| Release No. 34-22397 September 11, 1985
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 Table of Contents
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I. Introduction
Rule 10b-10 1 under the Securities Exchange Act of 1934 ("Act") 2 requires a broker-dealer executing a transaction with a customer to provide a written confirmation at or before completion of the transaction disclosing information concerning the transaction. The confirmation provides customers 3 the terms of trades executed by broker-dealers. For trades in which the broker-dealer acts as agent for the customer, the confirmation must disclose both the transaction price and the commission. 4 In trades in which the broker-dealer acts as principal, however, other than "riskless principal" transactions. 5 Rule 10b-10 currently permits the transaction to be confirmed at a single "net" price to the customer.
On February 12, 1985, the Commission issued a release requesting comment on a proposed amendment to Rule 10b-10 ("Release"). 6 The amendment would require a broker-dealer to disclose on customer confirmations the trade price and resulting mark-up in principal transactions in reported securities. These "reported securities" include listed securities meeting New York or American Stock Exchange listing requirements and over-the-counter ("OTC") National Market System ("NMS") Securities. 7
Specifically, under the amendment a broker-dealer executing a trade as principal must disclose on the customer confirmation the customers reported trade price, which for trades in OTC/NMS Securities would be the price the broker-dealer reported pursuant to the NASDs real-time last sale reporting requirements, 8 and for listed securities would be the price reported pursuant to exchange requirements and the CTA Plan. The amendment also requires the broker-dealer to disclose on the confirmation the dealer mark-up or commission equivalent, calculated by subtracting the reported trade price from the net price to the customer. 9
The Commission received 24 comments in response to the Release. After reviewing those comments and evaluating the proposed amendment in light of those comments, the Commission has determined to adopt an amendment to Rule 10b-10 substantially similar to that proposed. In addition, the Commission has determined to provide a phase-in period before the effective date of the amendment of 180 days from the date of publication of this release, to allow broker-dealers time to adapt to the new requirements.
II. Comments
The Commission received 24 comments: five from investors, 10 seven from broker-dealers, 11 eight from law firms and bar associations, 12 the American Stock Exchange ("Amex") and Midwest Stock Exchange ("Midwest"), 13 the Securities Industry Association ("SIA"), 14 and the NASD. 15
The commentators generally were divided over the desirability of the proposed amendments with a majority of the comment letters supporting adoption of the amendment. All of the investors as well as two broker-dealers submitting comments favored, and one broker-dealer did not oppose, adoption of the amendment. Three broker-dealer commentators, on the other hand, generally opposed the amendment. 16 The Amex, Midwest, two law firms and one bar association supported the amendment, while the NASD, one law firm and three bar association committees opposed the amendment. The SIA supported the goal of the amendments but questioned whether the anticipated benefits would result.
Commentators that supported the amendment argued that it would increase the efficiency of the market as a whole. One commentator noted:
while the amendment clearly should have a positive effect on best execution and the ability of customers to make informed decisions regarding the brokerage commissions they pay, disclosure of trade price and commission charges on confirmations on a consistent basis--regardless of whether the trade was executed in the OTC market or on an exchange--will have a beneficial impact on competition. 17
Others indicated that the number of instances of abuse of customers (e.g., undisclosed excessive mark-ups), or the potential for such abuse, would be greatly reduced by the increased disclosure, which would "alert the investor to any abuse or suggest the benefit of shopping around with other brokers." 18 One commentator who urged adoption of the amendment reported that he had observed numerous instances of customers misled by brokers who had indicated that "net" transactions were commission-free, and stated that customers often have no idea as to what commission or mark-up has been factored into the net price, nor realize the incentives brokers have in promoting and recommending certain securities. 19
Some commentators advocated adoption of the amendment to achieve consistency in the reporting and confirming of OTC transactions, and to obtain greater comparability of quotations and transaction reports in the exchange and OTC markets. 20 Others suggested that the amendment would act to reduce the bid-ask spread, increase efficiency in the OTC market, 21 and benefit the public by making trading in the OTC market a fairer and more efficient process. 22 One large integrated firm stated that the amendment "would enable customers better to evaluate transaction costs and execution quality, would provide certain regulatory benefits, and, limited to reported securities, would not impose significant incremental costs on broker-dealers." 23
Commentators opposing adoption of the amendment raised several arguments. First, they suggested that the additional disclosure would create confusion and mislead customers. 24 While some other commentators agreed that customers would benefit by the ability to better monitor execution costs, they concluded that customers would fail to understand the reason for a high mark-up printed on the confirmation. 25 This would in turn cause misunderstandings between customers and brokers, 26 with the latter being "open to criticism by the client, suspicion and possibly loss of the account to a competitor." 27 Commentators also argued that because of the "flexibility" and "subjective considerations" in last sale reporting under NASD guidelines, customers would not always receive useful information from which to evaluate execution quality. 28
Several commentators, including the NASD, questioned whether the amendment would be beneficial as applied to transactions with institutional customers. In their view, because many institutions have ready access to real-time quotation and last sale information and enjoy a strong bargaining position, disclosure of the information required by the amendment would provide them little benefit or protection.
Some commentators stated that the language of the proposed amendment required clarification. 29 They pointed out that the amendment as drafted only called for disclosure of the "mark-up, mark-down, or similar remuneration," while the discussion in the Release made clear that disclosure of the trade price would be required as well. It was suggested that the language of the rule be revised to indicate specifically that the rule required disclosing the reported trade price and the mark-up or mark-down, together with the presently disclosed net price. In addition, because the proposed rule amendment did not define "mark-up," some felt the words could be misconstrued as meaning the entire difference between the broker-dealers acquisition cost of the security and the price to the customer. 30
The Commission requested in the Release that commentators address the issue of the potential costs of the proposed amendment. Although a number of comments discussed this issue, none provided any numerical data estimating the costs of compliance for broker-dealers. A number of commentators favoring adoption of the amendment either questioned whether the amendment would result in significant costs to broker-dealers or believed that any costs could be minimized or eliminated. 31 These commentators doubted that reporting trade prices and mark-ups would impose much operational burden on broker-dealers because the amendment would apply only to reported securities and the information is already computed internally and made available to the registered representative. 32 They further argued that the value of the amendment would outweigh any additional burden that might result for brokerage firms. Merrill Lynch, which has voluntarily disclosed mark-ups in principal transactions in the over-the-counter market since 1968, stated that disclosure of this information had been beneficial to its customers without being unduly burdensome to the firm. 33
Commentators opposing the amendment argued that the amendment would place an additional burden on broker-dealers by consuming more time in providing the additional information required by the amendment. Two broker-dealers noted the additional responsibility the amendment would place on personnel who already must capture and enter quantity, description, account number, and price data, 34 at least for smaller broker-dealers who do not have internal automated execution and confirmation systems. 35 The NASD concluded, however, that if the proposal is adopted an exemption for small broker-dealers who do a limited number of principal trades is not warranted "because competitive considerations require that similar transactions be reported in a similar fashion by all broker-dealers."
Some commentators said that the Commission had effectively avoided placing any significant burden on broker-dealers by limiting the proposal to securities for which last sale information is already being reported to the consolidated system, e.g., OTC/NMS Securities. 36 Moreover, the NASD stated that the actual costs of complying with the Rule amendment would depend a great deal on its effective date. Thus, the NASD and one other broker-dealer requested a deferred effective date and phase-in period for the amendments so that with sufficient time existing supplies of confirmation forms could be exhausted and new ones re-ordered, thereby making these costs negligible. 37
III. Discussion
After careful consideration the Commission has determined to adopt the proposed amendment to Rule 10b-10 with certain non-substantive revisions to provide definitional clarity.
A. Benefits of the Amendment
The Commission believes that disclosure of the reported trade price and mark-up on customer confirmations provides significant tangible benefits to investors and will encourage market efficiency.
1. Ability to Evaluate Transaction Costs
First, the Commission has concluded that disclosure of the trade price and mark-up will provide investors with important information regarding the investors transaction costs. This disclosure will allow an investor over a period of time to assess the charges of his broker-dealer in principal transactions and may permit comparison of those costs to similar charges of other firms. Investors currently can make these evaluations and comparisons in agency and riskless principal trades, where commissions, mark-ups, or commission equivalents must be disclosed. An investors knowledge of his transaction costs is equally as important in other principal transactions; an investors ability to negotiate or obtain competitive transaction charges is limited, absent this knowledge.
Disclosure of the trade price and mark-up may also discourage excessive charges by broker-dealers by permitting customers to police the handling of their accounts. 38 By simply disclosing to investors their transaction costs, the amendment will enable investors to take a larger role in protecting against unreasonable mark-ups, instead of relying solely on Commission or self-regulatory organization inspection and enforcement efforts to control mark-ups. 39 Providing this information will place investors in a more informed bargaining position with broker-dealers in principal transactions, a position which customers have enjoyed since at least 1937 in agency transactions. Customers who feel they are not being charged reasonable mark-ups will be able to shift their brokerage business immediately to broker-dealers willing to charge more competitive mark-ups. In this way, the market will be able to operate more fairly and efficiently.
2. Ability to Evaluate Execution Quality
In addition to increasing the investors ability to evaluate his transaction costs, disclosure of trade prices and mark-ups on customer confirmations would afford an additional major benefit by enhancing the ability of the investor to monitor execution quality. Disclosure of trade prices and mark-ups on customer confirmations will inform the customer for the first time of the actual price at which his trade occurred. The customer then can compare this trade price to the best available price for the security being purchased or sold, either by monitoring a real time display, obtaining quotes for the security from his registered representative at the time he enters the order, or by comparing this price to the high and low prices for the day reported in newspaper stock tables. At present, an investor cannot ascertain his trade price from the single net price disclosed on his confirmation or readily determine whether the execution was favorable.
While achieving the most favorable net price is the rational goal of investors, disclosure of the separate components of this price allows the investor to assess each component of an execution and determine where improvement can be achieved. Thus, with disclosure of trade prices and resulting mark-ups, the investor can seek to obtain both the best trade price and a competitive mark-up.
3. Trade Reporting Benefits
The Commission also believes that the amendments will have a beneficial effect on trade reporting, especially in the OTC market. For the first time, OTC market makers will be required to disclose to customers the price at which the trade was reported; if this reported price differs from the trade price understood by the customer, customers can be expected to bring this disparity to the attention of the broker-dealer, and where necessary, regulatory authorities. Thus, customer monitoring will provide a safeguard strengthening the integrity of the trade reporting process. 40
The Commission recognizes that some comments have suggested that the NASD last sale reporting requirements 41 do not provide clear rules for the determination of reported trade prices, and as a result, trade prices and resulting mark-ups or mark-downs are largely hypothetical, 42 and of little use in evaluating transaction costs and execution quality. As an initial matter, it should be noted that the amendment directly addresses the issue of the lack of reliability of OTC trade reporting by causing broker-dealers to take greater care in determining a trade report price to avoid questions from their customers about an unrepresentative trade price or an unexpectedly large resulting mark-up shown on the customers confirmation.
Moreover, the Commission believes that the NASD last sale reporting rules do not grant reporting parties the degree of flexibility that some commentators have suggested. The NASD reporting rules clearly state that where principal transactions include a mark-up, mark-down, or service charge, the price reported shall exclude that mark-up, mark-down or service charge. 43 Thus, where an integrated firm has an established mark-up schedule that the firms OTC trading desk routinely adds to the trade price to obtain the net price to the customer, it is clear that the price reported must be the net price minus the added mark-up. 44 Furthermore, in those circumstances composing the majority of trades where there is an objectively determinable trade price, the NASD rule anticipates that the trade price will be reported. 45 Accordingly, the NASD rules stating that the reported price must be "reasonably related" to the market and providing guidance on factors bearing on this price only come into play in those relatively few trades where there is no clear benchmark which dictates the appropriate reported price.
The Commission is of the view that present rules governing last sale reporting in the OTC market are sufficiently reliable to ensure that disclosure of the trade price and resulting mark-up to customers is meaningful. From these items the customer can evaluate the proximity of the reported trade price to the prevailing market price, and the portion of the net price disclosed as the mark-up. Moreover, by requiring that the trade price disclosed on a customer confirmation be the same as that already determined and disseminated for real-time public reporting purposes, the rule avoids the potential arbitrariness of calculating a trade price for confirmation purposes alone. For these reasons, the Commission finds that the disclosure provided by the amendment is of substantial value.
B. Minimal Costs
The Commission specifically requested that commentators address the issue of costs with regard to the disclosure required by the amendment. Based on these comments and its own consideration, the Commission has determined that the amendment would impose relatively few costs on broker-dealers, and these costs would be substantially outweighed by the benefits of the amendment.
None of the comments received presented numerical cost data. Although several firms said that the amendment would result in direct costs of recording the trade price, it appears that, given the existing trade reporting, bookkeeping, and confirmation obligations of broker-dealers, disclosing the additional information the amendment requires is relatively simple. The Commission understands that traders at many firms already record the reported trade price for bookkeeping and compliance purposes, and this information can be provided to customers on confirmations by an adjustment of existing computer programs. 46 In addition, the increased use of internal computerized order tracking and execution systems simplify these processes even further. The Commission finds it significant that Merrill Lynch commented that the proposed disclosure requirement "would not impose significant incremental costs on broker-dealers." 47
Smaller firms that do not have automated systems and have employees manually enter and report last sale price data would at most be burdened by the incremental task of transferring that same data onto the confirmation form. This function would not differ from the existing task of identifying a commission on each agency confirmation.
One regional broker-dealer 48 commented that "the simplest procedure would be to handle principal transactions in the same way that we handle agency transactions by changing the heading on our confirmations which now reads "Commission" to read "Commission or Markup." This firm also suggested that a period of time be allowed to exhaust existing supplies of printed confirmation forms. Furthermore, comments received from one firm and the NASD indicate that transition costs can be minimized by deferring the effective date of the amendment. Accordingly, the Commission has determined to defer the effective date of the amendment for a period of 180 days.
C. Institutional Orders
The NASD and some other commentators argued that, because institutional investors generally conduct business with OTC market makers on a "net" basis, disclosure of the reported trade price and mark-up would not be of significant value to these institutional customers. Thus, these commentators suggested that transactions for institutions should be exempted from the amendments provisions.
The Commission agrees with the commentators who stated that institutional investors generally deal with OTC market makers on a net basis without charging a separate mark-up; in these circumstances, the reported trade price should equal the net price, i.e., the price the customer pays the broker. In such situations the amendment would help ensure, through institutional monitoring, that OTC institutional trades executed on a net basis are reported at the trade price. Furthermore, if, in the future, institutions increasingly begin to pay mark-ups on OTC transactions, the amendment will provide institutional customers benefits similar to those received by retail customers in monitoring transaction costs. In addition, institutional investors do pay mark-ups in listed securities trades executed by broker-dealers as principal. While institutions and money managers often have access to real time quotation information, they may be trading a number of stocks simultaneously and may not be able to monitor the quality of a particular execution without the aid of additional confirmation disclosure. Accordingly, the Commission believes there are significant benefits, and no additional costs, from including institutional OTC transactions within the scope of the amendment. 49
Moreover, the amendment also requires confirmation disclosure of the reported trade price and mark-up in principal block transactions in which institutions generally do pay mark-ups. The Commission believes that the disclosure provided by the amendment would allow customers engaging in principal block trades in listed securities a further means of monitoring their mark-ups, and would help to prevent the practice known as "tape dancing." 50 Tape dancing occurs, for example, when a broker-dealer dealing with an institutional customer on a net basis charges an unusually high mark-up equivalent or mark-up in a block trade, and reflects that mark-up or a portion of it in the sale price reported to the consolidated tape to make that reported price to the consolidated tape to make that reported price higher than the previous sale price. The Commission believes that artificially inflating a blocks reported price in this manner to create an "uptick" violates the antifraud and possibly other provisions of the federal securities laws. 51 In addition, the New York Stock Exchange ("NYSE") has indicated that tape dancing violates its reporting rules. Providing institutional customers and money managers or advisors (who have fiduciary obligations to their institutional investors) the opportunity to observe on confirmations the reported price in block trades in listed stocks, should help reduce tape dancing concerns.
D. Revisions to the Proposed Amendment
The Commission received a number of comments indicating that the proposed language of the amendment was inadequate to achieve the goals asserted in the Release. Specifically, by requiring disclosure of the "mark-up, mark-down, or other remuneration", the amendment, it was argued, did not expressly require disclosure of the reported trade price. The Commission generally is in agreement with these comments and accordingly is modifying the text of the amendment in the Release to require disclosure of "the trade price reported," "the price to the customer in the transaction" and the "difference, if any, between this reported trade price and the price to the customer in the transaction." 52 The Commission believes that this modified language will provide disclosure to the customer of the "wholesale" price (reported trade price), the "retail" price (net price to the customer), and the commission equivalent or mark-up, which is the difference between the two. 53
IV. Conclusion
Confirmation disclosure of trade prices and mark-ups for principal transactions in reported securities offers substantial benefits to public investors. In addition, such disclosure does not appear to present significant calculation difficulties or significant costs to broker-dealers. Because market makers presently must determine and report a last sale price for each trade, that same price can be used to determine and report a trade price on the customer confirmation. Consequently, the Commission has determined to adopt the amendments requiring disclosure on customer confirmations of the reported trade price, the net price, and the difference, if any. This disclosure approach is predicated on the belief that, through such disclosure, customers will be better able to monitor the quality and cost of their securities transactions. It will also provide for equivalent disclosure to all customers effecting transactions in reported securities, whether executed on an agency or principal basis.
V. Effects on Competition and Regulatory Flexibility Act Considerations
Section 23(a)(2) of the Act 54 requires the Commission, in adopting rules under the Act, to consider the anti-competitive effects of such rules, if any, and to balance any anti-competitive impact against the regulatory benefits gained in terms of furthering the purposes of the Act. The Commission has examined the amendment to Rule 10b-10 in light of the standards set forth in Section 23(a) and concludes that adoption of the amendment will not impose any burden on competition not necessary or appropriate in furtherance of the purposes of the Act. Indeed, as discussed above, the Commission believes the amendments will further competition by providing investors important additional information to evaluate and compare the transaction costs imposed by their broker and the overall quality of the executions they receive. The Commission believes that the amendment will substantially benefit the markets for reported securities, and will further the development of aspects of the NMS, in accordance with the Act.
The Commission has prepared a Final Regulatory Flexibility Analysis ("FRFA"), pursuant to the requirements of the Regulatory Flexibility Act, 55 regarding the amendment to the Rule. The FRFA indicates that the amendment requires broker-dealers to disclose any mark-up, mark-down, or similar remuneration on customer confirmations for principal transactions in reported securities. The FRFA states that the proposed new disclosure does not entail significant increases in costs for small broker-dealers, and that any minimal costs resulting from the new disclosure may be offset by benefits to market makers, investors, and the securities markets.
The Commission in the Release and Initial Regulatory Flexibility Analysis requested comment on exempting certain small broker-dealers who transact a limited number of trades from the requirements of the amendment. The NASD has concluded that such an exemption is not warranted because competitive considerations require that similar transactions be reported in a similar fashion by all broker-dealers. The Commission agrees with the NASD. Further, no smaller firms suggested that the amendments would place a disproportionate burden on them. Accordingly, the Commission has determined not to create an exemption for small broker-dealers which transact a limited number of principal trades from the requirements of the amendment.
A copy of the FRFA may be obtained by contacting Leland H. Goss, (202) 272-2827, Division of Market Regulation, Securities and Exchange Commission, 450 Fifth Street, N.W., Washington, D.C. 20549.
LIST OF SUBJECTS IN 17 CFR PART 240
Reporting and record keeping requirements, Securities
VI. Statutory Basis and Text of Amendment
The Commission proposes to amend Chapter II of Title 17 of the Code of Federal Regulations as follows:
Part 240--GENERAL RULES AND REGULATIONS, SECURITIES EXCHANGE ACT OF 1934
1. The authority citation for Part 240 is amended by adding the following citation:
Authority: Sec. 23, 48 Stat. 901, as amended, 15 U.S.C. 78w. * * * Section 240.10b-10 is also authorized under Sections 2, 3, 9, 10, 11, 11A, 15, 17, 23, 48 Stat. 891, 89 Stat. 97, 121, 137, 156(15 U.S.C. 78b, 78c, 78i, 78j, 78k, 78k-1, 78o, 78q) * * *
2. §240.10b-10 is amended by revising paragraph (a)(8)(i) and adding (e)(7) and (8) as follows:
§240.10b-10 Confirmation of transactions.
(a) * * *
(8) If he is acting as principal for his own account (i)(A) If he is not a market maker in that security and, if after having received an order to buy from such customer, he purchased the security from another person to offset a contemporaneous sale to such customer or, after having received an order to sell from such customer, he sold the security to another person to offset a contemporaneous purchase from such a customer, the amount of any mark-up, mark-down, or similar remuneration received in an equity security; or
(B) In any other case of a transaction in a reported security, the trade price reported in accordance with an effective transaction reporting plan, the price to the customer in the transaction, and the difference, if any, between the reported trade price and the price to the customer.
* * * * *
(e) * * *
(7) "Reported security" shall have the meaning provided in Rule 11Aa3-1 under the Act.
(8) "Effective transaction reporting plan" shall have the meaning provided in Rule 11Aa3-1 under the Act.
* * * * *
By the Commission.
1 17 CFR §240.10b-10.
2 15 U.S.C. §§ 78a et seq.
3 The term "customer" as used in Rule 10b-10 excludes broker-dealers.
4 17 CFR §240.10b-10(a)(7)(i).
5 See 17 CFR §240.10b-10(a)(8)(i).
6 Securities Exchange Act Release No. 21708 (February 4, 1985), 50 FR 5766.
7 "Reported securities" are defined in Rule 11Aa3-1 under the Act (17 CFR §240.11Aa3-1(a)(4)) as securities covered by an effective transaction reporting plan adopted pursuant to Rule 11Aa3-1. Listed securities meeting New York or American Stock Exchange listing requirements are reported pursuant to the Consolidated Tape Association ("CTA") Plan. OTC securities designated as NMS Securities pursuant to Rule 11Aa2-1 under the Act (see Securities Exchange Act Release No. 17549 (February 17, 1981), 46 FR 13992, adopting this rule) are reported pursuant to the National Association of Securities Dealers, Inc.s ("NASD") Transaction Reporting Plan.
8 To comply with the last sale reporting requirements applicable to OTC/NMS Securities. OTC market makers must determine, pursuant to NASD rules, a trade price for each trade in an NMS Security and report this price to the NASD within 90 seconds of execution of the trade. Last sale reporting requirements are contained in Rule 11Aa3-1 under the Act, the NASDs Transaction Reporting Plan adopted pursuant to Rule 11Aa3-1 (see Securities Exchange Act Release No. 18590 (March 24, 1982), 47 FR 13617, and the NASDs transaction reporting rules (NASD By-Laws, Article VII Schedule D, IV(2)(d)(3)).
9 The amendment does not, however, require a broker-dealer to disclose the price at which it acquired the securities. For example, assume an OTC broker-dealer buys a stock for its own account at 8. A week later the inside market for the stock is 10 bid and 10 1/4 ask. After executing a sale to a customer at 10 1/4, the broker-dealer adds a 1/4 point mark-up charge to the customer, with a resulting net price of 10 1/2. Under these circumstances the broker-dealer would report the trade price of 10 1/4 to the NASD, excluding the 1/4 point mark-up. See NASD By-Laws, Article VII, Schedule D, IX(2)(d)(3).
Under the amendment, the broker-dealer would be required to disclose on the customer confirmation the customers net price, which is 10 1/2, the customers trade price, which is 10 1/4, and the difference between the two, which is the mark-up of 1/4. The broker-dealer need not disclose that he acquired the stock at a price of 8.
10 Letter from Arthur F. Peterson, to John Wheeler, Secretary, SEC (February 7, 1985); letter from Frank S. Moran, Plante & Moran, to John Wheeler, Secretary, SEC (February 27, 1985); letter from Joseph C. White, Revere AE Capital Fund, Inc. ("Revere Fund letter"), to John Wheeler, Secretary, SEC, (March 20, 1985); letter from Joseph and Marion Oravec, to John Wheeler, Secretary, SEC (March 22, 1985); letter from Alan R. Silberman, President, Quantum Pharmics, Ltd., to John Wheeler, Secretary, SEC (March 22, 1985) ("Pharmics letter").
