Client Alert: What The FINRA Rule 2232 Amendments Mean

SEC approves Amendments to Require Mark-Up/ Mark-down disclosure on confirmations for trades with retail investors in Corporate and Agency Bonds (17-08)

In November 2016 the Security and Exchange Commission (SEC) approved a rule proposal of FINRA that requires disclosure for transactions conducted by FINRA members with non-institutional customers. Dealers have to disclose on retail customer confirmations their mark-ups and mark-downs on most municipal and corporate bond transactions, calculated from the bond’s prevailing market price (PMP).

The amendment will become effective on May 14, 2018. The already existing Rules 2232 (a) and (b) will remain the same. Additionally to those, the amendment will introduce Rules 2232 (c), (d) and (e).

Through these amendments FINRA member firms then have to disclose additional transaction-related information to retail customers for trades in certain fixed income securities. The disclosure requirement is limited to certain principle transactions with non-institutional customers in corporate debt or agency debt securities.

FINRA and the Municipal Securities Rulemaking Board (MSRB) adopted these rules, which have to be followed by their members. Working closely together, they developed similar rules to the existing rules concerning the transaction cost information when acting as principal with customers for equity trades. The amendment is supposed to ensure consistent disclosures to customers across debt securities and shall reduce the operational burdens for the firms that trade multiple fixed income securities.

The new mark-up disclosure requirements of rule 2232 (c) require members to disclose to a non-institutional customer the amount of mark-up or mark-down the customer paid for a trade in a corporate or agency debt security, if the member also executes one or more offsetting principal trades in the same security on the same trading day which in the aggregate meet or exceed the size of the customer trade.

To illustrate the concept of the new rules, both FINRA and MSRB provided the following example:

If a dealer purchased 100 bonds at 09:30 am and then satisfied three customer orders for 50 bonds each in the same security on the same day without purchasing any more of the bonds, the proposal would require mark-up disclosure on two of the three trades, since one of the trades would have been satisfied by selling out of the member’s inventory rather than through an offsetting principal transaction by the member.

Two exceptions from Rule 2232 (c) are made by Rule 2232 (d):

  • If the dealer has in place policies and procedures reasonably designed to ensure that the trading desk had no knowledge of the customer transaction, mark-up disclosure requirement will not be triggered by an offsetting same-day principal trade executed by a trading desk that is functionally separate from the dealer’s trading desk that executed the retail transaction.
  • Mark-up disclosure does not need to be provided for bonds that are acquired by a member in a fixed-price offering and sold to non-institutional customers at the same offering price on the same day the member acquired the bonds.

Dealers have to calculate their mark-ups and mark-downs in accordance with the PMP guidance contained in FINRA Rule 2121 and have to express them both as dollar amount and a percentage of PMP.

The calculation of the mark-ups made by the members may be based on the information they have available as a result of reasonable diligence at the time they input relevant transaction information into systems to generate confirmations. Amended rule 2232 does not prevent members from maintaining real-time, intra-day confirmation generation processes. Third-party service providers can be engaged to facilitate mark-up disclosure consistent with rule 2232.

The new Rule 2232 (e) requires members to provide a reference and if necessary a hyperlink to a web page hosted by FINRA that contains TRACE publicly available trading data for the specific security that was traded, along with a brief description of the type of information available on that page.

Therefore FINRA provided a short Uniform Resource Locator (URL): https://bondfacts.finra.org/

This URL has to be either attached in print form in case of paper confirmations, or as a hyperlink to the web page in case of electronic confirmations.

Besides the obligation of providing a reference, Rule 2232 (e) further requires members to disclose the time of execution for all non-institutional customer trades in corporate and agency debt securities. Trade time disclosure is required even in cases where mark-up disclosure is not triggered.

Conclusion:

  1. Non-institutional customers have to be informed about the amount of mark-ups or mark-downs they paid for a trade in a corporate or agency debt security when the firm executes one or more offsetting principal trades in the same security on the same trading day which in the aggregate meet or exceed the size of the customer trade.
  2. The mark-ups and mark-downs have to be calculated in accordance with the PMP guidance and have to be expressed in both the amount in dollar and the percentage.
  3. A reference or hyperlink to a web page hosted by FINRA that contains TRACE publicly available trading data, has to be provided.

Paul Lieberman has more than three decades of experience preparing and revising policies and procedures, developing effective supervision structures, leading and coordinating internal investigations and defending regulatory enforcement proceedings before the SEC, FINRA and state securities departments/commissions.

Laura K. Kues assisted in the preparation of these Alerts. Laura graduated from Johannes Gutenberg University in Mainz (Germany) in June 2015 (First State Exam) with the priority area in Competition Law Intern at Eaton & Van Winkle, LLP (USA) during the 2017 German legal clerkship at the district court of Mainz (Germany).

© Eaton & Van Winkle, LLP, 2017. All rights reserved. This memorandum was prepared as a service to clients and friends of the firm to report on recent developments that may be of interest to them. The information in it is therefore general, and should not be considered or relied on as legal advice.