Texas Securities Board Fines Broker-Dealers for Excessive Commissions
Commentary by Steven Lofchie
The Texas State Securities Board ("Board") entered separate Orders against five broker-dealers for charging retail customers unreasonable commissions on small-dollar equity transactions.
According to the Orders, the firms collectively charged Texas customers approximately $1.5 million in commissions, which exceeded five percent on 91,586 small equity transactions over a five-year period. Texas securities laws prohibit firms from charging customers unreasonable commissions, and FINRA Rule 2121 ("Fair Prices and Commissions") provides that a commission of five percent, or even less, may be considered unfair or unreasonable.
In one case, the Board found that the broker-dealers charged a minimum commission of $30 on equity transactions during a five-year period. The Board found that the firm executed approximately 7,469 equity transactions in Texas with principal amounts of $2,500 or less, where commissions exceeded five percent of the principal.
In another matter, a broker-dealer charged a minimum commission of $40 plus a $5 transaction fee on equity transactions. The Board found that the firm executed 1,585 equity transactions in Texas where commissions exceeded five percent of the principal trade amount. The Board said the firm's fee schedule permitted commissions to exceed five percent if the commission amount was less than $40, and its policies stated that small transactions may warrant higher percentage charges to cover services rendered.
In a third case, the Board found that a broker-dealer charged a fixed minimum commission for broker-assisted trades—$44.99 for a fixed period, then $25 thereafter—without adequate systems to detect when these minimum commissions became unreasonable on small principal transactions.
Collectively, the firms were ordered to pay a combined total of $1,495,226.26 in restitution to affected Texas customers and $255,000 in administrative fines and investigative costs. Each firm agreed to revisit its policies and procedures to include safeguards to prevent charging excessive fees in the future.
Commentary
These enforcement actions raise practical, legal and policy questions.
Practical. Firms must consider whether they are vulnerable to the same type of enforcement action that was brought by the State of Texas. They must also consider whether it is worthwhile to provide execution services to small clients executing low-dollar transactions.
Legal. The enforcement actions treat a 5% commission as an effective cap. It is not obvious that this should be good law. After all, there are operational costs to executing a securities trade; it would seem that a broker-dealer should be able to recover those (and make some profit) regardless of the size of the trade.
Policy. If the law is that broker-dealers cannot charge a minimum fee, that may effectively mean that small customers can only obtain brokerage services by going to a wholly automated online broker that has very low operational costs and does not provide any personal service. This may not be an illogical policy goal; it is hard to justify buying $100 of securities and paying a $30 or more minimum commission. On the other hand, if the fees are fully disclosed, it is not obvious that customers should not have the choice to pay the commission.