According to a study by a financial consulting firm that works with plaintiffs in securities litigation, JPMorgan Chase & Co. inflated the value of complex bonds it sold to individual investors, by 15 percent in one example.

According to the study from Securities Litigation & Consulting Group, by failing to account for fees for the indexes that determined the payouts on the securities, the bank overstated how much some of its structured notes were worth. The consulting firm found that some were sold with inflated valuations after it analyzed at least $253.7 million of one kind of structured note sold by JPMorgan between 2011 and 2014.

Amanda Smith, a spokeswoman for JPMorgan, declined to comment on the study.

For mom-and-pop investors that are starved for income in a low-interest-rate environment, structured notes have grown increasingly attractive. The bonds are usually created by combining a bond with a derivative that offers extra market exposure, as well as added risk and often pay higher interest than regular corporate debt.

According to data compiled by Bloomberg, up about 13 percent from 2012 levels, banks issued about $43.5 billion of structured debt that was registered with the Securities and Exchange Commission last year.

Regulators have fined banks for failing to disclose enough information about the bonds and they fear that individuals can have trouble figuring out fair prices for the securities. Structured notes tied to complex, self-designed indexes in particular have been at the centre of attention of rule makers. Issuance levels in recent years have been far below their pre-crisis highs with that pressure.

Encouraging banks to prominently disclose the difference between the public offering price of the note and the issuer’s estimated value for the bonds, the SEC sent a letter to banks that sell structured notes in April 2012.

According to the Securities Litigation & Consulting Group report, the estimated values are what JPMorgan may have overstated. A kind of bond called a “volatility note” was looked at by the consulting firm. Ranging from 67.5 to 85.5 cents on the dollar, it calculated an estimated value of the 10 largest such securities sold by JPMorgan between 2011 and 2013. JPMorgan had disclosed an estimated value of 98.6 cents, or about 15 percent higher in the case of the bond worth 85.5 cents. According to the report, without the bank having disclosed estimated values, many of the JPMorgan notes were sold to customers.

An index known as the CBOE Volatility index, or the “VIX” is increased by volatility notes that are designed to pay a higher return if futures market investors grow more concerned about stock market price fluctuations. Joe Halpern, chief executive officer at Exceed Investments in New York said that securities linked to volatility strategies “are complex to begin with.” They “can go from complex to almost impossible to understand” when they’re also designed to react to market conditions.

Its method for determining the value of the notes using its own index based on movements in VIX futures was described by JPMorgan in one of its prospectus for one of the securities. Applied each day to hypothetical futures positions, the level of the index would be reduced by two fees, one of 0.75 percent a year, the other ranging from 0.2 to 0.5 percent, it said. The fee did not impact the value of the notes, the bank also said. The fees reduced the index by at least 4.8 percent, and on average by 10.6 percent, according to the study from the Securities Litigation & Consulting Group.

(Adapted from Bloomberg)

Categories: Economy & Finance