United States: SEC Expands To Retail Customer Debt Transactions Disclosure Of Broker-Dealer Mark-Ups And Mark-Downs

Last Updated: January 25 2017
Article by Russell Sacks, Jennifer D. Morton, Jenny Ding and Steven Blau

Currently, U.S. broker-dealers are not required to disclose their compensation in respect of fixed-income transactions effected as principal. In November 2016, the SEC approved a rule proposal of the U.S. Financial Industry Regulatory Authority, or "FINRA," that will require such disclosure for the first time for transactions conducted by FINRA members with non-institutional customers.1 The revised rule's mechanisms for determining, first, to which debt transactions the disclosure requirement applies, and second, how the mark-up/mark-down is to be calculated are detailed and in some respects complex.

The SEC simultaneously approved similar requirements for municipal securities.2 The MSRB rule amendments will be effective May 14, 2018. FINRA has not yet announced an effective date for the amendments to Rule 2232, but it must be no later than May 23, 2018.

The Mark-Up/Mark-Down Disclosure Requirement

Covered Transactions: Overview

The disclosure requirement is limited to certain principal transactions with non-institutional customers3 in corporate debt4 or agency debt securities. The requirement is triggered only if the firm purchased (or sold) the same security in one or more offsetting transactions on the same trading day in an aggregate trading size meeting or exceeding the size of such customer sale (or purchase).

The disclosure requirement applies even if the customer transaction occurred earlier in the trading day than the offsetting marketplace transaction.

Covered Transactions: Affiliate Look-Through Requirement

If any such offsetting transaction is entered into with an affiliate, and if the affiliate transaction was not on an arms-length basis,5 then the firm must look through to the time and terms of its affiliate's purchase from or sale to a third party to determine whether the mark-up disclosure requirement is triggered.
One hypothetical scenario set forth by the SEC's Investor Advocate illustrates how the affiliate look-through requirement would operate between two affiliated dealers:6

  • Dealer A1 purchases a bond from an unaffiliated third-party for $90 ("Transaction 1")
    • Dealer A1 then displays the bond for sale for $93 on Dealer A2's customer-facing platform
    • During the day, no other dealers display any price for the bond
    • Retail Investor sees the bond listed for $93 and places an order with Dealer A2 to purchase it at the displayed price
  • Dealer A2 purchases the bond from Dealer A1 at $93 ("Transaction 2")
  • Dealer A2 sells the bond to Retail Investor for $93 + $1 trading fee

In this scenario, Transaction 2 would not in the SEC Investor Advocate's view be an arms-length transaction for purposes of the rule, and as such, the Prevailing Market Price (the basis for the mark-up disclosure, as discussed below) would be determined based on Transaction 1's price rather than Transaction 2's price. Note that this analysis assumes that mark-up disclosure was required, which assumes that Dealer A2 purchased as much or more of the bond on the trading day than it sold in Transaction 2.

FINRA has provided guidance in Regulatory Notice 14-52 and in its response to comments as to whether the disclosure requirement is triggered in several scenarios.7 For example, if a firm purchased 100 bonds from a dealer at 9:30 AM, and sold 50 of the same bonds to three customers on the same day without purchasing any more of the bonds, only two of the three customer confirmations would be required to have the mark-up/mark-down disclosure, as one of the customer trades would have been satisfied out of the firm's prior inventory.

Firms will need to establish systems to determine for which of its principal transactions mark-up disclosure is required. For introducing firms, this will require coordinating with their clearing firm(s). FINRA noted that firms may voluntarily provide the mark-up/mark-down disclosure more broadly than Rule 2232 will require if they find it beneficial to do so.

Exceptions to Disclosure Requirement

The revised rule's mark-up/mark-down disclosure requirement will not apply in the following scenarios:

  • Sales of securities acquired in fixed-price offering: The firm acquires the security in a fixed-price offering and sells the security to non-institutional customers at the fixed price offering price on the day the securities were acquired; or,
  • Transactions by separate trading desks: The non-institutional customer transaction is executed by a principal trading desk that is functionally separate from the principal trading desk within the same firm that executed the offsetting purchase, and the firm has in place policies and procedures reasonably designed to ensure that the trading desk through which the firm purchase/sale is executed had no knowledge of the customer transaction.8

Calculation of Prevailing Market Price

Under the revised rule, the mark-up/mark-down will be calculated with reference to the Prevailing Market Price as calculated pursuant to FINRA Rule 2121. The analysis required under Rule 2121 is outside the scope of this note, but several commenters noted the difficulty in automating processes to calculate Prevailing Market Price, given the subjective nature of some of Rule 2121's analyses. FINRA in response noted that it recognized the potential challenges involved in implementing the rule changes, and that it will provide firms with interpretive guidance during the implementation process as necessary.9

Revised Rule 2232 will require disclosure of mark-ups/mark-downs both as a total dollar amount (the dollar difference between the customer's price and the security's Prevailing Market Price) and as a percentage amount (the mark-up/mark-down's percentage of the security's Prevailing Market Price).

