Compensation

The whole unit on one sheet: how broker-dealers get paid, the fairness standard, fund compensation, soft dollars, and adviser fee limits.

How Do Broker-Dealers Get Paid?

• Agent (agency transaction): the firm is an intermediary, earns a commission, and discloses it separately on the confirmation.
• Principal (principal transaction): the firm trades from its own inventory and earns a markup (selling to the customer) or markdown (buying from the customer), embedded in the price.
• A firm cannot charge both a commission and a markup on the same trade.
• Non-transaction fees (maintenance, inactivity, transfer, wire, custodial, closing) must be reasonable and disclosed.
• Wrap fee programs bundle advice, execution, and administration into one asset-based fee and are regulated as advisory programs. That flips the incentive: the sponsor benefits from less trading (reverse churning). The wrap brochure must state whether the bundle costs more or less than paying separately.

What Makes a Charge Fair?

• Fairness has no fixed percentage. A low markup can be unfair and a higher one fair, depending on circumstances, and the standard covers all securities, listed and over-the-counter.
• The seven-factor analysis judges fairness: type of security, availability, price, dollar amount, disclosure, the firm's markup pattern, and the nature of its business.

What Are the Fund Compensation Rules?

• Breakpoints are dollar thresholds where the front-end sales charge drops. A letter of intent (LOI) commits a customer to future purchases to reach one, and rights of accumulation let prior purchases count toward a new breakpoint.
• Share class recommendations need a suitability basis. Leaving a customer holding duplicative similar portfolios without one is its own violation, separate from switching.
• A fund cannot be called "no-load" with a front-end load, a CDSC, or 12b-1 and service fees above 0.25% of average net assets per year.

What Does Regulation Best Interest Require?

• A broker-dealer must act in a retail customer's best interest when recommending. It binds broker-dealers and their associated persons only; advisers have a separate fiduciary standard.
• Four parts: Disclosure, Care, Conflict of Interest, and Compliance. Care includes considering reasonably available alternatives.
• The Conflict of Interest obligation must eliminate limited-period sales contests, quotas, bonuses, and non-cash compensation tied to specific securities. NASAA has incorporated Reg BI, so a violation is also a state dishonest practice.

How Do Soft Dollars and Adviser Fees Work?

• Soft dollars let a manager pay above-market commissions for research and brokerage under a good-faith safe harbor. Office rent, salaries, and marketing never qualify, and the safe harbor excludes security futures products.
• An adviser's contract cannot pay a share of capital gains or appreciation, and the fee provision must be in writing. A fee on total value averaged over a definite period (a "fulcrum fee") is allowed.
• True performance fees are allowed for a qualified client with proper disclosure, or for an adviser not registered and not required to register.
• Form ADV Part 2A, Item 5 covers more than the fee schedule: it also discloses compensation from non-client sources and sales compensation such as 12b-1 fees received by the adviser or a related person.

Which One-Liners Win Points?

• Commission splitting is allowed only with another registered agent at the same firm or an affiliated firm under common control.
• A trade confirmation goes out at or before completion and states agent or principal capacity on every trade.
• Affiliation disclosure comes before the contract, with written follow-up allowed at or before completion.

Which Numbers Matter Most?

Which Gotchas Trip Students Up?

• Markdown is not a discount. It is the firm's profit when buying from a customer, who receives less than current market price.
• Excessive charges are violations even under 5%, and disclosure does not cure unfair pricing.
• Breakpoint selling needs more than a purchase landing below a threshold: confirm an LOI, rights of accumulation, or deliberate structuring first.
• NASAA's induced-trading provision does not require control or intent as separate elements. It tests only whether firm-induced trading is excessive for the customer's resources and account character.
• Fund switching between similar funds without a suitability basis is a violation even if the customer agrees.
• An AUM fee is not a performance fee. The prohibition targets fees pegged to capital gains or appreciation, not to total value.

One-Breath Recap

A broker-dealer acts as agent (commission, disclosed separately) or principal (markup or markdown, embedded in price), never both on one trade, and every charge must be fair and reasonably related to current market value. The 5% policy is a guideline judged by seven factors, so an excessive charge is a violation even under 5% and even if disclosed. NASAA dishonest practices sweep in unfair pricing, unreasonable service fees, firm-induced excessive trading, and splitting commissions with unregistered persons. On mutual funds, disclose all sales charges and available breakpoints, and never switch similar funds without a suitability basis. Reg BI binds broker-dealers to a four-part best-interest standard, soft dollars cover only qualifying research and brokerage, and an adviser's contract cannot pay on capital gains outside the qualified-client route.

Need more than the recap? Read the full Compensation unit.