Firm Settles FINRA Charges for Unfair Pricing on Corporate Bond Transactions
Commentary by Glen Barrentine
A broker-dealer settled FINRA charges for pricing violations related to corporate bond transactions that resulted in excessive charges to customers.
According to the AWC, the firm failed to correctly assess the prevailing market prices in 89 corporate bond transactions, causing customers to pay unfair prices. FINRA found an additional 27 corporate bond transactions, in which the firm imposed markups and markdowns that were not reasonable compared "to other contemporaneous mark-ups and mark-downs of similar bonds, taking into consideration all relevant factors, including the type of security involved, the availability of the security in the market, the price of the security, and the size of the transaction." FINRA said these violations led to customer harm totaling approximately $68,857.
FINRA found that the firm's written supervisory procedures did not provide adequate guidance on determining the prevailing market price and allowed excessive discretion in setting markups and markdowns without appropriate oversight.
FINRA determined that the firm violated FINRA Rules 2121 ("Fair Prices and Commissions"), 3110 ("Supervision") and 2010 ("Standards of Commercial Honor and Principles of Trade").
The firm consented to (i) a censure, (ii) a fine of $270,000 and (iii) the payment of restitution to affected customers.
Commentary
As reflected in the AWC, FINRA's rules relating to bond prices and mark-ups/mark-downs in customer transactions are complicated, with the results being that firms continue to fall short of what the rules require and what FINRA wants to see.
With respect to pricing, as laid out in the AWC, FINRA Rule 2121 requires that the customer be given a "fair" price. Supplementary Material .02 to FNRA Rule 2121 requires this fair price be based upon the "prevailing market price." In the first instance, the prevailing market price should be based upon the dealer's "contemporaneous cost." Where the dealer's cost is no longer contemporaneous, however, calculating a fair price gets more complicated. Specifically, a fair price would then require consideration, in the order listed, of the following types of pricing information:
(1) Prices of contemporaneous intra-dealer transactions in the securities, or, if none,
(2) Prices of contemporaneous purchases or sales in the security from or to institutional accounts with which the dealer regulatory effects transactions in the same security, or, if none,
(3) For actively traded securities, contemporaneous intra-dealer bid or offer quotations for the security in question made through an inter-dealer mechanism, through which transactions generally occur at the displayed transactions.
Mark-ups and mark-downs must also be fair and, as provided at Supplementary Material .01 to FINRA Rule 2121, take into account the type of security involved, the availability of the security, the price of the security, and the size of the transaction. In addition, the AWC states that mark-ups and mark-downs should take into account other contemporaneous mark-ups and mark-downs charged on similar bonds.
Finally, of course, pursuant to FINRA Rule 3110, firms must also have a reasonable supervisory program in place to ensure that they are actually complying with the foregoing requirements. As discussed in the AWC, these procedures should have a process for determining the prevailing market price and cannot rely upon an unreasonably high threshold for pre-approved mark-ups and mark-down levels.