Monday, December 9, 2013

FINRA Fines Oppenheimer over Huge Municipal Bond Markups

By Tim Dulaney, PhD, FRM and Tim Husson, PhD

FINRA announced yesterday that it has fined Oppenheimer & Co., Inc. nearly $700,000 for "charging unfair prices in municipal securities transactions and for failing to have an adequate supervisory system."  FINRA found that over a 12 month period beginning in July 2008, Oppenheimer's head municipal securities trader, David Sirianni, priced bonds up to nearly 16% above the Oppenheimer's contemporaneous cost.

Oppenheimer put into place a system that would produce exception reports whenever an intraday trade went through with a markup of more than 3% of the firm's contemporaneous cost.  Such trades occur when Oppenheimer buys a bond through the inter-dealer market and then sells the bond to a customer on the same day.  Sirianni circumvented Oppenheimer's automated supervisory system by holding the bonds at least overnight.

The risk to Sirianni or to Oppenheimer from holding these bonds overnight was vanishingly small.  Municipal bonds tend to trade only infrequently and daily price movements are minimal.  Yesterday's FINRA action illustrates the degree to which brokers control the prices of municipal bonds sold to retail investors, which often bear little resemblance to their value or even recent cost.

Oppenheimer has been fined $175,000 for their failure to adequately supervise and $500,000 for fair pricing violations.  In addition, Oppenheimer has been ordered to pay "more than $246,000 in restitution, plus interest, to customers who were charged unfair prices."  Sirianni has also been suspended for 60 days.

We've talked a lot about mark-ups in municipal bonds.  Our colleagues have even written a paper (PDF) that estimates the cost to investors in terms of excessive markups may be in the billions of dollars per year.  Although Oppenheimer's supervisory system ignored the excessive markups charged to customers, the methodology used in our colleague's paper does not.

We encourage municipal bond investors to take full advantage of SIFMA's EMMA website, which shows the transaction history for municipal bonds, including inter-dealer trades.  We think municipal investors should always check the prices quoted by their brokers against recent transactions to see how much of a markup they are paying on each of their transactions.  If your broker is charging you a price well above recent trades, ask why.  Chances are the broker will have no good answer and you'll end up with a better deal.

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