Compensation

Review compensation, pricing, funds, and adviser fees.

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 for its own account and earns a markup (selling to the customer) or markdown (buying from the customer), embedded in the price.
• A covered confirmation states whether the firm acted as agent or principal for its own account.
• Fees for services such as collections, transfers, appraisals, safekeeping, and custody must be reasonable and equitable.
• Wrap fees bundle advice, execution, and administration. The sponsor may benefit from less trading, and the brochure compares bundled with separate costs.

What Makes a Charge Fair?

• Fairness has no fixed percentage. Circumstances determine whether a low or high markup is fair, for listed and over-the-counter securities alike.
• 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 lower front-end sales charges at purchase thresholds. A letter of intent (LOI) counts planned purchases; rights of accumulation count qualifying existing holdings.
• Share class recommendations need a suitability basis. Recommending a purchase that leaves a customer holding different portfolios with similar objectives and policies 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. Under Care, a firm generally should consider reasonably available alternatives it offers.
• The Conflict of Interest obligation must identify and eliminate sales contests, quotas, bonuses, and non-cash compensation based on sales of specific securities or specific types of securities within a limited period of time. 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 must state in writing that the adviser will not receive compensation based on a share of the client's capital gains or appreciation unless an exemption applies. An asset-based fee on total value averaged over a stated period or measured on stated dates 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.
• An adviser must disclose compensation from non-client sources, not just its stated fee schedule. That includes 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 confirmation for a transaction covered by the federal rule is due at or before completion and states agent or principal capacity. That rule excludes U.S. Savings Bonds and municipal securities; municipal confirmations have separate requirements.
• 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

On a trade, a broker-dealer acts as agent (commission, disclosed separately) or principal (markup or markdown, embedded in price), and the confirmation states which. A principal price must be reasonably related to current market value, a commission fair or reasonable under the circumstances, and a miscellaneous service fee reasonable and equitable. The 5% policy is a seven-factor guideline; disclosure and a charge below 5% do not cure unfairness. NASAA also prohibits firm-induced excessive trading and unregistered commission splitting. For mutual funds, disclose sales charges and breakpoints, and do not switch similar funds without a suitability basis. Reg BI imposes a four-part best-interest standard, soft dollars cover qualifying research and brokerage, and advisory contracts cannot pay on capital gains outside an exemption.

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