Fees on Structured Notes Tied to Stocks Climb to Three-Year High

Banks charged almost 2 percent in average fees on U.S. structured notes tied to stocks in the first quarter, the most for any three-month period in at least three years.

Issuers and underwriters earned $137.7 million in disclosed fees, or 1.95 percent of the $7.08 billion of equity-tied securities that paid a commission, according to data compiled by Bloomberg from offering documents. Non-fee paying notes were excluded because they’re generally sold to financial advisers who charge for their services separately.

Investors are paying more to buy the assets, which can involve complex bets and tie up funds for 20 years, as the Federal Reserve holds its benchmark interest rate between zero and 0.25 percent for a fifth year. Equity-tied notes account for almost 70 percent of U.S. structured note sales, their highest proportion since at least January 2010.

“Generally speaking, the more mainstream a product becomes, the lower the fees,” said Lori Schock, director of investor education and advocacy at the U.S. Securities and Exchange Commission in a telephone interview. “The fact that the fees are going up, it calls into question why and what’s the driver for that.”

Longer-dated notes, which usually have larger fees than securities that mature earlier, helped pushed the average higher last quarter, said Deryk Rhodes, executive director at Incapital LLC in Boca Raton, Florida, in a telephone interview.

“You’re not going to see the same fees in a one-year that you are in a ten-year,” he said.

Longer-Dated Notes

Banks sold $494.2 million of the notes tied to stocks with maturities of 10 years or more last quarter, more than five times the $84.6 million sold during the same period last year, Bloomberg data show. Fees for the longer-dated notes this year averaged 3.58 percent, or almost twice the 1.82 percent for securities with shorter maturities.

While investors paid 1.65 percent for fees overall on structured notes last year, an increase from 2011, the ratio was lower than the 1.83 percent in 2010, when Bloomberg first began collecting comprehensive data on U.S. SEC-registered securities. Still, not all fees embedded in notes have to be disclosed, and how issuers report them varies, making it challenging to arrive at an accurate figure.

“The issue is the incentives that are created in the system to steer people into these things,” said Marcus Stanley, policy director of the nonprofit organization Americans for Financial Reform, in a telephone call from his office in Washington, D.C. “These just seem like the wrong incentives for brokers to have when giving advice to people.”

Value Disclosures

Banks have been legally obligated to say how much underwriters charge for handling most registered securities since the Securities Act of 1933 was signed into law by President Franklin Delano Roosevelt. Other expenses don’t have to be listed though.

Determining the amount of embedded fees may become easier now that the SEC has told issuers they must start disclosing the estimated initial value of the securities to investors. The agency sent banks a letter in February, giving them 10 days to indicate whether they would comply with the rules. Banks usually don’t include their estimated profit in offering documents, Bloomberg data show.

JPMorgan Chase & Co. issued the two notes this year with the highest disclosed fees, at 7 percent. The larger of the two, $2 million of six-year callable securities, is linked to the worst-performing of the Euro Stoxx 50 Index and the Russell 2000 Index, according to a prospectus filed with the SEC.

The commission includes a distribution fee as well as projected profits related to hedging risks, according to the SEC document.

Elizabeth Seymour, a spokeswoman for the bank, declined to comment on the note.


The average fee on U.S. structured notes that pay a commission rose to 1.87 percent in the first quarter, the second-highest figure in similar periods going back to 2010, Bloomberg data show.

Notes with fees are usually sold through broker-dealers, private banks, or networks of advisers.

Banks create structured notes by packaging debt with derivatives to offer customized bets to retail investors while earning fees and raising money. Derivatives are contracts whose value is derived from stocks, bonds, commodities and currencies, or events such as changes in interest rates or the weather.