June 5, 2014 / 7:35 PM / 3 years ago

UPDATE 1-Pair of U.S. senators urges disclosure on bond markups

(Adds comment from Senator Coburn)

By Lisa Lambert and Sarah N. Lynch

WASHINGTON, June 5 (Reuters) - Municipal and corporate bond dealers would have to tell investors how much they charge to cover their compensation under bipartisan legislation currently in the U.S. Senate to end secret price markups.

The proposal, quietly introduced earlier this year by Virginia Democratic Senator Mark Warner and Oklahoma Republican Senator Tom Coburn, comes as momentum grows among U.S. securities regulators to increase transparency in the combined $13 trillion-plus municipal and corporate bond markets.

“The goal of the legislation is to bring transparency and clarity to the often-opaque municipal bond market and, in particular, to protect individual investors from paying a year’s worth of interest in excessive ‘markups’ when buying or selling a bond,” said John Hart, communications director for Coburn.

This week, executives from Charles Schwab met with lawmakers, Securities and Exchange Commission officials and other regulators to advocate for requiring disclosure on municipal bond markups.

“It’s very opaque,” said Peter Crawford, a senior vice president at Charles Schwab.

“One of the things we have found in this over-the-counter market is the degree of price difference from one dealer to the next can be significant.”

Most individual investors, the $3.7 trillion municipal bond market’s backbone, are in the dark about how much dealers add to prices in trades.

Complicating matters, regulation on compensation is hazy. Currently, dealers must disclose if they act as agents facilitating trades but not if they act as principals in the trades. For most trades in the municipal market, then, dealers are “riskless principals,” purchasing securities from their customers and immediately reselling them to other dealers.

Crawford, whose firm levies a flat charge of $1 per bond transaction, said Charles Schwab has studied the lack of disclosure for about seven years.

The brokerage analyzed a California general obligation bond with a 5.25 percent coupon bond offered by five different dealers on its trading platform. It found prices ran from $120.938 to $124.10, meaning on a $10,000 trade there was a $316.40 difference in prices.

The current federal push on compensation in the municipal market began two years ago, when a comprehensive SEC report found individual investors pay more for bonds than institutions because they lack information, specifically about markups.

In recent months the call for change has grown louder, with SEC Republican Commissioner Michael Piwowar saying in January retail investors must be given a better sense of markups.

Last month, his fellow SEC Republican Commissioner Daniel Gallagher said “‘riskless principal’ is basically just a fancy name for ‘agency,'” and disclosing markups “would enable customers to assess the fairness of the execution prices.”

Meanwhile, the two self-regulatory organizations helping the SEC oversee the bond markets are focusing on the issue.

The Municipal Securities Rulemaking Board is taking steps that may lead to new rules on riskless principal transactions. At the same time the Financial Industry Regulatory Authority is “reviewing” the issue for corporate bonds, Richard Ketchum, its head, recently told reporters.

Reporting by Sarah N. Lynch; Editing by Lisa Shumaker

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