United States: FINRA And The MSRB Issue FAQs On Bond Mark-Up Disclosure

Last Updated: July 25 2017
Article by Paul R. Eckert, Bruce H. Newman and Daniel Martin

On July 12, 2017, the Financial Industry Regulatory Authority (FINRA) and the Municipal Securities Rulemaking Board (MSRB) published new implementation guidance on the bond mark-up disclosure requirements set to take effect next spring.1 Under amended FINRA Rule 2232 and amended MSRB Rules G-15 and G-30, effective May 14, 2018,2 dealers will be required to disclose on retail customer confirmations their mark-ups on most municipal and corporate bond transactions, calculated from the bond's prevailing market price (PMP).3

Key insights from the new implementation guidance are summarized below. The guidance, provided in the form of frequently asked questions (FAQs), attempts to clarify when and how mark-ups should be disclosed and how to determine PMP, among other topics. Nevertheless, the FAQs may raise new questions as dealers work to overhaul their systems to comply with the controversial new requirements before the May 2018 deadline. FINRA and the MSRB coordinated on the publication of the FAQs, consulting with the Securities and Exchange Commission (SEC) in advance. Both FAQs use the same numbering scheme (followed here), with minimal differences between the two versions.

When Mark-Up Disclosure Is Required

Non-Institutional Customers. Under FINRA Rule 2232 and MSRB Rule G-15, the mark-up disclosure requirement applies only to trades with non-institutional customers. FAQ 1.6 clarifies that the requirement does not extend to transactions involving a dealer and a registered investment adviser—considered an institutional customer

for the purpose of the rules—even when the adviser allocates all or a portion of a transaction to a retail account or trades directly for a retail account.

Voluntary Disclosure. FAQ 1.8 clarifies that dealers may voluntarily provide mark-up disclosure on additional transactions that do not trigger mandatory disclosure; however, such voluntary disclosure should follow the "same format and labeling requirements applicable to mandatory disclosure." Presumably, this guidance applies only to transactions with retail customers in corporate or agency debt securities that, but for the lack of a qualifying offsetting trade, would otherwise be subject to the disclosure requirements of the rule.4 As the rulemaking focused exclusively on this category of transactions, we do not believe that this guidance should be interpreted to prescribe or limit the form and content of accurate post-trade price disclosure in other types of debt securities (e.g., asset-backed securities, Treasury securities) that are not currently subject to the rule and that trade and price differently, often in entirely institutional markets and with bespoke documentation.

Introducing/Clearing Dealers. FAQ 1.9 explains that the introducing (i.e., correspondent) broker-dealer "bears the ultimate responsibility" for mark-up disclosure, but "may use the assistance of a clearing dealer, as it may use other third-party service providers subject to due diligence and oversight."

Application to "Securitized Products" and "Asset-Backed Securities." FAQ 1.11, which is unique to the FINRA context, is confusing because it uses a defined term ("Securitized Product") without acknowledging that FINRA Rule 2232(f) uses a similar but different defined term, "Asset-Backed Security." Asset-Backed Security is basically defined in Rule 6710(cc) as a subset of Securitized Products. By having Rule 2232(f) define "corporate debt security" to exclude an Asset-Backed Security as defined in Rule 6710(cc), certain types of Securitized Products (as defined by Rule 6710(m)) would actually be included in the technical definition of corporate debt security—such as commercial mortgage-backed securities; mortgage-backed securities; and collateralized debt, loan and bond obligations. If the FINRA staff intends to exclude all Securitized Products as defined in FINRA Rule 6710(m) from the operation of Rule 2232(f), it should use that term in the rule. If not, FAQ 1.11 should be clarified to make clear that certain Securitized Products are in fact subject to Rule 2232(f).

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1 See FINRA, "Fixed Income Confirmation Disclosure: Frequently Asked Questions" (July 12, 2017); MSRB Regulatory Notice 2017-12, "MSRB Provides Implementation Guidance on Confirmation Disclosure and Prevailing Market Price" (July 12, 2017).

2 Unless otherwise noted, references in this alert pertain to the amended rules, effective May 14, 2018.

3See Exchange Act Release No. 79346 (Nov. 17, 2016), 81 Fed. Reg. 84659 (Nov. 23, 2016) (SR-FINRA-2016-032) (FINRA Approval Order); Exchange Act Release No. 79347 (Nov. 17, 2016), 81 Fed. Reg. 84637 (Nov. 23, 2016) (SR-MSRB-2016-12) (MSRB Approval Order). For additional detail on the amended rules and the rulemaking process, see our earlier client alert, "SEC Approves Bond Mark-Up Disclosure Rules" (Nov. 29, 2016).

4 That is, those transactions subject to the hyperlink and execution time disclosure requirements of FINRA Rule 2232(e) and MSRB Rule G-15(a)(i)(A)(2) / G-15(a)(i)(D)(4), but that do not have an offsetting transaction that triggers the mark-up disclosure requirements of FINRA Rule 2232(c) and MSRB Rule G-15(a)(i)(F).

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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