Bond Markup/Markdown Disclosure

Last Friday FINRA announced that it had approved a proposal to require the disclosure of bond markups and markdowns for retail fixed income investors. Markup and markdown (when buying or selling a bond, respectively) is the difference between a bond’s price and the price (higher or lower) at which a dealer will sell or buy the security. In these cases, the dealer is acting as a principal, at their own risk, as opposed to acting as an agent (and receiving a fee for facilitating a transaction). The new proposal would apply to transactions involving corporate or agency bonds, requiring new disclosures to be placed on any transaction in which the firm buys and sells the same security to a retail customer on the same day, essentially, transactions in which the firm is trading on a principal basis. The required disclosure would place the firm's markup or markdown on the customer confirmation and would also include a link back to FINRA's TRACE system so that the customer could see trade price data for that security. In the case of electronic confirmations, the TRACE data would be included as a hyperlink reference.

The proposal is similar to one that the MSRB put forward for municipal securities last October, which we blogged about then. In that post, Expert Pamela Peterson outlined some of the issues that arose as a result of the proposed requirements and discussed the difficulties surrounding the idea of 'fair pricing' in general. Her full treatment of the topic can be found (part one and part two, respectively) in the American Bar Association Securities Litigation Quarterly, Fall 2015 and Winter 2016 issues ("Fair Pricing for Municipal Bonds"). Part two, which appears in the current issue of the journal, is highly relevant as it takes an in-depth look at some of the problems with using EMMA data (essentially the TRACE system, but for municipal securities) to establish fair pricing. Since FINRA would be encouraging retail investors to make those comparisons (by including the TRACE trade data link in the confirmation), her discussion is very informative to the current proposal.

The press release touts the improvement in transparency for retail investors, with CEO Richard Ketchum noting that "FINRA has found that some individual investors pay considerably more than others for similar trades." The impact of the proposed rule, even with exceptions for bonds held more than a day by the firm between a retail buy and sell and for new issues, would still be large. According to FINRA, if the rule had been enacted in 2015 it would have covered 98% of all retail bond trades.