On August 12, 2016, FINRA proposed to amend FINRA Rule 2232 to require FINRA members to provide additional pricing information on retail customer confirmations for non-municipal fixed income transactions (the "New Proposal").9 The New Proposal revises to some extent FINRA's prior proposal from October 2015 (the "Revised Proposal"),10 which was initially issued in November 2014.11 Under the New Proposal, if a member trades as principal with a non-institutional customer in a corporate debt12 (including, for example, a structured note) or agent debt13 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 currently exists for transactions in fixed income securities.
Requirements Under the New Proposal
In response to the Revised Proposal, several commenters expressed that retail investors would also benefit from more enhanced price disclosure. Accordingly, the New Proposal would further amend FINRA Rule 2232 by requiring member firms to provide additional pricing information on customer confirmations in connection with non-municipal fixed income transactions with retail customers. Where a member trades as principal with a non-institutional customer in a corporate debt or agency debt security, the member would be required to disclose the member's mark-up or mark-down from the prevailing market price for the security on the customer confirmation.
Scope of the Requirements Under the New Proposal. The disclosure requirements under the New Proposal 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.
The New Proposal defines a "non-institutional customer" as a "customer account that is not an institutional account." FINRA notes in the New Proposal that requiring disclosure for retail customers (as opposed to institutional accounts) is appropriate, because retail customers frequently have less access to market and pricing information than institutional customers. To reduce the implementation costs associated with the New Proposal, the New Proposal utilizes the same definition of "institutional account" under FINRA Rule 4512(c) in an attempt to define the scope consistently with the definition in other rule contexts.
Same-Day Triggering Timeframe. The New Proposal would require disclosure of the mark-up or mark-down where a firm's offsetting principal trade(s) equal (or exceed) the size of the customer trade on the same trading day. In response to the Revised Proposal, several commenters expressed that the window for "triggering disclosure" should be limited to two hours--a two-hour window would be implemented more easily and more closely capture riskless principal trades, in line with the proposed disclosure requirements under Rule 10b-10 under the Exchange Act for equity securities. While FINRA acknowledges in the New Proposal that its review of statistics generated by the Trade Reporting and Compliance Engine indicates that the majority of firm principal/customer trades that occur within the same trading day occur within 30 minutes of one another, FINRA explains that there are several benefits to requiring disclosure more broadly for trades that occur within the same trading day, including:
- ensuring that more investors receive mark-up or mark-down disclosure;
- making member firms less likely to alter their trading patterns in response to the New Proposal, because members would be required to hold positions overnight to avoid having to make the proposed disclosure; and
- diminishing the variability that exists between the prices paid in firm principal/customer trades that occurred close in time to one another and the prices paid in firm principal/customer trades that did not occur close in time to one another.
Non-Arm's-Length Affiliate Transactions. Where a member firm buys from, or sells to, certain affiliates, the New Proposal would require the firm to "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.
Specifically, the New Proposal requires that the "look through" be applied where a member's transaction with its affiliate was not at "arm's-length." The New Proposal defines "arm's-length transaction" as 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.
Exemptions from the Disclosure Requirement. The New Proposal provides two exemptions from the proposed 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 in place policies and procedures 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.
Future Action by the Securities and Exchange Commission
The SEC published notice to solicit comments on the New Proposal on August 15, 2016, in the Federal Register-- comments to the New Proposal were due by September 5, 2016 (i.e., 21 days after its publication).