Markups and Disclosure Requirements

One of the most abusive sales practices in the securities brokerage industry is the suggestion that the broker is not charging a “commission.”  Victims of churning or excessive trading are often told that they ought not to be concerned because they are not paying or being charged commissions.  When your stockbroker or financial advisor acts as an “agent” in connection with purchase or sale of securities in your account and the account of another or contra-party, your stockbroker or securities broker-dealer is required to fully disclose “commissions.”

A clerk counts US dollar bills at a bankHowever, when your stockbroker or financial advisor acts as an “principal” in connection with purchase or sale of securities in your account and its own account, it is only required to disclose its mark-ups or mark-downs from prevailing bid and offer prices, and then only when it is not “at risk.”  So a brokerage firm may purchase at the bid and sell it to its customers as the offer, without disclosing its “compensation.”   In a riskless principal transaction the brokerage firm has both sides of the transaction but merely interpositions its principal account or trading account between the orders.   Even in a riskless principal transaction where the mark-up or mark-down is disclosed, it can be as much as 5%, and might only show on the confirmation as “m/u” or “m/d” expressed as a decimal point per share with no assigned total dollar value.

Bonds are more complicated and less transparent than stocks.  When a broker sells a bond as principal, as in this case from a proprietary firm account, the broker is only obligated to disclose the “mark-up” from the lowest prevailing offer price or the “mark-down” from the highest prevailing bid price.   So, for example, if a particular bond,  generally a low quality or high risk thinly traded bond) has a “bid” of $75 per bond and an “offer” of $100 per bond, or a $25 “spread” a broker may purchase the bond at $75, and immediately, sell it to a retail customer at $100 per bond, and thereby realize a $25 or 25% profit, without ever having to disclose this profit or fee to the customer.

In fact, in 2010,, the U.S. State and Local Public Finance Watchdog and Muni Market Investor Advocate, issued a Special Report Worst Spreads in 2010, where in several cases, a broker-dealer could “cross” the bonds by paying a selling customer the bid, and resell them at the offer per bond, and realize in some cases an instant profit, sometimes in excess of 30% exclusive of any “mark down” to the seller or “mark-up” to the purchaser. See also, Forbes, Broker Markups: A Bond Investor’s Worst Enemy (Feb. 26, 2009)(a markup is when a broker buys a bond at low price, then shortly thereafter resells it to an unaware customer at a higher price. The broker makes his money from that difference in price, called “spread.”).

wallet spilling cashThe MSRB, however, has consistently warned its members that “Reasonable Compensation Not Same as Fair Pricing,” and that excessive commissions, mark-ups or mark-downs obviously may cause a violation of the Rule, and in February 2011, FINRA issued Regulatory Notice 11-08, reminding members that “fair and reasonable” compensation is determined by a broker-dealer’s actual or contemporary cost, and not merely the bid and offer price of any particular fixed income security sold at principal.

However, unless the broker voluntarily discloses compensation to a customer, or the customer has access in intra-day bid and offer prices on any particular security, the broker’s actual compensation may go undisclosed, and a customer purchasing a security at the “offer” may be unaware of the actual bid price of the security.

Charging Investors Excessive Mark-ups and Mark-downs, is not only a form of self-dealing, and the breach of fiduciary duty, when these fees are concealed or not disclosed, it is fraud and is usually accompanied by other forms of stockbroker misconduct. As the SEC stated in Mark David Anderson, 56 S.E.C. 840 (2003), “we have long held that”a dealer violates anti-fraud provisions when he charges retail customers prices that are not reasonably related to the prevailing market price the best evidence of the current market is the dealer’s own contemporaneous cost to acquire the security at issue”.

Contact Us If You Believe You Have Been The Victim of Excessive Markups or Fees

If you think that you may have a claim for Excessive Mark-ups and Mark-downs, contact us for a free confidential evaluation.  The Guiliano Law Group was extensive experience representing investors in claims in arbitration before the Financial Industry Regulatory Authority or FINRA for stockbroker misconduct. If you believe that you may have a claim call our attorneys today at (877) SEC-ATTY.   All inquires are confidential, and we offer our services on purely a contingent fee basis, meaning we do not get paid unless we make a recovery for you.