Fixed Income – Fair Pricing

NEW FOR 2023

Regulatory Obligations and Related Considerations

Regulatory Obligations

The fair pricing obligations under FINRA Rule 2121 (Fair Prices and Commissions) apply to transactions in all securities—including fixed income securities—and MSRB Rule G-30 imposes similar obligations for transactions in municipal securities. In addition, FINRA Rule 2121 and MSRB Rule G-30 also include specific requirements for transactions in debt securities. These rules generally require a dealer that is acting in a principal capacity in a debt security transaction with a customer, and charging a mark-up or mark-down, to mark-up or mark-down the transaction from the prevailing market price (PMP). The PMP is presumptively established by referring to the dealer’s contemporaneous cost as incurred or proceeds as obtained. Where the dealer’s cost is no longer contemporaneous, or the dealer has overcome the contemporaneous cost presumption, member firms are required to continue down the “waterfall” within FINRA Rule 2121 or MSRB Rule G-30, as applicable, to determine the PMP.

Related Considerations

  • Does your firm have a reasonable supervisory system for compliance with the fair pricing rules tailored to your firm’s specific business model for fixed income securities? Do your firm’s WSPs identify the personnel responsible for compliance with the fair pricing rules for your firm’s fixed income business?
  • If your firm requires the use of exception reports to perform supervision for fair pricing of fixed income products, do these reports include information sufficient to make such a determination (e.g., mark-up/mark-down percentage, maturity, coupon, rating, yield)?
  • Does your firm conduct a reasonable supervisory review to confirm that mark-ups/mark-downs are not based on expenses that are excessive?
  • If your firm sells bonds to customers from inventory, what methodology is your firm using to determine the PMP for the security? Is the methodology employed consistent with the “waterfall” described in FINRA Rule 2121 and MSRB Rule G-30?
  • If your firm engages in transactions in different types of fixed income products, does your firm have targeted fair pricing supervisory procedures to address its fair pricing obligations for each type of product?

Findings and Effective Practices

Findings

  • Incorrect Determination of PMP: Not following the contemporaneous cost presumption or the waterfall required by FINRA Rule 2121 and MSRB Rule G-30, but rather:
    • using other methods, such as obtaining quotations from a limited number of market participants without considering contemporaneous inter-dealer or institutional transaction prices; or
    • referring to acquisition costs that are no longer contemporaneous.
  • Outdated Mark-up/Mark-down Grids: Employing mark-up/mark-down grids without periodically reviewing and updating them as needed. 
  • Failure to Consider Impact of Mark-up on Yield to Maturity: Charging substantial mark-ups in short-term fixed-income securities that may significantly reduce the yield received by the investor.
  • Unreasonable Supervision: Solely relying on grids or on fixed mark-up/mark-down thresholds in assessing fair pricing in fixed income securities without performing a facts and circumstances analysis as required by FINRA Rule 2121 or MSRB Rule G-30.

Effective Practices

  • PMP Documentation: Documenting the PMP for each transaction, even if it does not require a mark-up disclosure pursuant to FINRA Rule 2232 (Customer Confirmations) or MSRB Rule G-15.
  • Mark-up/Mark-down Reviews: Conducting periodic reviews of the firm’s mark-ups/mark-downs and comparing them with industry data provided in the TRACE and MSRB Mark-up/Mark-down Analysis Reports.
  • Exception Reports: Using exception reports or outside vendor software to ensure compliance with FINRA Rule 2121 or MSRB G-30, and periodically reviewing and updating the reports’ parameters so they perform as intended, even as market conditions change.

Additional Resources

Previous:
Disclosure of Routing Information
Up:
Fixed Income – Fair Pricing
Next:
Fractional Shares: Reporting and Order Handling