United States: Structured Thoughts: News For The Financial Services Community, Volume 7, Issue 7

Financing Subsidiaries and SEC Registration

As readers of this publication know, in order to address the expected new U.S. regulatory capital requirements, a number of U.S. bank holding companies have been creating new finance company subsidiaries. This article discusses a variety of SEC rules and regulations that simplify the registration process for using these entities, as well as certain limitations.

Using the Parent Company's Registration Statement. Under General Instruction I.C of SEC Form S-3, a wholly owned subsidiary of an S-3 eligible company can utilize the parent company's short form shelf registration statement for primary offerings of investment grade securities. This provision enables these subsidiaries to take advantage of the parent company's reporting status for purposes of effecting a shelf registration. This will be the case whether or not the parent corporation is a "WKSI" or a "non-WKSI" (including a WKSI that has become an "ineligible issuer").

Separate Financial Statements? Regulation S-X governs the financial statement requirements for registration statements and for periodic reports. Under Rule 3-10 of Regulation S-X, separate financial statements for a subsidiary with a parent guarantee are not required to be set forth in a registration statement if (a) that subsidiary is 100% owned (whether directly or indirectly) by the parent corporation, and if (b) the securities issued by the subsidiary are "fully and unconditionally" guaranteed by the parent corporation. Rule 3-10, as amended in 2000, builds upon some of the SEC's prior no-action guidance.

The SEC reached this position due to its reasoning:

"...if a finance subsidiary issues debt securities guaranteed by its parent company, full disclosure of the finance subsidiary's financial information would be of little value. Instead, investors would look to the financial status of the parent company that guaranteed the debt to evaluate the likelihood of payment."

What Is a Finance Subsidiary? A subsidiary will be a "finance subsidiary" if "it has no assets, operations, revenues or cash flows other than those related to the issuance, administration and repayment of the security being registered and any other securities guaranteed by its parent company." If this condition is satisfied, then no financial information about it will be required in the parent company's financial statements. The parent company's financial statements must include a footnote stating that this entity is a 100%-owned finance subsidiary of the parent company and that the parent company has fully and unconditionally guaranteed the securities.

New Form 10-K and Form 10-Q Requirements? When creating a new SEC registrant, the "sponsor" will of course ask whether or not it is creating a burdensome and potentially expensive ongoing disclosure obligation under the Exchange Act. However, this need not be the case—under Rule 12h-5 under the Exchange Act, these financing subsidiaries are not required to file separate periodic reports.

What Is a Full and Unconditional Guarantee? Under Rule 3-10, for a guarantee to be deemed "unconditional," when an issuer of a guaranteed security fails to make a scheduled payment, the guarantor is obligated to make the scheduled payment immediately and, if it doesn't, any holder of the guaranteed security may immediately bring suit directly against the guarantor for payment of all amounts due and payable.

However, under the rules, a guarantee will not be "full and unconditional" if it is not operative until some time after default. For example, a subsidiary guarantee would not satisfy this condition if the debt holder must first proceed against the parent issuer, and then only proceed against the subsidiary if a certain amount of time has passed without payment.


Cover Page Disclosures for Structured Notes

Overview

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:

  • index-linked.
  • 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.

Regulation S-K

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).

Additional Disclosures

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.


To view the full report please click here.

Footnotes

1 Under the SEC's guidance, the name cannot be misleading. For example, "debt securities" should not be described as "shares." And as readers of this publication know, the term "principal protected" in a title is somewhat problematic. 

2 Which is usually par for structured notes, unless there is a "bulk discount" or a lower price for advised accounts.

3 "Selling group members" are not required to be specifically identified. They would often not wish to be identified, as doing so may increase the likelihood that they will be viewed as "statutory underwriters" for liability purposes 

Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

© Morrison & Foerster LLP. All rights reserved

To print this article, all you need is to be registered on Mondaq.com.

Click to Login as an existing user or Register so you can print this article.

Authors
Anna Pinedo
Bradley Berman
 
In association with
Related Topics
 
Related Articles
 
Related Video
Up-coming Events Search
Tools
Print
Font Size:
Translation
Channels
Mondaq on Twitter
 
Register for Access and our Free Biweekly Alert for
This service is completely free. Access 250,000 archived articles from 100+ countries and get a personalised email twice a week covering developments (and yes, our lawyers like to think you’ve read our Disclaimer).
 
Email Address
Company Name
Password
Confirm Password
Position
Mondaq Topics -- Select your Interests
 Accounting
 Anti-trust
 Commercial
 Compliance
 Consumer
 Criminal
 Employment
 Energy
 Environment
 Family
 Finance
 Government
 Healthcare
 Immigration
 Insolvency
 Insurance
 International
 IP
 Law Performance
 Law Practice
 Litigation
 Media & IT
 Privacy
 Real Estate
 Strategy
 Tax
 Technology
 Transport
 Wealth Mgt
Regions
Africa
Asia
Asia Pacific
Australasia
Canada
Caribbean
Europe
European Union
Latin America
Middle East
U.K.
United States
Worldwide Updates
Registration (you must scroll down to set your data preferences)

Mondaq Ltd requires you to register and provide information that personally identifies you, including your content preferences, for three primary purposes (full details of Mondaq’s use of your personal data can be found in our Privacy and Cookies Notice):

  • To allow you to personalize the Mondaq websites you are visiting to show content ("Content") relevant to your interests.
  • To enable features such as password reminder, news alerts, email a colleague, and linking from Mondaq (and its affiliate sites) to your website.
  • To produce demographic feedback for our content providers ("Contributors") who contribute Content for free for your use.

Mondaq hopes that our registered users will support us in maintaining our free to view business model by consenting to our use of your personal data as described below.

Mondaq has a "free to view" business model. Our services are paid for by Contributors in exchange for Mondaq providing them with access to information about who accesses their content. Once personal data is transferred to our Contributors they become a data controller of this personal data. They use it to measure the response that their articles are receiving, as a form of market research. They may also use it to provide Mondaq users with information about their products and services.

Details of each Contributor to which your personal data will be transferred is clearly stated within the Content that you access. For full details of how this Contributor will use your personal data, you should review the Contributor’s own Privacy Notice.

Please indicate your preference below:

Yes, I am happy to support Mondaq in maintaining its free to view business model by agreeing to allow Mondaq to share my personal data with Contributors whose Content I access
No, I do not want Mondaq to share my personal data with Contributors

Also please let us know whether you are happy to receive communications promoting products and services offered by Mondaq:

Yes, I am happy to received promotional communications from Mondaq
No, please do not send me promotional communications from Mondaq
Terms & Conditions

Mondaq.com (the Website) is owned and managed by Mondaq Ltd (Mondaq). Mondaq grants you a non-exclusive, revocable licence to access the Website and associated services, such as the Mondaq News Alerts (Services), subject to and in consideration of your compliance with the following terms and conditions of use (Terms). Your use of the Website and/or Services constitutes your agreement to the Terms. Mondaq may terminate your use of the Website and Services if you are in breach of these Terms or if Mondaq decides to terminate the licence granted hereunder for any reason whatsoever.

Use of www.mondaq.com

To Use Mondaq.com you must be: eighteen (18) years old or over; legally capable of entering into binding contracts; and not in any way prohibited by the applicable law to enter into these Terms in the jurisdiction which you are currently located.

You may use the Website as an unregistered user, however, you are required to register as a user if you wish to read the full text of the Content or to receive the Services.

You may not modify, publish, transmit, transfer or sell, reproduce, create derivative works from, distribute, perform, link, display, or in any way exploit any of the Content, in whole or in part, except as expressly permitted in these Terms or with the prior written consent of Mondaq. You may not use electronic or other means to extract details or information from the Content. Nor shall you extract information about users or Contributors in order to offer them any services or products.

