SEC Approves New FINRA and MSRB Mark-Up Disclosure Requirements for Corporate, Agency and Municipal Fixed Income Principal Trades

Clark Hill PLC

On November 17, 2016, some 40 years after having first proposed mark-up disclosure requirements for riskless principal securities transactions,[1] the Securities and Exchange Commission ("SEC") approved rule changes by the Financial Industry Regulatory Authority ("FINRA")[2] and Municipal Securities Rulemaking Board ("MSRB")[3] to require confirmation disclosure of mark-ups and mark-downs on same-day offsetting principal trades[4] in corporate, agency and municipal fixed income securities ("covered securities") with non-institutional customers.[5] The new rules also will require certain additional information to be included on confirmations for all trades (not just principal trades or those involving offsetting trades) in covered securities with non-institutional customers. In addition to requiring new confirmation disclosures, the MSRB established a new mark-up policy for principal transactions in municipal securities under MSRB Rule G-30 that parallels FINRA's existing mark-up policy for non-municipal debt securities under FINRA Rule 2121.

While the obligation to provide the new confirmation disclosures will not become effective until 2018,[6] achieving compliance with these new requirements by broker-dealers as well as banks acting as municipal securities dealers (collectively, "dealers") will entail considerable changes for most dealers' existing processes, procedures, data flows and technology solutions involved in day-to-day sales and trading, as well as related back-office or out-sourced processing, of covered securities.

Simultaneously with coming into compliance with the new disclosure requirements, dealers engaged in municipal securities principal transactions with all types of customers (not just non-institutional customers) will need to begin to apply the "waterfall" approach to determining prevailing market prices under the new MSRB mark-up policy, which is significantly more structured than long-standing customary approaches to determining the prevailing market price of a municipal security based on a more flexible exercise of professional judgment by market professionals. Even with respect to corporate and agency debt securities that already have been subject for many years to FINRA's mark-up policy, the new mark-up disclosure rule will require dealers to reconsider how they have implemented the FINRA mark-up policy in order to incorporate new timing and other constraints triggered by the confirmation requirement. In addition, implementation of the mark-up disclosure requirement will likely result in a much more rigorous course of regulatory oversight regarding the application of the waterfall approach under FINRA Rule 2121 than has been the case up until the present.

Fixed Income Securities Covered by the New Mark-Up Disclosure Rules

Covered securities for purposes of the new mark-up disclosure rules consist of:

  • Corporate debt securities, including dollar-denominated debt securities with a maturity greater than one year issued by domestic and foreign private issuers, but excluding asset-backed securities
  • Agency debt securities, including debt securities issued or guaranteed by federal executive agencies or government-sponsored enterprises, but excluding U.S. Treasury securities and asset-backed securities securitized or guaranteed by any such agency or enterprise
  • Municipal securities, excluding municipal fund securities such as interests in 529 college savings plans

Transactions Triggering the New Mark-Up Disclosure Rules

Mark-up disclosures will be required for any transaction (a "covered transaction") if:

  • The covered transaction involves a covered security;
  • The dealer is acting in a principal capacity (that is, has an ownership interest in the covered security at some point in the transaction, even if only for an instant in a riskless principal transaction);
  • The dealer's counterparty is a non-institutional customer, consisting of any non-dealer counterparty other than:
    • A bank, savings and loan association, insurance company or registered investment company
    • An SEC-registered or state-registered investment adviser
    • Any other person (whether a natural person, corporation, partnership, trust or otherwise) with total assets of at least $50 million; and
  • Another offsetting transaction in the same covered security has occurred on the same trading day as the covered transaction (regardless of whether the offsetting transaction precedes, follows or is simultaneous with the covered transaction), provided that:
    • In the case of a covered transaction that is a sale to a customer, the dealer purchased the same security in one or more offsetting transactions in an aggregate amount at least equal to the amount of the covered transaction
    • In the case of a covered transaction that is a purchase from a customer, the dealer sold the same security in one or more offsetting transactions in an aggregate amount at least equal to the amount of the covered transaction
    • If an offsetting transaction is with an affiliate of the dealer (other than in a qualifying arms-length competitive transaction), the dealer must consider whether such affiliate's transactions with third parties in the covered security (if such transactions had been undertaken directly by the dealer) would themselves constitute offsetting transactions for purposes of the disclosure requirement

However, a dealer would not be required to provide mark-up disclosure in connection with a customer transaction:

  • In a corporate or agency fixed priced offering or a municipal securities new issue where the dealer is a syndicate member and the securities are sold at the initial fixed-price/list-offering price on the first day of sale; or
  • Executed through a principal trading desk if the only potentially offsetting transactions, if any, were executed through a different functionally separated trading desk of the dealer and the dealer has in place appropriate policies and procedures reasonably designed to ensure that each desk has no knowledge of the trades through the other desk

Content of New Fixed Income Confirmation Disclosures

While the FINRA and MSRB rulemaking was targeted specifically at mark-up disclosures for covered transactions - that is, principal trades in covered securities where an offsetting trade in the same security occurred on the same trading day - the new confirmation requirements include some elements that apply to all non-institutional transactions in covered securities, regardless of whether the trade was executed on a principal or agency basis or whether there exists an applicable offsetting trade.

