Fixed Income Mark-Up Disclosure
On May 14, 2018, FINRA and the Municipal Securities Rulemaking Board (MSRB) implemented amendments to FINRA Rule 2232 (Customer Confirmations) and MSRB Rule G-15, which require firms to provide additional transaction-related information to retail customers for certain trades in corporate, agency and municipal debt securities (other than municipal fund securities).9 This information includes the mark-up or mark-down for principal trades with retail customers that a firm offsets on the same day with other principal trades in the same security. Disclosed mark-ups and mark-downs must be expressed as both a total dollar amount for the transaction and a percentage of prevailing market price (PMP).10 In addition, for all retail customer trades in corporate, agency and municipal debt securities (other than municipal fund securities), firms must disclose on the confirmation the time of execution and a security-specific link to the FINRA or MSRB website where additional information about the transaction is available, along with a brief description of the information available on the website.
To ensure effective implementation of the rules, firms should consider performing a regular review of confirmations to ensure that they include the new disclosures on all confirmations that require them. In particular, firms should consider reviewing samples of their confirmations for all of the required disclosure elements, including the mark-up or mark-down, the time of execution and the security-specific link (with CUSIP). In addition to sampling and review, correspondent firms should familiarize themselves with their clearing firms’ processes for providing mark-up disclosure,11 and firms that rely on vendors to determine PMP on their behalf should consider similar diligence and oversight over their vendors’ processes. Firms should also consider whether they are maintaining consistent and correct disclosures for fixed income transactions executed across different vendors, platforms or trading desks.
Selected Examination Findings
FINRA observed that, in implementing the changes required by the amended FINRA and MSRB rules, some firms faced challenges relating to their confirmation review processes, systems and vendors.
- Failure to Enter Information Into the Firms’ Order Entry Systems – Some firms’ traders did not enter all of the necessary information, such as the PMP, into the firms’ order entry systems. As a result, the confirmations included inaccurate mark-ups or mark-downs, or these were not disclosed when required.
- Improper Adjustments to PMP – FINRA observed that some firms adjusted the PMP in their order entry systems to subtract registered representatives’ concession or sales credit from the mark-up, which resulted in inaccurate disclosures on customer confirmations.
- Inadequate Disclosure for Trades Conducted on an Agency Basis – Some firms failed to provide the security-specific hyperlink and time of execution on trade confirmations where the firm acted as agent rather than principal.12
- Failure to Provide Disclosure for Structured Notes – Some firms failed to provide disclosures on customer confirmations for trades in Trade Reporting and Compliance Engine® (TRACE®)-reportable structured notes because the firms did not realize the notes were subject to FINRA Rule 2232 (Customer Confirmations). In other cases, some clearing firms did not provide the mark-up on confirmations because they did not receive the PMP from the structured note distributors.
- Incorrect Designation of Institutional Accounts – Some firms failed to provide disclosures to certain customers because they identified those customers’ accounts as “institutional” even though they did not meet that definition in FINRA Rule 4512(c) (Customer Account Information) or MSRB Rule G-8(a)(xi).
- Improper Security-Specific Hyperlinks and Brief Descriptions – Several firms failed to include a brief description with the security-specific hyperlink of the type of information that is available on the security-specific web page or did not provide the description ”along with” the hyperlink.13
- Vendor Challenges – Some vendors did not always identify the correct PMP from which to calculate mark-ups and mark-downs. For example, instead of using the prices of a firm’s own contemporaneous trades, which were available to be considered, a vendor’s program incorrectly identified PMPs using lower levels of the “waterfall” as described in FINRA Rule 2121.02 (Fair Prices and Commissions) or MSRB Rule G-30.06. As noted in FINRA Fixed Income Confirmation Disclosure: Frequently Asked Questions (FAQ) Section 3.6 and MSRB Confirmation Disclosure and Prevailing Market Price Guidance Frequently Asked Questions Section 3.6, whenever firms engage third-party vendors to determine PMP on their behalf, firms retain compliance responsibility and must exercise due diligence and oversight.
9 Specific information on the MSRB requirements is available here. FINRA and the MSRB also published FAQs designed to assist firms with implementing the new rule requirements (see FINRA FAQs and MSRB FAQs).
11 As noted in FINRA FAQ 1.9 and MSRB FAQ 1.9, although an introducing or correspondent broker-dealer may use the assistance of a clearing broker-dealer to generate confirmations, the introducing or correspondent broker-dealer bears the ultimate responsibility for compliance with the disclosure requirements.
12 FINRA Rule 2232(e) (Customer Confirmations) and MSRB Rule G-15(a)(i)(D)(4) require disclosure of the security-specific hyperlink and the time of execution for all transactions with non-institutional customers.