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