Tuesday, December 02, 2014

Stein Calls for Enhanced Transparency in Municipal and Private Equity Markets

[This story previously appeared in Securities Regulation Daily.]

By Jacquelyn Lumb

In the keynote address at Columbia University Law School’s recent conference on current issues in securities regulation, Commissioner Kara Stein talked about the importance of transparency in the securities markets and the SEC’s recent efforts to enhance transparency in the municipal and private equity markets. There have been significant improvements in the transparency of the municipal securities markets in recent years, according to Stein, but large gaps remain with significant costs to retail investors.

Municipal securities markets. Stein said in the municipal securities markets, regulators should act to require post-trade pricing disclosure on customer confirmations for principal transactions. Investors do not receive disclosure on their confirmations showing the transaction costs they pay when they buy or sell a municipal security in a principal transaction, she explained, and nearly all customer transactions in this market are principal trades. The MSRB has issued a proposal to provide this disclosure and Stein encouraged comments on the MSRB’s proposal and a related proposal by FINRA.

Stein also called for more disclosure before trading occurs. Firm bid and ask quotes are generally unavailable, she noted, and municipal bond dealers usually do not provide firm quotations electronically. Limited information is available to institutional investors and participating dealers, primarily through alternative trading systems or municipal bond dealers that are broker’s brokers. Stein said ordinary investors should have equal access to this information.

One option is to amend Regulation ATS to require the public disclosure of pricing information, according to Stein. The SEC also could require broker’s brokers to publicly disclose pricing information. These alternatives are worth considering in her view, given the benefits that enhanced transparency would bring.

Private equity markets. Stein said there have also been improvements in transparency in the private equity markets. While investors in private equity tend to be sophisticated, Stein said the range of sophistication varies widely.

Stein noted that the Office of Compliance Inspections and Examinations has identified violations and material weaknesses with respect to fees and expenses at a number of private equity firms. She encouraged advisers to private equity funds to consider improving their disclosure about fees and fund performance. OCIE examinations have uncovered practices relating to the payment of consultants and monitoring agreements that are not disclosed with sufficient detail, if at all. Stein also believes it is fair and reasonable for advisers to explain the assumptions they use when calculating returns.

Exchange-traded funds. She also talked about exchange-traded funds and some of the novel exemptive applications the SEC has received. Actively managed ETFs wish to provide less transparency about their portfolio holdings to prevent competitors from front-running their investment strategies. However, Stein noted that a single trader’s order triggered a flash crash and the precipitous drop in the prices and liquidity of ETFs, and asked whether there are systemic risks that should be monitored. She expressed concern that larger questions are getting lost in the current ETF and exemptive application and exchange listing process. Stein said she has asked Chair Mary Jo White to authorize a request for comments to gain public input on issues relating to exchange traded products.

In closing, Stein noted that history has repeatedly demonstrated that the up-front costs that come from additional transparency are more than made up by increases in liquidity, reliability, and competitive returns. Transparency benefits both retail and institutional investors, she said. As the SEC considers changes in transparency, Stein said it must also be aware of the potential effects on the markets and the financial system.

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