Markups, Markdowns, and Commissions

These rules together govern the firm's pricing and disclosure obligations on every customer transaction. The exam tests them as a stack: the firm must price fairly, charge reasonable service fees, obtain proper consent for principal-trade structures, and confirm every trade in writing with the right disclosures.

The Fair Pricing Standard ("5% Policy")

Members must buy and sell securities for customers at prices that are fair, taking into account all relevant circumstances. The "5% Policy" is a guideline, not a safe harbor: a markup, markdown, or commission of 5% or even less may be unfair under all the circumstances.

Supplementary Material .01(b) lists factors a firm must consider in evaluating fairness:

• Type of security (listed equity vs. low-priced or thinly-traded vs. bond)
• Availability of the security (illiquid securities may justify higher cost)
• Price of the security (lower-priced securities may justify higher percentages)
• Transaction size (smaller dollar size may justify higher percentages)
• Disclosure of the markup or commission to the customer (a factor, but does NOT cure an unfair price)
• Pattern of the firm's markups
• Nature of the firm's business

Think of it this way: The 5% Policy is a rebuttable presumption ceiling, not a floor. A firm can charge less than 5% and still violate fair pricing if the security is liquid and widely traded; a firm can charge slightly more than 5% on a thinly-traded low-priced bond and still satisfy fair pricing because the costs justify it. Each transaction is evaluated on its own facts.

Exam Tip: Gotchas

• 5% is NOT a safe harbor. A 4.5% markup on a thinly-traded low-priced security may be acceptable; a 4.5% markup on a heavily-traded blue-chip stock will not be. Disclosure does not cure an unfair price.
• Disclosure is one factor in the fairness analysis, not a substitute for fair pricing. A firm cannot set whatever markup it wants and rely on customer disclosure to satisfy the fair pricing standard.

Charges for Services Performed

Miscellaneous charges (collection of dividends/interest, transfer or exchange of securities, appraisals, safekeeping or custody, etc.) must be:

• Reasonable
• Not unfairly discriminatory among customers

The customer must receive written notification of service charges:

• At account opening
• At least 30 days before any change in those charges

Exam Tip: Gotchas

• Service charge changes require 30 days' advance written notice. A firm that raises fees without advance notice violates the service-charge rule even if the new fees are themselves reasonable.

Net Transactions With Customers

A "net" transaction is a principal trade where the firm executes one leg at one price and the customer leg at a different price. The difference between the two legs is imputed compensation to the firm; it is not separately disclosed as a commission or markup on the confirmation.

The net-transaction rule sets the consent requirements based on customer type:

A negative-consent letter is a one-time written disclosure that net trades will occur unless the institutional customer objects. Silence after the letter is treated as consent. This option is not available for non-institutional customers, who must affirmatively consent in writing on every order.

Think of it this way: The disparity in consent rules tracks customer sophistication. An institutional customer with a portfolio manager and a compliance department can absorb a one-time disclosure and decide whether to opt out. A retail customer cannot reasonably be expected to manage that ongoing exposure, so each net trade requires a fresh, written approval.

Exam Tip: Gotchas

• Non-institutional consent is order-by-order in writing; institutional consent can be a one-time negative-consent letter. Read the question carefully to identify the customer type before answering.
• Net transactions are principal trades; agency trades do not raise the same net-transaction issue. When the firm acts as agent, the commission is separately disclosed and the customer knows the cost; net transactions exist only in the principal-trade context.

Customer Confirmations

A customer must receive a written confirmation at or before completion of each transaction. The confirmation requirement comes from the SEC's customer-confirmation rule, with the FINRA trade confirmation rule layering on additional retail-debt disclosures.

Required Confirmation Content

Think of it this way: The confirmation tells the customer what was traded, at what price, what role the firm played, and what the firm earned. The confirmation is the customer's primary record of every transaction; it must arrive at or before settlement so the customer can verify the trade.

Exam Tip: Gotchas

• The confirmation must disclose the firm's capacity (agent or principal) on every trade. This is a non-waivable requirement under the customer-confirmation rule. A confirmation that omits capacity violates the rule even if all other information is correct.
• Yield information on debt securities must include yield-to-worst when there are call provisions (the lower of yield-to-call or yield-to-maturity for a callable bond trading above par; yield-to-maturity for non-callable or below-par bonds).

Retail Debt Markup Disclosure (2018 Amendment)

For retail-customer principal trades in corporate or agency debt where the firm executes an offsetting principal trade on the same trading day on the same side, the confirmation must disclose:

• The firm's markup or markdown as a total dollar amount AND as a percentage of prevailing market price (PMP)
• Time of execution (to the second)
• A reference or hyperlink to a FINRA web page with publicly available trade data for the security (TRACE for corporate debt)

This amendment was adopted in 2016 and became fully effective in May 2018. It applies only to:

• Retail (non-institutional) customers
• Corporate or agency debt (not municipal debt, which has parallel MSRB customer-confirmation rules)
• Principal trades (not agency trades)
• Same-day offsetting principal trades on the same side (a buy-then-sell or sell-then-buy by the firm on the same trading day)

Think of it this way: When the firm buys a bond at one price and sells it to the retail customer at a higher price on the same day, the customer can now see the firm's exact markup, the time the firm bought it, and a link to verify the prevailing market price. The amendment was designed to bring transparency to retail bond trading, where markups had historically been opaque.

Exam Tip: Gotchas

• The same-day-offsetting-trade markup disclosure applies only to retail principal trades in corporate or agency debt. Institutional trades, agency trades, and trades without a same-day offset on the same side are not subject to this enhanced disclosure.
• Municipal debt confirmations are governed by parallel MSRB customer-confirmation requirements, not the FINRA rule. The structure is similar (same-day-offset markup disclosure for retail customers), but the source authority is different.

How These Rules Stack on a Single Trade

Imagine a firm sells a corporate bond to a retail customer as principal at 102, after buying it at 100 earlier the same day. Five rules touch this single trade:

• Fair-pricing standard: the 2-point markup must be fair under all circumstances (security type, liquidity, price, transaction size). Disclosure does not cure unfairness.
• Net-transaction rule: not a "net transaction" because the firm is taking a markup, not embedding compensation in two different transaction prices. Consent rules do not apply.
• Miscellaneous-charges rule: any service fees layered on (handling, settlement) must be reasonable and disclosed.
• Customer-confirmation rule: the confirmation must show capacity (principal), price, quantity, time, and yield information.
• Retail debt confirmation amendment: because this is a retail principal trade in corporate debt with a same-day offsetting purchase, the confirmation must additionally show the markup in dollars and as a percentage of PMP, the execution time to the second, and a TRACE hyperlink.

Exam Tip: Gotchas

• A single trade can implicate the fair-pricing standard, miscellaneous-charges rule, the customer-confirmation rule, and the retail debt confirmation rules simultaneously. The exam often tests these rules in combination by describing one trade and asking which rules govern which aspects.