Individual investors are at a major disadvantage in the $3.7 trillion U.S. municipal bond market, a place where information proves scarce and federal oversight is occasionally lacking, a federal watchdog agency said in a highly anticipated report on Tuesday.
The federal financial regulatory reform law known as Dodd-Frank required the agency, the Government Accountability Office, to survey the debt market that states, local governments, schools, hospitals and other authorities use to finance public projects.
"We found that institutional investors traded at more favorable prices than individual investors and were generally better equipped to make independent assessments of the value of a security," the GAO said in its 91-page report.
"That is, investors paid higher prices when buying smaller blocks of securities from broker-dealers - and received lower prices when selling them - than they paid or received for larger trades," the GAO said.
Because individual investors typically trade $100,000 or less in municipal bonds and institutional investors $1 million or more, this discrepancy hurt individual investors, it said.
Meanwhile "the large municipal securities market, with its many issuers and infrequent trades for a given security, does not have readily available, transparent information on the prices of securities," the GAO said.
Institutional investors, however, have access to other avenues of information that can help with price discovery.
"Unlike institutional investors that have access to and can compare thousands of daily offerings from their large networks of broker-dealers, individuals typically have brokerage accounts with a few broker-dealers, perhaps only one, that may or may not offer online access to their offerings," it said.
At the most basic level, institutional investors are more likely to employ credit analysts and traders who can provide professional expertise and judgment on the price of a municipal security, GAO said.
Dodd-Frank pushed to create more accountability in the municipal securities market and to build protections for individual investors.
At the same time, the Municipal Securities Rulemaking Board and the Securities and Exchange Commission are attempting to lift the veil on the market, posting continuing disclosures and real-time trade data on a website called EMMA, for Electronic Municipal Market Access.
The SEC enforces the rules that the MSRB, a self-regulatory organization made up of bankers, issuers and advisers, writes. The Financial Industry Regulatory Authority, an independent regulator of securities firms, also carries out some oversight of the market.
The GAO noted that there are weak threads tying the federal government to those organizations "because of staffing limitations and because of changes to its inspection approach."
The SEC inspection arm has not looked at the MSRB or FINRA's fixed-income surveillance programs since 2005, well before the financial crisis and credit freeze upended the municipal bond market, it said. The audit recommended monitoring the self-regulatory organizations more closely, mainly by gathering and analyzing information on an ongoing basis.
The SEC agreed with the GAO but said that it did not have the staff to carry out more frequent inspections.
(Reporting By Lisa Lambert; Editing by Leslie Adler)