WASHINGTON – The Municipal Securities Rulemaking Board's proposal to require dealers to disclose their markups and markdowns in certain transactions is long overdue and will greatly benefit retail investors, according to the Securities and Exchange Commission's Investor Advocate.
"By requiring firms to disclose the markups on customer confirmations, retail investors will be better equipped to evaluate transactions and the quality of service provided to them by a firm," Rick Fleming said in a letter to the SEC, which is weighing whether to approve the proposal. He said the proposal would also have a preventative effect because regulators and retail investors will more easily be able to detect improper practices.
Fleming's letter addresses markup disclosure requirements proposed by both the MSRB and Financial Industry Regulatory Authority. The two self-regulators have been coordinating on rule changes. The MSRB proposal, filed with the SEC in early September, would change MSRB Rules G-15 on confirmation and G-30 on prices.
The MSRB's proposal would require a dealer, which buys or sells munis for or from its own account to a retail customer and engages in one or more offsetting transactions on the same trading day in the same security, to disclose its markups and markdowns in the confirmation it sends the customer.
The proposal establishes a waterfall of factors for determining prevailing market price (PMP), which dealers would then use to calculate their compensation. Dealers would initially look at their contemporaneous trades of the same muni with other dealers or customers to establish a presumption of prevailing market price. They would then make a series of other successive considerations if that data is not available. They can look at contemporaneous trades of the muni in interdealer trades, then trades of the muni between other dealers and institutional investors, then trades on alternative trading systems or other electronic platforms.
Further down the waterfall, firms could look at contemporaneous trades of similar securities. The MSRB included a list of "non-exclusive factors" like credit quality, size of the issue, and comparable yield that could be used to determine if securities are similar.
The bottom of the waterfall allows dealers to use prices or yields derived from economic models.
Fleming said that his office paid special attention to four key issues it had found with previous versions of the FINRA and MSRB proposals while evaluating the most recent iterations. The issues include: maintaining consistency between the two proposals; requiring the proposals to encompass a full trading day; using the PMP to calculate the markup; and making sure the PMP guidance requires dealers to look through transactions with affiliates.
"Each of these issues has been resolved to our satisfaction in the current proposals," Fleming wrote.
He said the "deliberate approach" that the MSRB and FINRA have taken in coordinating their rules "will lead to consistent disclosures across the fixed income markets and will provide retail investors with better post-trade price transparency." The full-day trading window both proposals would require will also help prevent dealers from trying to avoid disclosures by holding their inventory for longer periods, according to Fleming.
The investor advocate added that he believes there is a chance that dealers could eventually, for competitive reasons, decide to disclose markups on all transactions after seeing how initial implementation of the proposals goes. Additionally, he said his office has encouraged both the MSRB and FINRA to carefully monitor the industry's implementation of the proposals, if approved, to limit any misleading information that could result from intentional or inadvertent errors in calculation.
Dealers have raised concerns that the MSRB proposal is overly complex and could hurt liquidity. They complained in previous comment letters that the procedure for calculating prevailing market price includes a level of subjectivity that makes it hard to computerize compliance and warned that the one-year implementation period the proposals lay out is too short.
Fleming said his office agrees with the implementation timeline and called it "reasonable."
