Canadian offering rules required the delivery of a variety of disclosures, particularly relating to potential Canadian securities law liabilities and rescission rights, to Canadian investors. The U.S. offering documents would be "wrapped" in the pages for these disclosures, and they would be furnished solely to Canadian investors, without any filings being made in the U.S. under Rule 433 or otherwise, and without delivery to U.S. investors.
From a U.S. securities law perspective, no U.S. disclosures or filings were viewed as necessary for these Canadian documents. They related to jurisdictional matters that (a) were required only under particular Canadian rules, (b) were relevant only to Canadian investors, and (c) would be immaterial to U.S. investors. In the present case, while "a" would be true as to the KID disclosures, it is less clear that "b" and "c" would be the case.
Use Different Program Documents. Of course, most major issuers of structured products in the U.S. have analogous EMTN or similar programs that they use in Europe for offerings intended principally for European investors. These issuers could simultaneously offer securities with substantially identical terms (a) to U.S. investors under their SEC-registered programs, and (b) to European retail investors under their European program. Each offering would conform solely to the rules of the relevant jurisdictions, such that only the European retail investors would receive the disclosures in the KID. This approach would presumably help an issuer defend the delivery of different "disclosure packages" to different types of investors each investor would receive solely the disclosures required under the relevant rules and regulatory framework. However, taking this approach would impose the paperwork and administrative burden of preparing a duplicative set of offering documents in connection with the relevant offerings. In addition, some distributors may not know whether there will be European retail purchasers in an offering until relatively late in the offering period. In any event, to the extent additional disclosures and risks about an economically comparable product are set forth in the KID that are not in the U.S. offering documents, an issuer could possibly face claims that U.S. investors were not provided with all of the relevant disclosures.
A Chilling Effect?
U.S. market participants have not yet determined a consistent approach to addressing these issues. If unable to resolve this conundrum in a satisfactory manner, some issuers and product manufacturers may decide that it is easiest to simply avoid selling U.S.-registered structured notes to European retail investors. Of course, if that is the result, it would be another example of financial regulation reducing investor options in the relevant market.