Financial advisors who buy and sell individual bonds in the secondary market on behalf of their clients know all too well how difficult it can be to know exactly how much of the prices they pay or receive are pocketed by the firm on the other side of those transactions.
There are no commissions charged, as in the stock market, but markups and markdowns of a bond’s price ranging between 1% and 5%. They are hidden, built into the price an advisor pays when buying a bond or receiving when selling one. They are not disclosed.
That will change for some bond market transactions as a result of new rules from FINRA and MSRB (Municipal Securities Rulemaking Board) rule just approved by the SEC.
The new FINRA rule requires that a firm selling a corporate or agency bond to a retail investor disclose the markup from the prevailing market price if it bought the bond from another party that same day.
Similar disclosures are required when a firm buys a corporate or agency bond from a retail investor that it sells the same day.
Firms will have to include this information on the customer’s confirmation, with the exact time of the trade and a reference to trade-price data from TRACE, FINRA’s Trade Reporting and Compliance Engine.
The MSRB’s rule is similar to FINRA’s. Municipal securities dealers will be required to provide retail investors information about markups and markdowns when the sale or purchase of a muni bond involving retail investors occur on the same day as an offsetting purchase or sale from a third party.
The MSRB expects this disclosure will affect an estimated 8,000 retail investor municipal securities transactions daily. The new MSRB rule will take effect in 18 months. FINRA has not dislcosed a time frame for the effective of its rule.
“This is a step in the right direction for clients to get some transparency into the real price of the bond they are buying,” says Katie Brewer, president of Your Richest Life, an online fee-only planner in Dallas-Fort Worth, Texas, about the new rules.
“Unfortunately, it only applies when the firm is buying the same bond as a principal and the firm sells the bond to the retail client on the same day. So if the firm buys a large inventory of bonds (which they usually do) and marks the bonds up, but sells them a week later, the new rule doesn’t require the firm to disclose the markup…. It would be better if firms always had to disclose the mark-up on bonds.”
Larry Stein, president of Disciplined Investment Management in Deerfield, Illinois, says the new rules are a “step forward and hopes regulators continue to … bring more transparency to the investment market. “
Stein currently favors bond ETFs over individual bonds because they provide more diversification and because of the secret fees involved in bond purchases and sales, but he says he may take a closer look now at individual bonds. “I would like to know what the impact is.”
— Related on ThinkAdvisor: