This rule is no longer applicable. NASD IM-2440-1 has been superseded by FINRA Rule 2121. Please consult the appropriate FINRA Rule.
The question of fair mark-ups or spreads is one which has been raised from the earliest days of the Association. No definitive answer can be given and no interpretation can be all-inclusive for the obvious reason that what might be considered fair in one transaction could be unfair in another transaction because of different circ*mstances. In 1943, the Association's Board adopted what has become known as the "5% Policy" to be applied to transactions executed for customers. It was based upon studies demonstrating that the large majority of customer transactions were effected at a mark-up of 5% or less. The Policy has been reviewed by the Board of Governors on numerous occasions and each time the Board has reaffirmed the philosophy expressed in 1943. Pursuant thereto, and in accordance with Article VII, Section 1(a)(ii) of the By-Laws, the Board has adopted the following interpretation under
Rule 2440.
It shall be deemed a violation of Rule 2110 and
for a member to enter into any transaction with a customer in any security at any price not reasonably related to the current market price of the security or to charge a commission which is not reasonable.
(a) General Considerations
Since the adoption of the "5% Policy" the Board has determined that:
(1) The "5% Policy" is a guide, not a rule.
(2) A member may not justify mark-ups on the basis of expenses which are excessive.
(3) The mark-up over the prevailing market price is the significant spread from the point of view of fairness of dealings with customers in principal transactions. In the absence of other bona fide evidence of the prevailing market, a member's own contemporaneous cost is the best indication of the prevailing market price of a security.
(4) A mark-up pattern of 5% or even less may be considered unfair or unreasonable under the "5% Policy."
(5) Determination of the fairness of mark-ups must be based on a consideration of all the relevant factors, of which the percentage of mark-up is only one.
(b) Relevant Factors
Some of the factors which the Board believes that members and the Association's committees should take into consideration in determining the fairness of a mark-up are as follows:
(1) The Type of Security Involved
Some securities customarily carry a higher mark-up than others. For example, a higher percentage of mark-up customarily applies to a common stock transaction than to a bond transaction of the same size. Likewise, a higher percentage applies to sales of units of direct participation programs and condominium securities than to sales of common stock.
(2) The Availability of the Security in the Market
In the case of an inactive security the effort and cost of buying or selling the security, or any other unusual circ*mstances connected with its acquisition or sale, may have a bearing on the amount of mark-up justified.
(3) The Price of the Security
While there is no direct correlation, the percentage of mark-up or rate of commission generally increases as the price of the security decreases. Even where the amount of money is substantial, transactions in lower priced securities may require more handling and expense and may warrant a wider spread.
(4) The Amount of Money Involved in a Transaction
A transaction which involves a small amount of money may warrant a higher percentage of mark-up to cover the expenses of handling.
(5) Disclosure
Any disclosure to the customer, before the transaction is effected, of information which would indicate (A) the amount of commission charged in an agency transaction or (B) mark-up made in a principal transaction is a factor to be considered. Disclosure itself, however, does not justify a commission or mark-up which is unfair or excessive in light of all other relevant circ*mstances.
(6) The Pattern of Mark-Ups
While each transaction must meet the test of fairness, the Board believes that particular attention should be given to the pattern of a member's mark-ups.
(7) The Nature of the Member's Business
The Board is aware of the differences in the services and facilities which are needed by, and provided for, customers of members. If not excessive, the cost of providing such services and facilities, particularly when they are of a continuing nature, may properly be considered in determining the fairness of a member's mark-ups.
(c) Transactions to Which the Policy is Applicable
The Policy applies to all securities, whether oil royalties or any other security, in the following types of transactions:
(1) A transaction in which a member buys a security to fill an order for the same security previously received from a customer. This transaction would include the so-called "riskless" or "simultaneous" transaction.
(2) A transaction in which the member sells a security to a customer from inventory. In such a case the amount of the mark-up would be determined on the basis of the mark-up over the bona fide representative current market. The amount of profit or loss to the member from market appreciation or depreciation before, or after, the date of the transaction with the customer would not ordinarily enter into the determination of the amount or fairness of the mark-up.
(3) A transaction in which a member purchases a security from a customer. The price paid to the customer or the mark-down applied by the member must be reasonably related to the prevailing market price of the security.
(4) A transaction in which the member acts as agent. In such a case, the commission charged the customer must be fair in light of all relevant circ*mstances.
(5) Transactions wherein a customer sells securities to, or through, a broker/dealer, the proceeds from which are utilized to pay for other securities purchased from, or through, the broker/dealer at or about the same time. In such instances, the mark-up shall be computed in the same way as if the customer had purchased for cash and in computing the mark-up there shall be included any profit or commission realized by the dealer on the securities being liquidated, the proceeds of which are used to pay for securities being purchased.
(d) Transactions to Which the Policy is Not Applicable
The Mark-Up Policy is not applicable to the sale of securities where a prospectus or offering circular is required to be delivered and the securities are sold at the specific public offering price.
Amended by SR-NASD-2003-141 eff. July 5, 2007.
Amended by SR-NASD-98-86 eff. Nov. 19, 1998.
Adopted eff. Oct. 31, 1943, see SEC Release No. 3574 (June 1, 1944) and SEC Release No. 3623 (Nov. 25, 1944).
Selected Notices to Members:
75-65, 89-20, 91-69, 92-16, 93-81, 94-62, 08-36.