Trade Confirmation

A trade confirmation is the written notification a brokerage firm must provide to a customer for each securities transaction. Under SEC Rule 10b-10 it is "unlawful for any broker or dealer to effect for or with an account of a customer any transaction in, or to induce the purchase or sale by such customer of, any security (other than U.S. Savings Bonds or municipal securities)" unless the firm, "at or before completion of such transaction, gives or sends to such customer written notification" disclosing specified information. That information starts with the date and time of the transaction, or the fact that the time will be furnished on written request, and the identity, price and number of shares or principal amount of the security. It then requires the firm to state the capacity in which it acted.

The naming is worth a sentence, because the two regulators use different words. The SEC rule is titled "Confirmation of transactions" but its operative text never uses the noun; it says "written notification" throughout. FINRA's rule supplies the everyday name, requiring a member to "give or send to such customer written notification ('confirmation') in conformity with the requirements of SEA Rule 10b-10". So the document is a written notification in the SEC's language and a confirmation in FINRA's and in everybody else's, and the two describe the same piece of paper.

Capacity is the field that explains the firm's compensation, and it is the reason the rule asks for it. The rule requires the firm to say whether it acted "as agent for such customer, as agent for some other person, as agent for both such customer and some other person, or as principal for its own account", and, if as principal, "whether it is a market maker in the security". Acting as agent, the firm arranged the trade with someone else and must disclose the remuneration it received from the customer, unless that remuneration is set by written agreement on something other than a transaction basis. Acting as principal, the firm sold the customer something out of its own inventory, and what it earned is embedded in the price rather than shown as a separate charge. The trade can look identical on both sides of that line, and the cost to the customer is arrived at in completely different ways.

The agency disclosures go further than most readers expect. For an agency trade the firm must also disclose the name of the person the security was bought from or sold to, or the fact that the information will be furnished on the customer's written request, and the source and amount of any other remuneration it received in connection with the transaction. For a transaction in an NMS stock the confirmation must state whether payment for order flow was received, and that the source and nature of that compensation will be furnished on written request. That last item is a doorway rather than an answer, and what lies behind it is a subject of its own.

What FINRA adds on top of the SEC's list. FINRA's confirmation rule requires, beyond conformity with the SEC rule, the settlement date for transactions in NMS stocks and securities reported under its 6600 Series, other than direct participation programs; a statement that a callable equity security is callable, together with a line telling the customer they may contact the firm for more information; and, in the paragraph that matters most to a bond buyer, the firm's mark-up or mark-down "expressed as a total dollar amount and as a percentage of the prevailing market price". That last requirement is conditional in two ways: the firm must be acting in a principal capacity in a corporate or agency debt security with a non-institutional customer, and it must have bought or sold the security in one or more offsetting transactions of at least the customer's size on the same trading day. Both conditions matter, and the second is why a bond confirmation sometimes carries the figure and sometimes does not.

The institutional line runs through this document too. Because the mark-up disclosure applies only where the customer is non-institutional, the same classification that governs how a firm's marketing material is supervised also decides whether a customer sees the firm's compensation written on the confirmation. A customer whose account meets the institutional definition is presumed able to work the number out unaided.

The rule's own opening note warns against reading it as a ceiling. The Preliminary Note to Rule 10b-10 states that the requirements "that particular information be disclosed is not determinative of a broker-dealer's obligation under the general antifraud provisions of the federal securities laws to disclose additional information to a customer at the time of the customer's investment decision". In other words, a firm that discloses exactly what the confirmation rule lists has not thereby discharged its obligations. The confirmation is a floor.

What the document is good for, in practice. It is the contemporaneous record of what actually happened, produced by the firm, at the moment of the trade. Checking it takes a minute and answers a small number of questions well: was this the security intended, was the quantity right, was the price what was expected, and in what capacity did the firm act. A discrepancy found now is a correctable error; the same discrepancy found at tax time is an argument.

What to check, in the order the rule requires it to be disclosed:

1. The transaction facts. Date and time (or a note that the time is available on written request), the security, the price, and the number of shares or the principal amount.

2. The capacity. Agent for the customer, agent for someone else, agent for both, or principal for the firm's own account, and if principal, whether the firm is a market maker in the security.

3. The money. For an agency trade, the remuneration received from the customer. For a principal trade in corporate or agency debt with a non-institutional customer, and where the same-day offsetting condition is met, the mark-up or mark-down in dollars and as a percentage.

4. The dates that follow. For NMS stocks and certain reported securities, the settlement date.

A hypothetical, to show what the mark-up disclosure reveals. Assume a firm buys corporate bonds in the market and sells $10,000 of face value to a retail customer at $99.40 per $100 of face, so the customer pays $9,940. Assume the prevailing market price for the purposes of the rule is $98.20 per $100 of face, which values the same bonds at $9,820. The firm's mark-up is $9,940 minus $9,820, or $120, and as a percentage of the prevailing market price that is $120 divided by $9,820, or 1.22 percent. Both figures must appear on the confirmation. (Numbers hypothetical, for illustration. FINRA's rule requires the mark-up to be calculated in compliance with its own pricing rule, and the prevailing market price is determined under that rule rather than stipulated.)

Without that disclosure the customer sees a single price and no charge at all, which is exactly why the requirement exists: on a principal trade there is no commission line to look at, and $120 of compensation is invisible inside a quoted price.

Pros

• The document is mandatory and immediate. The rule makes effecting the transaction without it unlawful, and it must arrive at or before completion of the trade.
• The capacity disclosure tells a customer how the firm was compensated even when no separate charge appears anywhere on the document.
• The mark-up disclosure on retail principal trades in corporate and agency debt turns an invisible cost into two printed figures.
• It is a contemporaneous record from the firm itself, which makes it the strongest evidence a customer has if something was executed wrongly.

Cons

• Several of the most useful disclosures are available only "upon written request", including the time of the transaction and the source and nature of any payment for order flow, so the default document is less informative than the rule sounds.
• The mark-up disclosure is conditional on capacity, security type, customer type and a same-day offsetting-trade test, so its absence tells a reader almost nothing.
• U.S. Savings Bonds and municipal securities are excepted from the SEC rule entirely, so it is not the source of the obligation for those.
• Complying with the confirmation rule is a floor, not a safe harbor. The rule's own Preliminary Note says the required disclosures do not determine what the antifraud provisions may separately require.