WASHINGTON, Jan 27 (Reuters) – The compensation that dealers
receive in U.S. municipal bond trades is once again in
regulators’ crosshairs, with a member of the Securities and
Exchange Commission saying on Monday that he is investigating
how to give investors more information about markups.
SEC Commissioner Michael Piwowar, a Republican sworn in last
August, is calling for retail investors to have a better sense
of dealer markups – or compensation – in “riskless principal
transactions.”
Most individual investors are in the dark about how much
dealers add to prices in trades.
In its sweeping report on the $3.7 trillion municipal bond
market released more than a year ago, the SEC recommended
requiring dealers to disclose markups, saying the lack of
information put individual investors at a disadvantage. Since
then, the commission has fallen quiet on the issue.
Regulation is hazy on dealer compensation. Dealers must
disclose their remuneration if they act as agents facilitating
trades, but not if they act as principals in the trade. For most
trades in the municipal bond market, dealers are “riskless
principals” purchasing securities from their customers and
immediately reselling them to other dealers.
Piwowar told a meeting of the U.S. Chamber of Commerce that
he asked the commission’s municipal securities office “to work
with me to develop a few proposals to improve how the
fixed-income markets operate,” highlighting markups as an area
of concern.
Piwowar took an in-depth look at dealer compensation when he
worked at the SEC as an economist, and his academic research on
markups was frequently cited in the commission’s 2012 report.
“We engaged in a lot of conversations with the dealers and
the dealers were saying things like ‘we commit capital to this
market,'” he told reporters after the meeting.
“But we started looking at the data and a lot of these
transactions look like they might be riskless principal
transactions where the dealers aren’t actually committing any
capital,” he said. “If they simply mark it up from where they
bought it at, they don’t have to disclose what the markup is.”
Recording the markup would “enable investors to have better
information,” he added.
Piwowar did not give details about the proposals, or when
they might be released.
In recent years, federal regulators have expressed concerns
that individual investors, the “mom and pop” buyers that support
the municipal bond market, do not have adequate information
about the debt they use for income. An investigation by the
Government Accountability Office concluded that those investors
often paid more for bonds than banks and other institutions
because of this lack of information.
The SEC enforces the rules for the market written by the
Municipal Securities Rulemaking Board, a self-regulatory
organization made up of banks, issuers and advisers. But FINRA,
or the Financial Industry Regulatory Authority, has
traditionally overseen markups and fined banks for not dealing
fairly with their customers when they have tacked on excessive
amounts. In one case in 2011, FINRA fined a bank for markups as
large as 8.49 percent. Typically, they are closer to 2 percent.
“When you think about the number of securities in the
market, the number of participants, the number of issuers, the
spreads in these markets – I really think we can get more bang
for our buck in terms of our resources and helping retail
investors understand these markets better,” Piwowar said.
He added that the coming flood of retiring baby boomers and
current uneasiness about the direction of interest rates should
inspire deeper consideration of pricing.
