Confirmations

There are very specific rules that must be followed that standardize the process of firms dealing with other firms and with customers. MSRB and FINRA requirements are extremely similar.

When it comes to bonds, MSRB Rule G-15 (for municipal securities, the MSRB’s territory) requires showing the dollar amount and the percentage of the dealer’s markup or markdown from the prevailing market price on the confirmations. FINRA Rule 2232 requires the same disclosure, in the same form, for corporate and agency bonds. Under both rules, it applies when the firm buys from or sells to a retail (non-institutional) customer as principal and, on the same day, made offsetting trades in that bond at least as large as the customer’s trade.

Customer confirmations are written documents that must be sent for every customer transaction; they cannot be refused. The confirmations will include:

• Name, address, and telephone number of the firm executing the transaction.
• The name of the customer, the owner of the account.
• Whether the transaction is a buy or a sell.
• Whether the transaction is long or short (not generally used in MSRB confirmations)
• The number of securities
• The description of the securities involved, or the name and symbol (for FINRA)
• The par value of any securities (not generally useful for FINRA equity confirmations)
• CUSIP number for any security that has one.
• The trade date, the settlement date, and the time of the trade execution
• Yield and dollar price (yield is not used for equity)
• The taxable nature of the investment, if the income is subject to AMT
• Whether the transaction was done in an agency capacity or a principal capacity.
• Total dollar amount of the transaction.
• Any accrued interest (not used on FINRA equity)
• If any of the bonds are insured (primarily MSRB)
• Source and amount of compensation, whether commission or markup/markdown

MSRB vs. FINRA: MSRB rules (such as G-15) apply only to municipal securities trades, while FINRA rules (such as Rule 2232) govern everything else, including equities. Because of this split, items like par value, accrued interest, and yield appear on MSRB (debt) confirmations but are dropped from FINRA equity confirmations.

The following disclosure rules apply specifically to municipal (MSRB) confirmations:

For MSRB zero-coupon bonds (those maturing in more than 2 years), accrued interest is not shown. Confirmations must still show the par value, the maturity value if it differs from par, and that the interest rate is 0%.

For MSRB OID (original issue discount) bonds that pay periodic interest, the confirmation must say they are original issue discount securities and state the initial public offering price.

Bonds that normally pay interest but are trading without it, usually because the issuer is in default or bankruptcy, must be marked “flat” on the confirmation.

When the dealer acts as the customer’s agent and buys the bonds at a discount (a concession) from the net price the customer pays, the confirmation must show that discount, in dollars, as the dealer’s remuneration from the customer.

Yield basis means the trade was negotiated using a yield, and the dealer calculates the dollar price from that yield. For a callable bond, this can produce more than one possible dollar price - one for each call date plus one for maturity - and the confirmation shows the lowest of those prices, since that’s the worst case for the customer.

Dollar price basis means the trade was negotiated using a dollar price, and the dealer calculates the yield from that price. For a callable bond, this produces more than one possible yield - yield to maturity and yield to call for each call date - and the confirmation shows the lowest of these yields; this “worst case for the customer” result is called yield to worst.

Here is a helpful guide to which yield will be shown on the confirmation:

• For a par bond, simply the dollar price is used, as par bonds don’t have yield confusion. All are the same.
• For a discount bond, the yield would be YTM
• For a premium bond, that is not callable the yield would be YTM
• For a premium bond that is callable, the yield given is whichever is worst: YTM or YTC is used as “Yield to Worst”.
• For a bond that has already been called, YTC is used

On a premium bond, the coupon rate is higher than the yield to maturity, and the yield to call is usually lower still, because an early call leaves fewer years of interest to make up for the premium paid. That is why yield to call is the yield most often shown on the confirmation for a callable premium bond.

Additional information

The previously discussed information is required on all confirmations; some may not be, depending on whether we are discussing the differences between FINRA and MSRB. There may be additional information, depending on specific circumstances.

• For new issues, the dated date must be disclosed if it will affect the price.
• They will disclose the first coupon payment date if it affects the security.
• How the security is issued, whether physically or in book entry form.
• If the bond can be called before maturity: the notation “callable”, and the date and price of the next pricing call. Other call features do not have to be listed; if there are any, the confirmation must say that additional call features exist that may affect yield, and that complete information will be provided upon request.
• If the municipal dealer is acting as agent for both the customer and the other side of the trade, potential conflict of interest. The dealer must either directly disclose the name of the other party or state that they will do so upon request.
• The denominations of the bond certificates to be delivered, if they are nonstandard: for registered bonds, anything other than multiples of $1,000, or over $100,000.

Replacing confirmations

Confirmations are paper and can be lost. Clients can request a copy. Firms must have policies in place to maintain copies. A related MSRB deadline covers information the confirmation says is available on request, such as the name of the other party to the trade. That information must be sent within 5 business days of the request, or within 15 business days if the trade was more than 30 calendar days earlier.

Account records, address changes, and statements of financial condition

Within 30 days of opening an account, and at least every 36 months after that, the firm sends the customer a copy of the account record (name, tax ID, address, phone, date of birth, employment, income, net worth, and investment objectives) so the customer can correct it. When the record is updated for a change of name or address, the firm sends notice of the change to the customer’s old address, or to each joint owner, and to the representative on the account, within 30 days. A change of investment objectives gets an updated copy of the account record, also within 30 days (SEC Rule 17a-3(a)(17)).

Address changes get extra scrutiny because a new address followed by a request to send money there is a common pattern in account takeovers, so branch inspections test how the firm validates changes of address and investment objectives (FINRA Rule 3110(c)(2)). A few kinds of address need care:

• P.O. boxes. The customer identification program needs a residential or business street address for an individual. A P.O. box can’t be that address, although an Army or Fleet Post Office (APO or FPO) box can for someone with no street address (31 CFR 1023.220). A P.O. box can still be a mailing address, and sending funds or securities to an address other than the customer’s primary residence is a transmittal the firm’s procedures must check.
• Foreign addresses. A customer who isn’t a U.S. person still needs a street address on file, and can identify with a passport number and country of issuance, an alien identification card, or another government-issued photo ID in place of a U.S. taxpayer identification number.
• Holding mail. A firm may hold a customer’s mail only on the customer’s written instructions giving the time period, and holding it longer than 3 consecutive months needs a reason other than convenience, such as safety. While mail is held, the firm must still be able to reach the customer (FINRA Rule 3150).

Customers also receive the firm’s own statement of financial condition, its balance sheet: an audited statement within 105 days after the end of the firm’s fiscal year, and an unaudited statement dated six months later, within 65 days of its date (SEC Rule 17a-5(c)). Instead, a firm can send a short summary of its net capital twice a year, post the full statements on its website, and provide a toll-free number customers can call for a free copy.

Municipal fund securities (529)

Municipal fund securities resemble mutual funds, but they’re legally classified as municipal securities rather than investment companies, because they’re issued by a municipal entity and are exempt from the Investment Company Act of 1940.

Confirmations for these are far simpler: they show the total dollar amount involved and the total number of shares involved. The same simplified format applies whether the customer is buying or selling, though the confirmation still shows which it is. It must still identify the securities purchased so the customer can distinguish their holdings from other purchasers of the same issue. These confirmations don’t include par value, accrued interest, or maturity dates. A dealer doesn’t have to confirm each transaction made under a periodic plan, such as automatic monthly contributions. After telling the customer in writing, and with the customer’s or the issuer’s written consent, it can instead send a statement within five business days after the end of each quarter that gives the confirmation details of every purchase, sale, and redemption in the period. The quarterly statement replaces those confirmations; it isn’t an extra requirement for every 529 customer.