Compensation and Fee Structures

The whole unit on one sheet: how BDs get paid, the fairness standard, the NASAA dishonest-practice provisions, mutual fund compensation, Regulation Best Interest, and disclosure.

How Broker-Dealers Get Paid

• Agent (agency transaction): BD is an intermediary; earns a commission; commission is separately disclosed on the confirmation.
• Principal (principal transaction): BD trades from its own inventory; earns a markup (selling to the customer) or markdown (buying from the customer); the amount is embedded in the price.
• A BD cannot charge both a commission and a markup on the same trade. Agent = commission. Principal = markup/markdown.
• Non-transaction fees (maintenance, inactivity, transfer, wire, custodial, closing) must be reasonable and disclosed.

The One-Liners That Win Points

• Capacity (agent vs. principal) drives compensation type (commission vs. markup), which drives disclosure method (separate line vs. embedded).
• Fairness has no fixed percentage: a low markup can be unfair, a higher markup can be fair, depending on circumstances.
• The standard applies to all securities, listed and over-the-counter (OTC), and to both commissions and markups/markdowns.
• The seven-factor analysis judges fairness: type of security, availability, price, dollar amount, disclosure, the firm's markup pattern, and the nature of the firm's business.
• Breakpoints are dollar thresholds where the front-end sales charge drops; a letter of intent (LOI) lets a customer commit to future purchases to reach one.
• Reg BI applies to BDs and their associated persons only; investment advisers have a separate fiduciary standard.
• Commission splitting is only allowed with another registered agent at the same BD or an affiliated BD under common control.

Numbers to Lock In

• 5% policy: a fairness guideline, not a hard cap. At or below 5% is not automatically fair; above 5% is not automatically a violation.
• Trade confirmation: delivered at or before completion of the transaction; must state agent or principal capacity on every trade.
• Affiliation disclosure: must come before entering the contract; written follow-up allowed at or before completion if not initially in writing.

Top Gotchas

• Markdown is not a discount. It is the BD's profit when buying from a customer, who receives less than current market price.
• Excessive charges are violations even under 5%. The test is the relationship to current market value and reasonableness, not the percentage.
• Disclosure does not cure unfair pricing. An 8% markup is not defensible by saying "I told the customer."
• Breakpoint selling (structuring a purchase just below a breakpoint to avoid the discount and earn more) is always a violation.
• Churning requires control (discretionary authority or de facto control); a customer who independently trades a lot is not being churned.
• Fund switching between similar funds without a suitability basis is a violation even if the customer agrees.

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 price and 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, churning (which needs control), and splitting commissions with unregistered persons. On mutual funds, disclose all sales charges and breakpoints, never sell just below a breakpoint or switch similar funds without a suitability basis, and remember Reg BI binds broker-dealers at the best-interest standard while disclosure alone never cures an unfair price.

Need more than the recap? This is a condensed summary. If it is not enough, read the full Compensation and Fee Structures unit for the complete lesson.