Under the Government Securities Act Amendments of 1993 (P.L. 103-202), bank and nonbank securities regulators were authorized to write sales practice rules to govern the activities of those entities under their respective jurisdictions that trade in government securities. Among the rules that were expected to be issued were those relating to markups.
Markup is defined as the difference between the broker-dealer's cost of purchasing an instrument and the selling price to the customer, relative to the current price of the security. The question of fair markups, or spreads, frequently depends on a particular circumstance. In addition to the price of the security, other criteria to be considered in determining whether a markup is fair are: the type of security involved; the availability of the security in the market; the amount of money involved in a transaction; pattern of markups; expenses involved in effecting the transaction; the fact that a broker-dealer is entitled to a profit; and the nature of the broker-dealer's services.
For registered securities (equities), the National Association of Securities Dealers (NASD) has adopted a 5 percent mark-up guideline for its members. The Securities and Exchange Commission (SEC) has taken the position that markups in excess of 5 percent are questionable, while any undisclosed markup in excess of 10 percent of the price of the security is fraudulent because it is far in excess of industry norms. The SEC also takes the position that markups smaller than 5 percent can also be considered fraudulent if they are undisclosed and in excess of industry norms.
The Municipal Securities Rulemaking Board (MSRB) has not adopted a specific mark-up guideline, but requires that Ano broker, dealer or municipal securities dealer shall purchase or sell municipal securities as agent for a customer for a commission or service charge in excess of a fair and reasonable amount, taking into consideration all relevant factors.
In addition, there are no requirements that markups be disclosed to customers prior to their undertaking a securities transaction in any market. Excessive markups can be generated by the size of the lot or lots purchased. Purchases of smaller or odd lots will result in a higher markup and higher costs to an investor than a purchase of a single large lot. This is a cost that should be available to the customer upon request and that may influence a customer=s decision to purchase particular instruments or purchase them from a particular broker-dealer.
Excessive markups in the government securities market are considered to be a violation of the NASD=s Rules of Fair Practice. Disclosure of markups is not covered by any NASD rule. Although a proposed mark-up rule was issued by the NASD in August 1994, no action has been taken on it since that time by either the NASD or the SEC. Recent charges alleging that U.S.Treasury securities have been sold at greater than fair-market value at fraudulently excessive markups by broker-dealers in connection with the investment of bond proceeds has highlighted the absence of mark-up rules in the government securities market.
The Government Finance Officers Association (GFOA) views the adoption by market regulators of mark-up guidelines for the government securities market and the requirement to disclose markups, if requested, as well as the use of competitive selection process, as essential to assure just and equitable trading in order to preserve the integrity of the marketplace and to reduce the costs of investing for all investors, including state and local governments and their taxpayers. GFOA supports efforts to write appropriate rules based on readily ascertainable and verifiable information so that investors are able to determine if a markup is reasonable and to compare prices. GFOA urges regulators to carry out the intent of Congress to curb market abuses expeditiously.
- Publication date: June 1997