Excessive Muni Bond Markups / Markdowns

Excessive markups and markdowns have been a problem, particularly in the municipal bond market due to lack of transparency for many years. Recently, it has been an issue the public has increasingly become aware of whether due to the large fines levied by the Securities and Exchange Commission on major firms or the numerous studies being conducted on the issue. The Financial Industry Regulatory Authority (FINRA) as well as the Municipal Bond Rule Board (MSRB) have created numerous rules to combat the issue of excessive markups and markdowns, including recent rule proposals to further protect investors.

A markup and markdown is essentially the spread or difference between what the security was purchased for versus what it was sold for by the brokerage firm. The markup/markdown is embedded in the price the customer pays or receives for a municipal bond trade. It is the compensation a brokerage firm makes on the transaction.

A brokerage firm is entitled to compensation, but the issue becomes what is “reasonable.” On typically riskless principal transactions, the markup or markdown on municipal bonds can quickly enter excessive territory. A riskless principal transaction occurs when a dealer matches a purchase and a sell order therefore effectively eliminating the risk to the dealer.

What makes matters worse is that, up until recently, there has been no requirement to disclose the markup or markdown on a municipal bond transaction, so many times an investor is not even aware of the cost. The issue is particularly evident for municipal bond transactions, as these securities typically have lower interest rates, so markups/markdowns can take a large bite out of any profit an investor would make on the transaction.

For example, if a broker purchases a municipal bond that will pay 3% in dividends on the year, a 2% markup would require the investor to hold the bond for almost an entire year before he or she broker even. The issues with undisclosed markups and markdowns become more precarious if a broker is churning an investor’s accounts to maximize the commissions he or she earns on the investor’s money.

Municipal bond pricing is governed by MSRB Rules G-17 and G-30. MSRB Rule G-17 is a sort of “good conscience” rule that states that a financial advisor will deal with all persons fairly and not engage in any deceptive, dishonest or unfair practices concerning municipal securities.

MSRB Rule G-30 governs prices and commissions of municipal bonds. The rule states that brokers, dealers and municipal securities dealers shall purchase or sell municipal securities at an aggregate price that is fair and reasonable and lists numerous factors to help determine fairness and reasonableness of prices, most important among these being the yield to the customer compared to the yield on comparable securities available in the market.

Recently, the SEC approved a new version of MSRB Rule G-30, which will go into effect May 14, 2018. The amended rule now requires brokers and other municipal bond dealers to disclose markups and markdowns on most municipal and corporate bonds transactions. The disclosure will appear on retail customer trade confirmations.

Silver Law Group ’s team of lawyers can help you determine whether an investment loss is the result of excessive markups and/or markdowns on municipal or corporate bonds in a brokerage account. If you have suffered losses as a result of excessive markups and/or markdowns, you may be able to recover your losses through FINRA arbitration. We work on a contingency fee, meaning you pay nothing unless we recover. Contact our firm for a free consultation.