The SIPA

The Blog Of The Securities Industry Professional Association
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Are commissions really the problem?

For a long time the SIPA has wondered why there is an obsession with the amount of money a broker earns on any transaction.  The 5%  “Guideline” that is the holy grail of rules even though it is considered a guideline is outdated and not reasonable in this day and age of compliance and regulatory oversight.  Why in the world would any firm take any sort of risk for a meager 5% on a trade that could potentially blow up the firm and put them out of business?   Here are a couple every day examples to consider:

Physical Certificate: A customer deposits 200,000 shares of a stock you have never heard of and you are supposed to believe the stock has a current price of .10 per share.  This appears to be a simple $20,000 trade for the firm and at 5% commission, you can count on a whopping $1,000 commission to the broker and after a 50% commission the firm will net $500.00.  In what world is this risk acceptable?  The firm and clearing firm has to literally do a legal search and practically get a legal opinion on whether the certificate is registered, in good standing and the submitter is not on some sort of list.  God forbid the registration of the security used the wrong exemption that even some attorneys may miss and the firm is facing a 30 day suspension and a $100,000 fine for failure to do everything in the yellow pages. All for about $500.00 in commissions to the firm.  This is the exact reason why most clearing firms have exited this business.  It is just not worth it and even the attempts to put a $1500.00 deposit fee does not offset the risk v reward problem.  We believe it’s time for FINRA to allow all physical stock certificates to be charged a 20% commission and in some cases perhaps 50%.  It may shock your senses after decades of the 5% guideline, but what is the reward for taking the risk on the aforementioned trade? 

Margin Trades: Why in the world would you lend a client hundreds of thousands of dollars to do a margin trade for fewer than 5% commission?  Some may claim that you will be receiving margin interest for the balance, however with interest rates at all time lows for much of the last decade, there is no interest rebates to share with the firm.  A client makes a million dollar trade and are charged a 3% commission and the firm receives $30,000 to split with the broker. Assuming a 50% payout, the firm may only net a mere $15,000.  This may seem like a lot but $500,000 is on loan and if the stock drops or gets halted for any reason the firm is on the hook for the full amount.  In what world do you risk over $500,000 for a mere $15,000?  Is a 1.5% return( to the firm after commissions) really worth it for the firm to take the risk that the clearing firm may come knocking and demand they put up more capital or sell the position?  Quite frankly the firm would be better off investing the 500k into a muni bond, treasury or a piece of real estate on the outside of town. 

Investment Advice:  Why in the world would a broker recommend an investment for 5% or less to a client when he holds all the risk and none of the reward?  If he/she recommends a stock that goes up, everything is fine but god forbid it goes down and now the broker is on the hook for suitability.  A $100,000 investment at 5% will amount to approximately $2500 to the firm and in return the firm bares the risk that if the stock goes south, has accounting issues or is another ENRON or WCOM…the firm has to pay the customer their $100k plus legal costs.  In what world does this trade make sense to any small firm?

The grim reality is that the 5% guideline is antiquated and does not correspond to the modern challenges of running a brokerage firm.   In addition, why do Americans obsess over how much their broker makes?  In Real Estate, Stocks, Automotive and other areas we have become obsessed with how much our professionals make for providing a service.  We say it’s time to stop focusing on how much the professional makes and focus more on what type of service they will give you.  After all, would you rather pay a maximum of 5% to a broker who will lose you $10,000 or would you rather pay 10% to a rep who makes you $25,000?  Our entire country has become obsessed with what others make instead of focusing on what they will make.

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Date
February 22nd, 2019

Author
jbusacca

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