For covered transactions (i.e., principal trades with same-day offsetting trades), trade confirmations will be required to include:

  • The dealer's mark-up or mark-down for the transaction, expressed as a total dollar amount and as a percentage of the prevailing market price, calculated in compliance with:
    • FINRA Rule 2121 for corporate and agency debt securities or
    • MSRB Rule G-30, Supplementary Material .06 for municipal securities

For all transactions in covered securities (both covered and non-covered transactions executed either as principal or agent), trade confirmations will be required to include:

  • The time of trade execution, shown:
    • To the second, for corporate and agency debt securities or
    • To the minute (omitting seconds), for municipal securities
  • A reference and, if the confirmation is electronic, a hyperlink to a webpage containing trading data for the specific security that is:
    • Hosted by FINRA, containing data from its Trade Reporting and Compliance Engine (TRACE) for corporate and agency debt securities
    • Hosted by the MSRB on its Electronic Municipal Market Access (EMMA) system, containing data from its Real-Time Transaction Reporting System (RTRS) for municipal securities
  • A brief description of the type of information available from such webpage

Determination of Prevailing Market Prices for Municipal Securities Principal Trades

Dealers engaged in municipal securities principal transactions with all types of customers (not just non-institutional customers)[7] will need to begin to apply the "waterfall" approach to determining prevailing market prices that currently applies to corporate and agency debt securities, with a limited number of modifications. While a detailed discussion of the precise requirements of this approach and the many factors to consider in developing appropriate policies and procedures (as well as associated process and technological solutions) to implement and support compliance with the new mandate will be addressed in a future alert, it should be noted that dealers will need to engage in a structured approach to establishing the prevailing market price from which mark-ups and mark-downs are to be calculated. This structured approach prioritizes factors to be considered in determining the prevailing market price, with particular emphasis on contemporaneous transactions in the security, and generally permits consideration of the next lower priority factor only if a contemporaneous transaction does not exist, if specified evidence persuasively indicate that contemporaneous cost (or proceeds) do not provide the best measure of the prevailing market price, or if another higher priority factor does not exist.

Integrating Mark-Up Calculations Into the Confirmation Process

As noted above, even for dealers accustomed to being subject to FINRA's mark-up policy for corporate and agency debt securities, the requirement to disclose mark-ups and mark-downs on confirmations taking into account, in many cases, offsetting transactions occurring later in the day than the covered transaction, as well as regulatory and practical time constraints on the production of confirmations, will create a pressing need to engage in a top-to-bottom review of every aspect of a dealer's fixed income sales and trading process. Dealers will be confronted with considering whether existing processes and technology solutions will allow for the appropriate flow of information within the firm that will be needed to make consistent and legally supportable calculations, to make such calculations available for timely confirmation disclosure, and to provide for appropriate supervisory review and, as needed, post-trade corrections, among other needs. In many cases, dealers may find that significant and costly changes will be required.


[1] Exchange Act Release No. 12806 (September 16, 1976).

[2] Exchange Act Release No. 79346 (November 17, 2016), approving amendments to FINRA Rule 2232, on customer confirmations.

[3] Exchange Act Release No. 79347 (November 17, 2016), approving amendments to MSRB Rule G-15, on confirmation, clearance, settlement and other uniform practice requirements with respect to transactions with customers, and Rule G-30, on prices and commissions.

[4] The same-day standard, as described below, extends the coverage of the new rules well beyond the generally accepted understanding of a riskless principal transaction.

[5] In general, "mark-up" refers to the difference between a security's prevailing market price and the higher price at which a broker-dealer sells the security in a principal transaction to a customer, and "mark-down" refers to the difference between a security's prevailing market price and the lower price at which a broker-dealer purchases the security in a principal transaction from a customer. The concept of how mark-ups and mark-downs are to be calculated is sometimes referred to simply as a "mark-up policy." Mark-ups and mark-downs are viewed as providing information regarding a broker-dealer's remuneration in a principal trade, although there are differing views as to whether all or only a portion of the calculated mark-up or mark-down should be viewed as remuneration.

[6] FINRA and the MSRB will publish, by no later than February 15, 2017, the implementation dates for their respective rules, which will be no later than May 17, 2018. Presumably, FINRA and the MSRB would expect to, but are not required to, establish simultaneous implementation dates.

[7] While FINRA's mark-up policy under FINRA Rule 2121 does not apply to qualified institutional buyers under Securities Act Rule 144A purchasing or selling a non-investment grade corporate or agency debt security when the dealer has determined that the buyer has the capacity to evaluate independently the investment risk and in fact is exercising independent judgment in deciding to enter into the transaction, the MSRB has not provided a parallel exception from its new requirements under MSRB Rule G-30 applicable to municipal securities for institutional customers or other so-called Sophisticated Municipal Market Professionals as defined in MSRB Rule D-15. Dealers that sell municipal securities will need to take into account this difference between the FINRA and MSRB mark-up policies when architecting their approach to the new regulatory requirements.


DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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