There have been more changes in the commission schedule for brokerage transactions during the last six years than in the previous 60, and no one seems to connect that fact with the 85 generally lousy market we’ve enjoyed during that period.
Perhaps such a connection should be made, because now the next actin the theater-of-the-absurd production of “Everyman Gets a Commission Break”—a production so complicated it makes an Ionesco plot seem simple—is beginning. By April 30, 1975, all commissions on security transactions must be fully negotiated. As a trial, brokerage firms began negotiating commissions on trades involving less than $2000 this April.
At this writing the experiment with negotiated commissions has not begun, but it’s pretty easy to write a scenario that’s likely to happen. Your broker will call you and tout you onto the next hot number: call it a company that has discovered an alloy mine. You will resist, but avision of high grade alloy ore pouring out of a hole in the ground will persuade you to buy 100 shares at $15 each.
“What’s the commission on that trade?” you’ll ask.
“Well, I guess we ought to negotiate that,” the broker will say.
“What’s to negotiate? You’ll just charge the maximum, right?”
“No. Today we have negotiated commissions. Now, let’s see. I calculate that buying the stock cost you $24.11. My advice, of course, costs you $8.75. We’ll keep your stock for you. That’s $6.94. I’m sending you an S&P sheet on the company, but that’s only 47 cents. I think that’s all. Oh, wait a minute, I forgot the confirmation. That’s 93 cents. That all comes to $41.20.”
“But that’s a lot more than it used to cost,” you’ll protest.
“I know,” your stockbroker will say, “but don’t you feel better, having negotiated?”
Perhaps it won’t be quite that bad, but if history is a guide, the small investor will be asked to pay the freight for government’s latest effort to make things better for the small investor. The current change in commissions is Act IV in the comedy of errors that began in the late Sixties when government decreed that Wall Street must grant volume discounts to large investors, those who bought in 1000-share lots or larger. Up until that time, investors, large and small, paid the same percentage, no matter how many shares they purchased. It cost $17 to buy 100 shares of a $10 stock, or $170 to buy 1000 shares of the same stock, or $1700 to buy 10,000 shares, and so on.
The Congress, through the Securities and Exchange Commission (SEC), said that was unfair because costs of executing large transactions did not go up accordingly. Wall Street said, “Don’t monkey around with something that works.” But Congress prevailed, and volume discounts were ranted on trades of more than 1000 shares. Two years later the ombination of reduced commissions and a bad market sent Wall Street back to the SEC, begging for relief. The short-term solution was simple: just add a $15 per transaction surcharge to everything. But in order notto upset its original decision, the SEC decreed that 1000-share and larger transactions were exempt from the surcharge.
This action wasn’t enough to save several brokerage firms from collapse, but the market turned up and the crisis was avoided, temporarily.
During the brief respite between bad markets, the SEC approved a new commission schedule. It incorporated the $15 surcharge, lowered the volume discount from a 1000-share minimum to 300 shares, and required fully negotiated commissions on trades involving $500,000 or more. Atthe same time the SEC announced that it was tired of fooling around. Having seen that a commission schedule favoring large investors over small investors tended to drive small investors out of the market and increase their costs, the SEC declared that negotiated commissions ontrades involving $2000 or less would begin in 1974, and regardless of the results of the experiment, fully negotiated commissions would begin by the end of April 1975.
But since the market was turning sour again and brokerage firms were getting sick again, the SEC had to step in and grant another short-term palliative. Temporarily, another surcharge was added: ten per cent ontrades involving less than $5000 and fifteen per cent on trades involving $5000 or more.
The net result of all these peregrinations was that the purchase of 100 shares of a $10 stock that cost $17 in commissions in 1968 now costs $27.50. While Senator Lloyd Bentsen was busy holding hearings to find out why the small investor was getting out of the market, the SEC was busy damning the torpedoes. But look what a break all these reduced commissions have been to the institutional investor, the professional money manager who pilots the small investor’s pension fund money through the stock market shoals. Without the commission advantages, your average mutual fund would probably have been down more than the twenty percent it was down in 1973.
The commission schedule doesn’t mean a whole lot to anyone except investors and brokers, but both had better watch out for what can result from negotiated commissions. Small investors are going to suffer again, not only from higher charges, but also from the efforts of the brokerage firms they patronize to make up for revenues lost through negotiated commissions.
Brokers are about to start selling insurance, real estate, tax shelters, financial planning, and, probably, cemetery plots. Brokerage firms will operate on the premise that if brokers can sell the research a brokerage firm produces, they can sell anything. And there are all those customers already on the books. Just crank today’s inflationary figures into a computer along with a customer’s net worth, and you can prove beyond a doubt that he can’t afford to live until he dies without making a lot of money in investments.
Brokerage firms may be making a serious if not fatal mistake. Investors might buy stocks and bonds from a broker, but they probably won’t buy a used car, much less insurance, from him. There are thousands of reputable, knowledgeable, experienced insurance salesmen in Texas representing established companies, for instance. What are brokers going to offer insurance buyers that these men and women don’t?
The other technique Wall Street envisions to offset declining revenue due to negotiated commissions is unbundling, the separation of services so that each one commands an individual fee. Charging for research, for instance, or for holding securities in an account might help offset the revenue lost because transaction charges are less. Investors who keep doing business in the same old way could very well find that their commissions will increase under the negotiated rules.
But if brokerage customers feel they are getting the short end of the new commission stick, they will find that stockbrokers at the other end will be holding on by a veritable nub. Every time the total commission pie gets smaller, the individual broker’s share shrinks by an even greater percentage.
But the past six years have been bad ones in the stock market. Investors are fed up with stockbrokers’ problems and SEC decisions, both of which wind up costing investors money. Perhaps now they’ll come up with the solution to this riddle:
If an SEC commissioner and a stock-broker jump off the top of the San Jacinto Monument at the same time, which one will hit the ground first?
Answer: who cares?