Is there such a thing as a ‘fair’ markup in muniland?

June 20, 2013

It’s well known in muniland that retail investors, who buy smaller lots of bonds than institutional buyers, get hit with high markups. The rule is that dealers must deal “fairly” with investors. Translation: Markups to customers cannot exceed 5 percent. So if a dealer sells a bond worth $5,000, he may not charge the client more than a $250 markup. However, there is no regulatory requirement for the dealer to tell the client how much the bond has been marked up; just that it was marked up. Many believe these differences in bond prices are excessive, but no one has figured out a way to reduce or stop the practice.

Securities and Litigation Consulting Group of Fairfax, Virginia, recently published a report that analyzed almost $3.7 trillion worth of municipal bond trades that happened between 2005 and 2013 (page 8):

SLCG found that the median markup for a trade up to $25,000 in size is 1.79 percent. Here is an example of a trade with an excessive markup, from page 11 of the study:

The folks over at SIFMA, the trade association for dealers, have pushed back on SLCG’s methodology. But remarkably similar conclusions have come out of Standard & Poor’s Fixed Income Indices Team. Here is the S&P breakdown of markups using its methodology on a smaller set of retail trades (worth less than $100,000) that used a wider variety of bonds. S&P found that the average markup in March, 2013 was 1.62 percent, compared to 1.79 percent found by SLCG:

This isn’t the only literature that shows retail investors pay higher (sometimes excessive) markups on bonds than larger institutions. I have a lot of opinions on the subject, but I am going to withhold them until the release of the long-awaited report from Erik Sirri, former director of the SEC Division of Trading and Markets, who has been studying municipal bond market structure for the last two years. Sirri contributed to some of the seminal work on markups and transparency for the corporate bond market, and his muniland study may teach us a lot. Stay tuned.


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There is a growing literature on municipal bond markups which analyzes the MSRB EMMA data. That literature is listed in the bibliography to our study and listed below. Craig McCann

Report on the Municipal Securities Market, US Securities and Exchange Commission, July 31, 2012.
Municipal Securities, Overview of Market Structure, Pricing and Regulation, GAO-12-265, U.S. Government Accountability Office, January 2012.
Department of Enforcement v David Lerner Associates, Inc. and William Mason, Disciplinary Proceeding No. 20050007427, Extended Hearing Panel Decision, April 4, 2012.
Dario Cestau, Richard C. Green and Norman Schürhoff, Tax-Subsidized Underpricing: Issuers and Underwriters in the Market for Build America Bonds, Working Paper, Feb 2013, available at bstract_id=2162960
Sugato Chakravaty and Asani Sarkar, “Liquidity in U.S. Fixed Income Markets: A Comparison of the Bid-Ask Spread in Corporate, Government and Municipal Bond Markets”, FRB Staff Bulletin 1999-73. Subsequently published as “Trading Costs in Three U.S. Bond Markets”, Journal of Fixed Income, 13(1), 39-48, 2003.
Peter Ciampi and Eric Zitzewitz, “Corporate and Municipal Bond Trading Costs During the Financial Crisis”, White Paper, August 2010.
Amy Edwards, Lawrence E. Harris, and Michael S. Piwowar, “Corporate Bond Market Transaction Costs and Transparency”, Journal of Finance, 62(3), 1421-51, 2007.
Allen Ferrell, The Law and Finance of Broker-Dealer Markups NASD 2008.
Gwangheon Hong and Arthur Warga, “Municipal Marketability”, Journal of Fixed Income, 14(2), 86-95, 2004.
Richard C. Green, Burton Hollifield and Norman Schürhoff, “Financial Intermediation and Costs of Trading in an Opaque Market”, Review of Financial Studies, 20(2), 275-314, March 2007a.
Richard C. Green, Burton Hollifield and Norman Schürhoff, “Dealer Intermediation and Price Behavior in the Aftermarket for New Bond Issues”, Journal of Financial Economics, 86(3), 643-682, 2007b.
Lawrence E. Harris and Michael S. Piwowar, “Secondary Trading Costs in the Municipal Bond Market”, Journal of Finance, 61(3), 1361-97, 2006.
Dan Li and Norman Schürhoff, Dealer Networks, Working Paper, Nov. 2011, available at bstract_id=2023201.
Justin Marlowe, “Municipal Bond Liquidity Before and After the Financial Crisis”, Working Paper, Jan. 2013, available at bstract_id=2206730
Paul Schultz, “The Market for New Issues of Municipal Bonds: The Roles of Transparency and Limited Access to Retail Investors”, Journal of Financial Economics, 106(3), 492-512, 2012.
Jason Zweig, “Will New Rules and Fees Slow Down Eager-Beaver Brokers?” The Wall Street Journal, March 26, 2012.

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