Securities & Derivatives Enforcement and Regulatory Update

On Nov. 17, the U.S. Securities and Exchange Commission (SEC) approved1 final rules, proposed in coordination with the Financial Industry Regulatory Authority (FINRA) and the Municipal Securities Rulemaking Board (MSRB), which will amend transaction confirmation requirements to require disclosure of mark-ups/mark-downs in corporate, agency and municipal debt transactions where a FINRA member or MSRB registrant is transacting in a principal capacity with a non-institutional customer (respectively, the FINRA Rule and MSRB Rule, and collectively, the Rules). In addition, the Rules will require that all transaction confirmations for corporate, agency, and municipal debt transactions with non-institutional customers, whether or not mark-up/mark-down disclosure is required, include a hyperlink (if the confirmation is electronic) or otherwise include a reference to publicly available trade data on the subject security2, as well as the execution time of the transaction (to the second for the FINRA Rule, and to the minute for the MSRB Rule).3

Under new FINRA Rule 2232(c), member firms will be required to disclose all mark-ups/mark-downs for all corporate4 or agency5 debt transactions effected with a non-institutional customer6, where the FINRA member firm, on the same day as the customer transaction, purchases/sells the relevant security in one or more offsetting transactions meeting or exceeding the size of the customer’s purchase/sale. Where the member firm is effecting any of the same-day offsetting transaction(s) with an affiliated party, if the transaction is not an “arms-length transaction,”7 then the member firm will be required to “look through” to the affiliated party’s transaction with a third party in order to determine the applicability of the mark-up/mark-down disclosure requirement with respect to the date and timing of the transaction, as well as the price at which the affiliate traded the shares in order to calculate the mark-up/mark-down.

Where disclosure is required, mark-ups/mark-downs must be calculated in compliance with existing FINRA Rule 2121, and must be based on a comparison to the “prevailing market price” (PMP) for the relevant security. When disclosed on the transaction confirmation, the mark-up/mark-down must be expressed both as a dollar amount and as a percentage of the PMP.

As a result of the limitation of the definition of “offsetting transaction” to include only same-day transactions, disclosure of mark-ups/mark-downs will not be required if the relevant securities are sold out of inventory acquired by the member firm prior to the transaction date. In addition, the FINRA Rule provides two express exceptions from the disclosure requirement. First, where the same-day offsetting trade is executed by a trading desk that is functionally separate from the trading desk that executed the transaction with the non-institutional customer, the principal trade by the former desk does not trigger the confirmation disclosure requirement. In order to use this exception, the FINRA member firm must have implemented policies and procedures reasonably designed to ensure that the separate desk had no knowledge of the customer transaction. Second, the FINRA Rule includes an exception to the disclosure requirement for transactions where the FINRA member firm acquired the securities in a fixed-price offering, and sold the non-institutional customer at the same fixed-price on the day the securities were acquired by the firm.

Under the MSRB Rule, MSRB confirmation rules will be amended to essentially parallel the requirements of the FINRA Rule. New MSRB Rule G-15(a) requires that all mark-ups/mark-downs be disclosed if the dealer transacts in municipal securities (not municipal fund securities) with a retail customer8 and engages in one or more offsetting transactions on the same trading day. As with the FINRA Rule, the “look through” requirement will apply to municipal dealers who conduct the offsetting transaction with an affiliated party. Transactions effected out of inventory purchased by the dealer prior to the transaction date would not be covered by the disclosure requirement, and the same express exceptions would apply to offsetting transactions with functionally separate trading desk, and transactions that are list offering transactions9 with a retail customer. Finally, as with the FINRA Rule, municipal dealers would be required to provide a hyperlink or reference to any publicly available trading data for the specific security traded, as well as the specific trade execution time (expressed to the minute).

The Rules represent a significant change in trade confirmation requirements for FINRA members and municipal dealers. Previously, mark-up/mark-down disclosure has only been required for equity transactions. As noted in industry comments to the Rule proposals, the challenges posed in implementation will include devising an operational framework that potentially accounts for the aggregation of trading activity preceding and following a given securities transaction during the course of the relevant trade date, as well as providing for mechanisms to establish the PMP for the transaction. Firms that have been the subject of a fair pricing review know that the factors considered in a mark-up/mark-down determination are not always contemporaneously documented. And, firms’ surveillance systems often rely on imprecise calculations (e.g., comparison to high/low) to identify transactions that potentially warrant further scrutiny. Firms will have to implement more agile, dynamic systems.

Firms will also need to establish systems and procedures to address the Rules’ requirements regarding transactions with affiliated parties, both to establish reliance of the “functionally separate” exception as well as to manage the “look through” requirements. Given the highly automated means through which firms generate transaction confirmations generally, caution will be required to implement the Rules' requirements and not to disrupt the function of existing confirmation systems, so as to avoid risk caused by unintended malfunctions when generating confirmations.

Among other things, the SEC’s adopting releases address the concerns expressed regarding situations where the disclosure-triggering offsetting transaction occurs hours after the customer transaction for which confirmation disclosure is required. The releases note that in such circumstances, firms can automate their systems to calculate the mark-up/mark-down determined as of the time of the execution of the non-institutional customer transaction, and not be required to update the disclosure with market information as of the time of the offsetting transaction. Although this provides some relief regarding the computation of the required disclosure, it leaves a firm with the difficult choice in how it programs its automated systems. In other words, the SEC’s guidance leaves open the question of whether a firm should calculate the mark-up/mark-down for all principal transactions as of the time of transaction and disclose for all transactions, or delay its automated processes to the end of the day and only calculate a different PMP when the market has moved between the time of the customer transaction and the offsetting transaction.

Although the SEC has invited the public to comment on the Rules, it has already approved each of the Rules on an accelerated basis. FINRA and MSRB member firms will be required to comply with the Rules within 18 months of their publication in the Federal Register.


These initiatives have progressed with little opposition from the industry, in part due to the pressure from Congress and the Commission. The biggest hurdle appears to have been getting FINRA and MSRB to reconcile their different proposals. The 18-month implementation deadline is relatively lengthy and firms should not expect an of an extension of time.