The practice of dealers showing clients different prices for the same securities on electronic bond-trading platforms is drawing the scrutiny of the U.S. Securities and Exchange Commission, which is concerned that smaller investors are being penalized.
SEC regulators want to understand why brokers sometimes block their rivals and clients from seeing some of their prices for municipal, corporate and other bonds, according to a person with direct knowledge of the examination. They’re examining whether being able to turn quotes on and off allows market manipulation, and whether smaller buyers are given worse prices, the person said.
The probe underscores the growing concern that the infrastructure of the U.S. bond market hasn’t kept pace with a 23 percent expansion in the past six years, with much of the trading still conducted through telephone conversations and e- mails. The SEC is separately looking into the way the biggest banks allocate corporate-bond offerings and whether they give preferential treatment to certain clients.
“There’s a club-within-a-club sort of atmosphere people started to get very concerned about,” said Robert Smith, chief investment officer at Austin, Texas-based Sage Advisory Services Ltd., which oversees about $10.5 billion. “In essence, you could start to see two different prices for the same security.”
The inquiry into alternative trading systems has focused on those that cater to individual investors as well as dealers trading among themselves, according to the person, who asked not to be identified because the examination isn’t public.
Increased Trading
The probe is an attempt to get more information, rather than build a case for an enforcement action, and is being conducted by the Office of Compliance Inspections and Examinations wing of the SEC, according to the person familiar with the matter.
Even if alternative trading systems “don’t account for a majority of the trading, they can be a source of information, and there’s the potential for filters to be used in a manner that would distort the market,” Kevin Goodman, national associate director of the broker-dealer examination program at the division, said in a telephone interview.
U.S. investment firms predict that 30 percent of corporate- bond trading will occur electronically by 2015, up from 14 percent of investment-grade notes in 2012, according to an August 2013 report by Greenwich Associates and McKinsey & Co. As much as 50 percent of municipal trades already may occur electronically, according to a TMC Bonds comment letter to the SEC last year.
Promoting Transparency