An investor needs to know the material terms of a security before agreeing to make a purchase. In the structured products market, there are some types of terms that the issuer and the investor may agree will be determined after they enter into an agreement to purchase on the pricing date. Typically, this issue arises in determining the “starting value” of the underlying asset for the note.
A few examples:
- A note linked to a non-U.S. index may have a starting value based on the level of that index on the trading day following the pricing. That level may be higher or lower than the level on the pricing date.
- A note may have a starting level that is based on, for example, the lowest level of the underlying asset during a fixed period after the pricing date. (Sometimes called an “optimal entry” note.) In that case, the starting level would not be known until well after the note has priced. In other notes, the starting level may be determined based on an average level of the underlying asset over a certain number of trading days.
- An index linked note may have had a market disruption event on the pricing date. In such a case, the note may have a mechanism for determining the starting level of the asset based on the market value of one or more index components on a date after the pricing date.
Impact on the Final Pricing Supplement
Under SEC Rule 424(b), the final pricing supplement has to be filed within two business days after the pricing date. Accordingly, in a note of this kind, the final pricing supplement, like the preliminary pricing supplement, may only contain the methodology for determining the starting level or other term, and not the “final number.” SEC Rule 423 permits the final pricing supplement to be dated after the date of the trade date, and any determinations made after the trade date, but before the filing, can be reflected in the filed document.
Rule 159 under the 1933 Act provides that, “for purposes of determining whether a statement includes or represents any untrue statement of a material fact or any omission to state a material fact necessary in order to make the statements made, in the light of the circumstances under which they were made, not misleading at the time of sale (including, without limitation, a contract of sale), any information conveyed to the purchaser only after such time of sale (including such contract of sale) will not be taken into account.”
How does this rule impact offerings with terms determined after the pricing date? Investors may not have the specific starting level of a structured note on the pricing date, and as noted above, the final pricing supplement may be prepared before that information is available. However, in these cases, the issuers and the underwriters satisfy their obligations to deliver the material information about the terms of the offering to investors by clearly explaining in the red herring (or base offering document, such as a product supplement) the methodology by which the starting level will be determined.
Conveying the Information to Investors after Pricing
The offering will price, and the final offering terms, such as the starting value, will be determined in the manner described in the offering documents. There may be no new prospectus delivery obligation as to the final information, since the investor has already received the material terms through the disclosure of the methodology. However, most market participants who engage in offerings of this type will convey the final information to investors. This may be done by amending the final pricing supplement, providing a short supplement to the final pricing supplement, or by having the investor’s broker confirm the final information by telephone or e-mail.
In offerings where one or more terms are determined after the pricing date, issuers, underwriters and their counsel should carefully determine:
- How the determination of the term is explained to investors, and whether that explanation is clear.
- When the determination of the term will occur, and who will make the determination.
- How investors will obtain information about the terms.