In February 2017, FINRA adopted its amendments to the confirmation requirements of Rule 2232. The new rule, which becomes effective in May 2018, requires broker-dealers to disclose the amount of their mark-ups or mark-downs in trades with retail customers in corporate debt securities, if the broker-dealer also executes an offsetting principal trade in the same security on the same trading day.
We discussed the application of Rule 2232 to the structured products market and other securities in the September 14, 2016 issue of this publication.27 In this article, we discuss how the rule impacts certain initial offerings of structured products that involve sales made at different prices to advisory accounts.
Rule 2232 and Fixed Price Offerings
A key exception to the disclosure requirement is set forth in Rule 2232(d). The disclosure need not be provided for bonds that are acquired by a FINRA member in a fixed price offering, and sold to retail investors at the same offering price on the same day the member acquired the bonds.
The majority of structured note sales are conducted in this manner. Since purchasers pay the same amount for the bonds (that is, usually par), and the underwriter's profit (the commission or spread) is set forth on the cover page of the prospectus, the broker-dealer's profit is easy to determine. Accordingly, no new disclosures are required in this situation.
Variable Price Re-offers
At the other end of the spectrum are variable price re-offerings. In these transactions, different investors may pay different purchase prices for the notes during the offering period. In addition, the broker-dealer's commission for each sale may vary. Since the difference between the broker's purchase price and the investor's purchase price may not be possible to calculate from the prospectus, Rule 2232(d) does not provide an exception in this case, and the new disclosures are required.
Fixed Discount from Purchase Price/Fixed Discount to Underwriting Discount
In some situations, an offering may be structured so that most investors pay par, and the bonds are sold with the indicated underwriting discount. However, some bonds may be sold at a fixed lower price, and a fixed lower underwriter discount. This may be the case if, for example, the offering is structured with a specified volume discount, and/or if there is a fixed discount on the purchase price and underwriting discount when sales are made to advisory accounts.
In this case, as in the case of a typical fixed price offering, providing additional disclosure about the mark-up on a brokerage statement would appear to have no value to retail investors. These investors can determine the broker's markup, if any, based upon the information in the prospectus.
Advisory Sales with Variable Underwriting Compensation
There is more ambiguity in a situation where advisory accounts may pay different prices, especially where the relevant broker-dealer's compensation may also vary. For example, in many offerings involving advisory accounts, the investors' purchase prices are set forth as an expected range from par. In addition, the lead underwriter's compensation in respect of these sales may be set forth in the prospectus as a range, or as a maximum amount, as may be the case for the selling concessions received by any relevant selling group members.
For retail accounts under these circumstances, the prospectus may provide an approximate sense of the broker-dealer's mark-up for the sale; however, the precise amount may be impossible to determine from the prospectus. It may be more appropriate for the broker-dealer making the sale to the retail investor to add the disclosure required by Rule 2232. This disclosure would help address the goals of the Rule:
"FINRA believes this additional pricing information will better enable customers to evaluate the cost and quality of the services firms provide by assisting customers in monitoring current same-day prices a firm and a customer pays or receives in connection with a transaction. The proposal will provide customers with pricing information that customers cannot currently obtain through TRACE data. FINRA further believes this type of information will promote transparency into firms' pricing practices and encourage communications between firms and their customers about pricing of their fixed income transactions. This proposal also may provide customers with additional information that may assist them in detecting practices that are possibly improper, which would supplement FINRA's own surveillance and enforcement program."28
Accordingly, even though an offering of this kind may not be a variable price offering in the typical sense, the new disclosures may be relevant in this situation as well.