WASHINGTON -- The Public Securities Association yesterday adamantly opposed the SEC's proposed rule that would require dealers to disclose on customer confirmations the markup or markdown on a riskless principal transaction.
The group also objected to a proposed Securities and Exchange Commission rule that dealers disclose on confirmations whether a bond is unrated. Comments on the proposals, which the SEC approved March 9 for comment, were originally due June 15. Recently, however, the comment deadline was extended to July 15.
"We strongly disagree that [there is a problem concerning riskless principal transactions] that needs to be addressed by new regulatory initiatives or that the disclosure of markups would be sufficiently valuable to investors to justify the additional burden on the market," R. Fenn Putman, PSA chairman, said in 25-page letter to the SEC.
"The amendments will have severe and adverse consequences on market liquidity, will result in investor confusion, increase issuers' costs of issuance as well as systemic risk and have anticompetitive effects throughout the fixed income securities industry," said Putman, a managing director with Lehman Brothers.
Putman said that current sales practice rules bar excessive markups, and regulators have not shown that dealer markups are enough of a problem to require added rules. The National Association of Securities Dealers took 336 enforcement actions between 1982 and 1992, an average of 33 a year, Putman said.
"This represents an extremely small amount, given the fact that literally millions of transactions occurred during that time period;" said Putman, who noted that dealer opposition to the rule was "remarkably consistent" at five meetings that the PSA sponsored nationwide over the last two months on the issue.
Regulators say that the new rule is part of a trend that began a decade ago when the commission issued rules requiring firms to disclose markups on riskless principal transactions in equities. Market fears that disclosure would harm liquidity in that market have not played out, thus the agency has decided to repropose the rule for municipal and corporate bonds, SEC sources said recently.
But the PSA warned that there are critical differences between transactions in the debt and equities markets. The price quoted on stock exchanges does not include the dealer's commission, which tells the customer that the total cost is higher than the price quoted on the exchange, Putman said.
In the over-the-counter markets, on the other hand, the quoted price is the total amount customers pay, PSA said. The markup covers dealers' overhead costs, compensation to the salesperson, and profit, if any, the group said.
The PSA noted that the markup proposal would not apply to transactions made out of a dealer's inventory. As a result, sales by firms out of inventory would appear to have no markup. That would put small dealers that do not carry inventory, and therefore conduct most of their business on a riskless principal basis, at a disadvantage to large firms, which can carry large inventories, PSA said.
The anticompetitive impact could reduce the number of dealers "active in any given securities that are willing to provide quotations," the PSA said.
The group also objected to the SEC's proposal that dealers disclose on bond confirmations whether the bonds they are selling are unrated. It said such disclosure could mislead investors, since it would not require disclosure of the credit quality of rated bonds, which, in some cases, may be lower than unrated bonds.
The confirmation process may become "overloaded with data, and more difficult to comprehend, thereby detracting from its basic purpose," Putman said.
A better indication of credit quality is yield, which dealers already are required to disclose on confirmations, the PSA said.
The group urged the SEC to hold off on the rule until the Municipal Securities Rulemaking Board has proposed rules it is developing aimed at clarifying the role of the confirmation.
The MSRB issued a notice last week in which it requested broad comment on the confirmation issue, including whether dealers should provide customers with a summary sheet of the features of the bonds they are buying. The notice also asks whether the standard 9-by-5-inch confirmation form should be expanded.
The PSA also questioned whether regulators should be talking about beefing up information on customer confirmations when regulators are planning to shorten settlement times from five days to three. Under the so-called T-plus-three settlement time frame, confirmations that are mailed to customers may not reach them before a transaction is final, the PSA said.
"This calls into question the long-term utility of customer confirmations as a disclosure vehicle," the PSA said.
The group also urged the commission not to shift some of the disclosures on confirmations to customers' periodic account statements. The commission raised the issue in its request for comments. The PSA said. investors do not rely on periodic statements for material information about the features and risks of their bonds.
In other comments, Jon S. Corzine, a partner at Goldman, Sachs & Co., agreed with the PSA that the SEC has not justified the need for disclosing markups on riskless principal transactions.
He took issue with the SEC's statement in defense of the rule that market makers have a much more limited function in the debt markets. "It is unclear how the SEC reaches this conclusion," Corzine said. "Brokerdealers in debt routinely hold themselves out as ready to by and sell particular securities," he said.
Corzine warned that there will be "practical difficulties" in implementing the rule.
"For example, a broker-dealer may buy a security without having a customer order because the security is attractively priced, and shortly thereafter resell the security to a customer. How will the dealer be able to demonstrate that he was at risk where these trades occur in rapid succession?"
Alternatively, Corzine said, "where a broker-dealer has a customer order for $50 million of debt and sells the customer $30 million from inventory and contemporaneously purchases $20 million from another customer, the broker dealer is clearly at risk for part of the transaction."