In your use of the Website and/or Services you shall: comply with all applicable laws, regulations, directives and legislations which apply to your Use of the Website and/or Services in whatever country you are physically located including without limitation any and all consumer law, export control laws and regulations; provide to us true, correct and accurate information and promptly inform us in the event that any information that you have provided to us changes or becomes inaccurate; notify Mondaq immediately of any circumstances where you have reason to believe that any Intellectual Property Rights or any other rights of any third party may have been infringed; co-operate with reasonable security or other checks or requests for information made by Mondaq from time to time; and at all times be fully liable for the breach of any of these Terms by a third party using your login details to access the Website and/or Services

however, you shall not: do anything likely to impair, interfere with or damage or cause harm or distress to any persons, or the network; do anything that will infringe any Intellectual Property Rights or other rights of Mondaq or any third party; or use the Website, Services and/or Content otherwise than in accordance with these Terms; use any trade marks or service marks of Mondaq or the Contributors, or do anything which may be seen to take unfair advantage of the reputation and goodwill of Mondaq or the Contributors, or the Website, Services and/or Content.

Mondaq reserves the right, in its sole discretion, to take any action that it deems necessary and appropriate in the event it considers that there is a breach or threatened breach of the Terms.

Mondaq’s Rights and Obligations

Unless otherwise expressly set out to the contrary, nothing in these Terms shall serve to transfer from Mondaq to you, any Intellectual Property Rights owned by and/or licensed to Mondaq and all rights, title and interest in and to such Intellectual Property Rights will remain exclusively with Mondaq and/or its licensors.

Mondaq shall use its reasonable endeavours to make the Website and Services available to you at all times, but we cannot guarantee an uninterrupted and fault free service.

Mondaq reserves the right to make changes to the services and/or the Website or part thereof, from time to time, and we may add, remove, modify and/or vary any elements of features and functionalities of the Website or the services.

Mondaq also reserves the right from time to time to monitor your Use of the Website and/or services.

Disclaimer

The Content is general information only. It is not intended to constitute legal advice or seek to be the complete and comprehensive statement of the law, nor is it intended to address your specific requirements or provide advice on which reliance should be placed. Mondaq and/or its Contributors and other suppliers make no representations about the suitability of the information contained in the Content for any purpose. All Content provided "as is" without warranty of any kind. Mondaq and/or its Contributors and other suppliers hereby exclude and disclaim all representations, warranties or guarantees with regard to the Content, including all implied warranties and conditions of merchantability, fitness for a particular purpose, title and non-infringement. To the maximum extent permitted by law, Mondaq expressly excludes all representations, warranties, obligations, and liabilities arising out of or in connection with all Content. In no event shall Mondaq and/or its respective suppliers be liable for any special, indirect or consequential damages or any damages whatsoever resulting from loss of use, data or profits, whether in an action of contract, negligence or other tortious action, arising out of or in connection with the use of the Content or performance of Mondaq’s Services.

General

Mondaq may alter or amend these Terms by amending them on the Website. By continuing to Use the Services and/or the Website after such amendment, you will be deemed to have accepted any amendment to these Terms.

These Terms shall be governed by and construed in accordance with the laws of England and Wales and you irrevocably submit to the exclusive jurisdiction of the courts of England and Wales to settle any dispute which may arise out of or in connection with these Terms. If you live outside the United Kingdom, English law shall apply only to the extent that English law shall not deprive you of any legal protection accorded in accordance with the law of the place where you are habitually resident ("Local Law"). In the event English law deprives you of any legal protection which is accorded to you under Local Law, then these terms shall be governed by Local Law and any dispute or claim arising out of or in connection with these Terms shall be subject to the non-exclusive jurisdiction of the courts where you are habitually resident.

You may print and keep a copy of these Terms, which form the entire agreement between you and Mondaq and supersede any other communications or advertising in respect of the Service and/or the Website.

No delay in exercising or non-exercise by you and/or Mondaq of any of its rights under or in connection with these Terms shall operate as a waiver or release of each of your or Mondaq’s right. Rather, any such waiver or release must be specifically granted in writing signed by the party granting it.

If any part of these Terms is held unenforceable, that part shall be enforced to the maximum extent permissible so as to give effect to the intent of the parties, and the Terms shall continue in full force and effect.

Mondaq shall not incur any liability to you on account of any loss or damage resulting from any delay or failure to perform all or any part of these Terms if such delay or failure is caused, in whole or in part, by events, occurrences, or causes beyond the control of Mondaq. Such events, occurrences or causes will include, without limitation, acts of God, strikes, lockouts, server and network failure, riots, acts of war, earthquakes, fire and explosions.

By clicking Register you state you have read and agree to our Terms and Conditions