Confirmation Disclosures

In response to commenters' inquiries as to whether FINRA members may add explanatory or qualifying descriptions of the mark-up/mark-down figure, FINRA stated that it does not believe that members should be permitted to label the mark-up/mark-down disclosure as an estimate or approximate figure, but that firms would not be prohibited as a regulatory matter from including language that explains Prevailing Market Price as a concept or providing details regarding the firm's methodology for determining Prevailing Market Price, provided that such disclosures are accurate.10

Introducing Firms

Introducing firms' customer confirmations are generally prepared and sent by their clearing firms, and introducing and clearing firms will need to work to ensure availability of information regarding principal transactions necessary to comply with the rule.

Rule 2232(e): TRACE Link and Execution Time

Rule 2232(e) will also require that the firms provide on all confirmations for corporate or agency debt securities in transactions with non-institutional customers (i) a reference, and hyperlink if the confirmation is electronic, to a web page hosted by FINRA that contains TRACE publicly available trading data for the specific security that was traded, in a format specified by FINRA, along with a brief description of the type of information available on that page; and (ii) the execution time of the customer transaction, expressed to the second. The 2232(e) requirements apply regardless of whether the 2232(c) mark-up/mark-down disclosure requirement is triggered.


The revised rule will require substantial operational changes to existing broker-dealer systems. Firms will need to work quickly to establish processes that will permit compliance with the rule by its anticipated effective date.


1.  FINRA is the principal US self-regulatory organization for the US securities dealer community; virtually all US-registered broker-dealers, and all US-registered broker-dealers holding retail accounts, are FINRA members. Certain US banks also provide securities brokerage and dealing services to US retail customers pursuant to various statutory and regulatory provisions that exempt specified bank activities from broker-dealer registration. FINRA rules do not apply to a bank operating pursuant to such statutory and/or regulatory exemptions.

2.  This publication cites the provisions of FINRA Rule 2232 for convenience, as MSRB rule G-15(a) will largely parallel FINRA Rule 2232.

3.  A non-institutional customer is any customer with an account other than an institutional account, as defined in FINRA Rule 4512(c). Examples of institutional accounts under Rule 4512 are accounts of registered investment advisers, registered investment companies, banks, and any person with total assets of greater than $50 million.

4.  Rule 2232 will define corporate debt securities as a debt security that is U.S. dollar-denominated and issued by a U.S. or foreign private issuer and, if a "restricted security' as defined in Securities Act Rule 144(a)(3), sold pursuant to Securities Act Rule 144A.  The only exclusions from the definition are for securities that are money market instruments as defined in FINRA Rule 6710(o) and asset-backed securities as defined in FINRA Rule 6710(cc).

5. Rule 2232 will define arms-length transaction as a transaction that was conducted through a competitive process in which non-affiliate firms could also participate, and where the affiliate relationship did not influence the price paid or proceeds received by the firm.

6.  Investor Advocate's letter dated Nov. 7, 2016, at pp. 9–10, available at https://www.sec.gov/comments/sr-finra-2016-032/finra2016032-10.pdf.

7.  Regulatory Notice 14-52 is available at http://www.finra.org/sites/default/files/notice_doc_file_ref/Notice_Regulatory_14-52.pdf. While the version of Rule 2232 approved by the SEC differs in some respects from that discussed in the regulatory notice, most of the guidance set forth in the notice's thirteen scenarios would seem to continue to be applicable. See also FINRA's responses to comments dated November 14, 2016 at page 5, available at http://www.finra.org/sites/default/files/SR-FINRA-2016-032-response-to-comments.pdf [hereinafter FINRA Response to Comments].

8.  It is unclear what standards of separation will emerge for purposes of this rule. Similar concepts exist, and are already implemented, in SEC rules relating to short selling. For additional information regarding such concepts, please see "SEC Regulation SHO Takes Effect, Implementing a Mixed Bag of Changes to Short Sale Rules" (March 2005), available at: http://www.shearman.com/~/media/files/newsinsights/publications/2005/03/sec-regulation-sho-takes-effect-implementing-a-m__/files/view-full-text/fileattachment/cm_0305.pdf and "Short Sales: SEC Adopts Amendments to Rule 105 of Regulation M, Including Important Exceptions For Purchasers," available at: http://www.shearman.com/~/media/files/newsinsights/publications/2007/10/short-sales--sec-adopts-amendments-to-rule-105-o__/files/view-full-text/fileattachment/cm_103007.pdf.

9.  See FINRA Response to Comments at page 7.

10.  See FINRA Response to Comments at page 10.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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