SEC shines light on derivative backed notes

Bloomberg reports that the SEC is pushing the large banks to disclose to investors just how much money they are making on derivative backed notes.

Specifically, the large banks will be required to say how they value the securities.

Lenders from JPMorgan Chase & Co. to Bank of America Corp. that sold $51 billion of securities backed by equity derivatives the past two years are being pushed by regulators to disclose that the banks valued the debt as much as 10 percent less than customers paid. 

Banks are being given 10 days to tell the U.S. Securities and Exchange Commission whether they will comply with rules intended to increase transparency in the structured-notes market, the SEC said in a letter sent to some banks this month.  

Goldman Sachs Group Inc., Bank of America, and Royal Bank of Canada began disclosures as early as May on securities sold at prices that were typically 2 to 4 cents on the dollar more than where the banks valued them, data compiled by Bloomberg show. 

Regulators are increasing oversight of equity-linked note sales that have soared 39 percent the past two years as investors buy them as an alternative to traditional bonds with record-low yields. 

The securities generally are sold to individuals who lack pricing models employed by banks to value the securities, which use derivatives to boost yields. 

“These are complex and opaque products, and the more sunshine and disclosure, the better,” said Jacob Zamansky, a lawyer at Zamansky & Associates in New York representing investors in lawsuits over structured notes. “It’s important that the SEC focus on the disclosure of structured products because they’re exploding in sales to ordinary retail investors.”

Please re-read the highlighted text again and recall Yves Smith's dictum:  nobody on Wall Street is compensated for creating low margin, transparent products.

These securities are just another example of Wall Street profiting behind a veil of opacity.

The five-page letter sent to banks Feb. 21 doesn’t set a date for when all structured-note issuers must include market valuations in offering documents. The SEC will require banks to provide a “narrative disclosure” of how it valued the securities.

They also will be required to explain why the value they place on the note may be higher than the price at which an investor could sell the security on secondary markets immediately after being issued, according to the letter. 

Regulators “believe that investors should be able to understand the difference between the issuer’s valuation and the original issue price that they are paying for the structured note,” the SEC said in the letter, signed by Amy Starr, head of the agency’s capital markets trends office in Washington.