Costs of Trading Securities

The compensation method depends on whether the firm acts as broker (agent) or dealer (principal). Understanding the three types of trading costs and when each applies is frequently tested on the Series 65 exam.

When Are Commissions Charged?

• Charged when a broker-dealer acts as agent
• A fee for executing the trade on behalf of the customer
• Must be disclosed on the trade confirmation

When Are Markups and Markdowns Charged?

• Charged when a broker-dealer acts as principal
• Markup = the amount added above the prevailing market price when selling to a customer
• Markdown = the amount subtracted below the prevailing market price when buying from a customer
• Must be fair and reasonable (Financial Industry Regulatory Authority (FINRA) 5% markup policy is a guideline, not a hard rule)

Exam Tip: Gotchas

• FINRA's 5% markup policy is a guideline, not an absolute cap. Markups above 5% are not automatically violations, and markups below 5% are not automatically reasonable. The determination is based on all relevant facts and circumstances.

How Does the Bid-Ask Spread Function as a Cost?

• An implicit cost borne by the customer on every trade
• Wider spreads on illiquid securities mean higher implicit costs

Exam Tip: Gotchas

• The spread is an implicit cost, not a separate fee. Wider spreads on thinly traded securities mean higher implicit costs for the investor.

What Should You Check on Exam Day?

• Commissions apply only when the broker-dealer acts as agent; markups and markdowns apply only when it acts as principal
• A markup is added above market price on a sale to a customer; a markdown is subtracted below market price on a purchase from a customer
• FINRA's 5% markup figure is a guideline, not an absolute cap; reasonableness depends on all relevant facts and circumstances
• The bid-ask spread is an implicit cost on every trade, separate from any commission or markup/markdown, and widens as liquidity decreases