NEW YORK – Market participants trying to comply with Municipal Securities Rulemaking Board and other rules are suffering from growing pains related to technology, procedures, and communications, panelists at a regulatory conference said Thursday.
Representatives of the Financial Industry Regulatory Authority, the MSRB, and broker-dealer firms discussed the muni market and the wider fixed income regulatory landscape at FINRA’s Fixed Income Conference. Topics of discussion included the MSRB’s new markup disclosure requirements and the difficulty some firms have had in implementing them, as well as an ongoing effort to get dealers and regulators communicating more clearly.
Michael Nouri, a lawyer with FINRA’s fixed income regulation division, said that examiners looking at both best execution and markup disclosure compliance are most commonly finding problems with the written supervisory procedures dealers are producing. Dealers have to have WSPs “reasonably designed” to ensure compliance with applicable rules and they have to periodically review and update them if necessary. Both those rules are relatively new, with Rule G-18 on best execution taking effect in 2016 and the markup disclosure requirements of G-15 on confirmation and G-30 on prices and commissions effective since May of this year.
Best execution requires dealers to seek the most favorable terms reasonably available for their retail customers’ transactions. The markup disclosure requirements oblige dealers to disclose their markups and markdowns on certain transactions in the confirmations they send to retail customers. Markup disclosures have to be given as a total dollar amount and a percentage of the prevailing market price, commonly referred to as the “PMP.” The amendments establish a “waterfall” of factors for determining the PMP, beginning with contemporaneous trades of the same security and followed by series of other considerations.
Nouri said that when FINRA examiners have found problems, WSPs have been the major culprit.
“They might have some process, but not actually follow it,” Nouri said.
Don Winton, chief operating officer at Crews & Associates, said that the markup disclosure rules caused a “significant technology struggle” for his firm. Winton said Crews looked at all of the several vendors offering products to calculate PMP before selecting one. Many dealer firms have said that they had challenges in integrating PMP calculators into their existing systems, though others reported doing so successfully.
“It was frustrating because we knew technology hadn’t quite caught up with the rule,” Winton said.
Participants on a later panel touched on the importance of clear communications between the regulators and the regulated. Saliha Olgun, MSRB associate general counsel, said that the MSRB is emphasizing that most of its communications with the market are not regulatory standards but are instead intended as guides. MSRB communications in recent years have come in various forms, including interpretive guidance, compliance advisories, compliance resources, and more. The MSRB website provides explanation on the different types of communications and how they should be used by the market.
“Each of our documents should be very clearly labeled, so there is no confusion,” Olgun said.
David Cohen, senior counsel and director at RBC US Law Group – capital markets, said he and his colleagues are voracious readers of the MSRB’s materials.
“We devour each one of these publications from the MSRB,” Cohen said. “The nomenclature is confusing.”
“But I think to the MSRB’s credit,” he continued, “they’re trying to narrow it down.”
Ultimately, the panelists stressed, only the MSRB’s rules and formal interpretive guidance will inform FINRA examiners during inspections.
Panelists also briefly discussed the Securities and Exchange Commission’s recent “flipping” case in which the commission charged multiple firms and individuals with colluding to impersonate retail investors in order to buy bonds at favorable prices during retail order periods and “flip” them for a quick profit. The case has already resulted in settlements with two now-defunct firms and several individuals with some litigation still pending.
The MSRB has said recently it is planning to ask for comment about “pre-arranged trading,” a practice which can resemble the conduct alleged in the flipping case. According to a document circulated by the MSRB in the past, the board is concerned about situations in which a dealer contractually agrees to buy bonds from an investor at a marked up price in order to have a better chance of getting those bonds into its inventory. The dealer compensates the investor with that mark-up because it believes it will be able to sell those bonds at an even higher price in the secondary market.
The MSRB said in that document that it has concerns about customer orders being given less priority because orders appearing to be for an investor, but which in reality are dealer stock orders, get priority.
On Thursday, Cohen called for a muni market discussion in an effort to better understand the landscape. Acknowledging the apparent bad actors in the SEC’s enforcement case, Cohen noted that “flipping” and “pre-arranged trading” aren’t defined or explicitly covered by MSRB rules.
“Let’s talk about it, and we’ll see where it goes,” Cohen said.
