WASHINGTON – J.W. Korth & Co. is appealing a Financial Industry Regulatory Authority three-person panel decision that found the firm charged excessive markups on 38 sales of municipal bonds, moving the issue before FINRA’s National Adjudicatory Council.
Another firm, New York-based BGC Financial, agreed to pay $30,000 to settle FINRA charges related to reporting failures in munis. It agreed to the settlement without admitting or denying FINRA’s findings.
FINRA included J.W. Korth's decision to appeal and BGC's settlement in its monthly disciplinary report for April. J.W. Korth declined to comment for the article, citing the ongoing nature of the case and BGC Financial could not be reached for comment.
J.W. Korth has yet to file a brief explaining its case for appeal, but argued to the hearing panel before it ruled against the firm, that its markups were warranted because of the unique services the firm provides its customers. If NAC were to affirm the panel’s findings, J.W. Korth would have to pay about $22,000 in restitution to investors and, in lieu of a fine, hire an independent consultant with experience establishing pricing procedures. Those sanctions are not effective while the matter is on appeal.
J.W. Korth made clear in the prior proceedings that it researches and recommends smaller, more obscure bond issues with ratings that are below investment grade or bonds with complicated structures that a general, less specialized firm may not recommend. It also said that markups of more than 3% are justified by its services and expertise, including offering each client access to its proprietary online service Shop4Bonds, which gives them access to the interdealer prices of bonds, without markups, for about 90% of U.S. bond offerings.
The firm argued it is entitled to make a reasonable profit based on its business model and its high costs because of its particularized services. The FINRA panel rejected that argument, saying “if a firm cannot be profitable by charging fair and reasonable markups, the solution is not to charge excessive markups, but rather to revise the firm’s pricing practices.”
J.W. Korth had asked that FINRA look at the average markup per customer that it charges, citing evidence that while it may charge customers higher markups on some trades, the average markup per customer is less than 2.2%. The panel concluded that “a markup on one transaction cannot … be justified by a smaller or no markup on another transaction.”
While the FINRA panel generally disagreed with the firm’s analysis of how its work justified the markups being charged, there were some instances of agreement that led to the overturning of changes in six of the 44 sales that FINRA enforcement officials believed involved excessive markups.
In one trade, the panel said J.W. Korth’s decision to charge a 3.9% markup on bonds was not excessive because the bonds were not rated, involved a smaller issue size, and had not been actively traded in the days before the trade. The panel came to a similar conclusion in a sale that had a 3.28% markup but involved a small issue size and required more research to locate, sell, and service the bonds.
However, the FINRA panel found that one trade with a 3.65% markup was not fair or reasonable because it involved bonds that had a large issue size and an average amount of liquidity. J.W. Korth also held the bonds for only a short time, from 4:00 pm one day to 10:00 am the next, according to FINRA. FINRA found the firm charged a 5.87% markup on bonds that it held for only an hour, during which time the market did not appear to move.
In other cases, the FINRA panel found that the firm did not properly document the efforts it said it undertook for some of the sales, hurting its chances of proving those higher markups were reasonable.
FINRA’s action against BGC Financial stems from findings that the firm had a number of trade reporting failures between July 1 and March 31 in 2015. During that period, the firm failed to report 257 purchase and sale transactions in municipal securities to the Municipal Securities Rulemaking Board’s Real-time Transaction Reporting System within the 15 minutes required under MSRB Rule G-14 on reports of sales and purchases, according to FINRA.
The self-regulator also referenced a past finding that BGC settled involving a $25,000 fine over muni trade reporting and supervision-related decisions. Those findings covered the time period between April 1 and June 30 in 2014.