In November 2016, the Securities and Exchange Commission approved FINRA’s proposed rules amending Rule 2232, which will require FINRA members to provide additional pricing information on retail customer confirmations for non-municipal fixed income transactions. The additional requirements have proven quite controversial and over the years FINRA had proposed and re-proposed various similar amendments. The Municipal Securities Rulemaking Board, or MSRB, has adopted corresponding rule amendments.
The amended rule requires that if a FINRA member trades as principal with a non-institutional customer in a corporate debt or agent debt security, the member would, subject to certain exceptions, be required to disclose the member’s mark-up or mark-down from the prevailing market price for the security on the customer confirmation. Rule 10b-10 under the Exchange Act already requires that FINRA members provide customers with limited pricing information (e.g., transaction cost information) in connection with transactions in equity securities where the member acts as principal; however, no such requirement had existed for transactions in fixed income securities.
The disclosure requirements would apply where:
- a member buys (or sells) a security on a principal basis from, or to, a non-institutional customer and engages in one or more offsetting principal trades on the same trading day in the same security; and
- the size of the member’s offsetting principal trade(s) equals or exceeds, in the aggregate, the size of the customer trade.
A “non-institutional customer” is a “customer account that is not an institutional account.” An “institutional account” is defined under FINRA Rule 4512(c).
Where a member firm buys from, or sells to, certain affiliates, the member firm must “look through” the member’s transaction with the affiliate to the affiliate’s transaction with a third party in order to determine:
- when the security was acquired; and
- whether the “same trading day” requirement discussed above has been triggered.
The “look through” requirement applies where a member’s transaction with its affiliate was not at “arm’s-length.” An “arm’s-length transaction” is any transaction that was “conducted through a competitive process in which non-affiliate firms could also participate” (e.g., pricing was sought from multiple firms or the posting of multiple bids and offers) and where the affiliate relationship did not include the price paid or proceeds received by the member.
There are two exemptions from the disclosure requirement for: (1) functionally separate trading desks; and (2) fixed-priced offerings.
First, a firm will be exempt from the disclosure requirement if the non-institutional customer transaction was executed by a principal trading desk that is functionally separate from the principal trading desk within the same member firm that executed the member purchase (in the case of a sale to a customer) or member sale (in the case of a purchase of a customer) of the security.
To qualify for this exemption, however, the member firm must have policies and procedures in place that are reasonably designed to ensure that the functionally separate principal trading desk through which the member purchase (or member sale) was executed had no knowledge of the customer transaction.
Second, a firm will be exempt from the disclosure requirement if the member:
- acquired the security in a fixed-price offering (including an underwritten offering); and
- sold the security to non-institutional customers at the fixed-price offering on the day the securities were acquired.
These amendments will require substantial attention for FINRA member firms. Firms will need to consider their approach to calculating the prevailing market price in light of guidance in this respect, automation of calculations, the presentation of their calculations or their methodology on confirmations, the possibility of formulating standard disclosures and samples, the preparation of policies and procedures, and training. Compliance is expected to be required by May 2018, although additional details are expected in a forthcoming FINRA notice.