First -- these are complicated instruments, and I am not done looking at this yet, but what I've seen so far is troubling. Why was/is JP Morgan publishing research on Schering-Plough, while it was/is still likely making calls and soliciting indications of interest, or in SEC-speak, "entering a distribution" on at least some of these oddly-featured, and mis-shapen notes (Heh!) -- which are driven, in large part, by SGP common stock price fluctuations?
UPDATED -- 4.26.08 4 PM EDT -- I've made a video (only 40 seconds long!) quickly-examining the JP Morgan "Jekyll & Hyde" routine, here:
UPDATED -- 06.26.08 @ 7:00 AM: The plot thickens, here -- I had been looking, early this morning, over at the SEC's EDGAR database, for proof that JP Morgan had closed the offering described below. I am not done yet, but again, what I found was puzzling -- to me. Apparently, on June 16, 2008, JP Morgan removed Schering-Plough's common stock, as a reference security for this offering. [Note that Schering-Plough is no longer mentioned, or offered, in the updated term sheet I've linked.] Now there are only three being offered -- Microsoft, NuCor and AT&T. It may be that JP Morgan already closed on the investors interested in a Schering-Plough indexed security (I'll know once I review all the filings for this month), or it may be that JP Morgan chose to scrap that part of the offering. Wild. Then, in any event, only nine days later, JP Morgan Securities -- through the research arm -- put out a bullish note on Schering.
There may very well be exemptions in the SEC's rules for such activity, but generally, writing research during a distribution would be considered a manipulative practice. Figuring this out will take some time for me to sort out, here. In the mean-time -- as to what it means for Schering-Plough, directly, though -- it would seem that the "Upgrade/positive outlook" issued by JP Morgan, this morning, should be viewed with an even more-jaundiced eye, tonight.
Why? Consider this (click it to enlarge):
Well, because for the last two weeks, JP Morgan has apparently been actively involved in the marketing (and the likely re-marketing) of a Reverse Exchangeable Note issuance which is driven by -- and related to -- Schering Plough's common stock. It appears to be a so-called "Bearish" note. So -- is JP Morgan bearish, or bullish on Schering?
That is the question I am still trying to sort out, tonight. I am getting sleepy, so I'll likely not return to this -- until late-morning, tomorrow (after some meetings), but by then, I should have it all in the form of a 30 second video-blog piece, right here.
So -- what have I discerned thus far? Well, interestingly, and despite their "bearish" colloqial handle, it would appear that JP Morgan stands to profit handsomely (by causing a forefeiture of partial principal payments at maturity) on these notes, if Schering common stock rises.
Generally speaking, so-called "Bearish" Reverse Exchangeable Notes pay a higher interest rate than would normally be associated with a particular company's credit-worthiness, at the same maturity-date. The (mostly-institutional) investor buys these notes, looking for "extra-juice" on its interest income return-line, quarter to quarter. This one is just one-year in duration -- to end of June 2009. So far, so good, right?
But if these are, in fact, being marketed as "bearish" notes, then JP Morgan, the issuer of the notes, has some odd views of Schering-Plough, at the moment, doesn't it? Upgrade today, selling Bearish securities last week. Hmmmmm. What gives?
This graphic, above (click it to enlarge), albeit unintentionally, really amplifies the older 2007 conflicts still afflicting JP Morgan (I added the text-copy on the chart, in yellow) -- but it is derived from a page of the current term-sheet which is incorporated into the Bearish Notes (Schering) prospectus.
Perhaps more importantly, JP Morgan, as the obligor on these notes, has created for itself, I gather, an entirely-new, and separate, financial incentive to see increases in the common stock price of Schering-Plough. That would make it seem very convenient that JP Morgan analysts chose this moment to initiate coverage at "Buy" on Schering-Plough.
Note this from the applicable SEC-filed prosepectus (at page PS-9) -- Risk Factors:
The protection offered by the Upside Protection Amount may terminate at any time during the term of the notes.
If the closing price (in the case of daily monitoring) or price (in the case of continuous monitoring) of the Reference Stock at any applicable time during the Monitoring Period exceeds the Initial Share Price (or Strike Price, if applicable) by more than the Upside Protection Amount and the Final Share Price is greater than the Initial Share Price (or Strike Price, if applicable), you will be fully exposed, on an inverse basis, to any appreciation in the closing price of the Reference Stock [Ed. Note: that is Schering common stock]. We refer to this feature as a contingent buffer. Under these circumstances, you will lose 1% of the principal amount of your investment for every 1% increase in the Final Share Price above the Initial Share Price (or Strike Price, if applicable). You will be subject to this potential loss of principal even if the price of the Reference Stock subsequently declines such that the Final Share Price is less than the Initial Share Price (or Strike Price, if applicable) plus the Upside Protection Amount. If these notes had a non-contingent buffer feature, under the same scenario, you would have received the full principal amount of your notes plus accrued and unpaid interest at maturity. As a result, your investment in the notes may not perform as well as an investment in a security with a return that includes a non-contingent buffer. . . .
That seems immensely odd -- given today's action -- does JP Morgan even believe its own analysis? Is it possible that the "Bearish" Notes were to offset the as yet unrealized losses incurred by the September 2007 JP Morgan clients who bought Schering common stock at $27.50, in the offering co-managed by JP Morgan? What, exactly was going on here? We may never really know.
More to come. G'night.