11 Letter from John E. Herzog, President, Herzog, Heine Geduld, to John Wheeler, Secretary, SEC (March 11, 1985) ("Herzog letter"); letter from Frederic J. Reif, Vice President, Operations Division, A.G. Edwards & Sons, Inc., to John Wheeler, Secretary, SEC (March 22, 1985) ("A.G. Edwards letter"); letter from Norman J. Wechsler, President, Wechsler & Krumholz, Inc., to John Wheeler, Secretary, SEC (March 22, 1985); letter from Glenn E. Anderson, Chairman, Carolina Securities Corporation, to John Wheeler, Secretary, SEC (March 27, 1985) ("Carolina Securities letter"); letter from Joseph R. Hardiman, Alex. Brown & Sons, Inc., to John Wheeler, Secretary, SEC (March 28, 1985); letter from Kathy Miller, Treasurer, Charter Investment Group, Inc., to John Wheeler, Secretary, SEC (April 10, 1985) ("Charter letter"); letter from Samuel E. Hunter, Senior Vice President and Division Director, Securities Trading Division, Merrill Lynch Capital Markets, to John Wheeler, Secretary, SEC (May 6, 1985) ("Merrill letter").
12 Letters from Richard D. Greenfield, Greenfield, Chimicles & Lewis, to the Division of Market Regulation (February 5, 1985 and April 25, 1985) ("Greenfield letter"); letter from Milton H. Cohen, to John Wheeler, Secretary, SEC (February 8, 1985) ("Cohen letter"); letter from Sullivan & Cromwell, to John Wheeler, Secretary, SEC (March 29, 1985) ("Sullivan & Cromwell letter"); letter from Raymond L. Aronson, Committee on Securities & Exchanges, New York Country Lawyers Association, to John Wheeler, Secretary, SEC (April 4, 1985); letter from Arnold S. Jacobs, Chairman, Association of the Bar of the City of New York, to John Wheeler, Secretary, SEC (March 28, 1985); letter from Richard M. Phillips, Chairman, Committee on Federal Regulation of Securities and Robert C. Lewis, Chairman, Subcommittee on Broker-Dealer Matters, Section on Corporation, Banking, and Business Law, American Bar Association, to John Wheeler, Secretary, SEC (May 1, 1985); letter from Richard R. Howe, Chairman, Committee on Securities Regulation, New York State Bar Association, to John Wheeler, Secretary, SEC (May 28, 1985).
13 Letter from Richard O. Scribner, Executive Vice President, Legal and Regulatory Affairs, Amex, to John Wheeler, Secretary, SEC (March 28, 1985) ("Amex letter"); letter from J. Craig Long, Vice-President-Legal and Secretary, Midwest, to John Wheeler, Secretary, SEC (July 9, 1985) ("Midwest letter").
14 Letter from J. Patrick Campbell, Chairman, OTC Trading Committee, and William R. Harman, Chairman, Federal Regulation Committee, SIA, to John Wheeler, Secretary, SEC (April 26, 1985) ("SIA letter").
15 Letter from Gordon S. Macklin, President, NASD, to John Wheeler, Secretary, SEC (May 24, 1985) ("NASD letter").
16 Herzog, letter, supra note 11. A.G. Edwards letter, supra note 11. Alex Brown letter, supra note 11.
17 Midwest letter, supra, note 13.
18 Revere Fund letter, supra note 10.
19 Greenfield letter, supra note 12.
20 See, e.g., Cohen letter, supra note 12 at 12; Amex letter, supra note 13.
21 Revere Fund letter, supra note 10.
22 Pharmics letter, supra note 10.
23 Merrill letter, supra note 11.
24 Commentators expressed concern that a customer would conclude, inappropriately, that he was better off in a trade with a low mark-up, compared to another trade with a higher mark-up and a slightly better execution price. See, e.g., Alex. Brown letter, supra note 11.
25 For example, some commentators noted that higher mark-ups were warranted for "difficult" trades than routine ones, but that customers would mistakenly interpret such higher mark-ups as evidence of over-reaching by their broker. Id.
26 Alex Brown letter, supra note 11.
27 Herzog letter, supra note 11.
28 The ABA offered the following example: The traders inside spread for a stock is 10 bid and 10 1/4 ask. Because the trader has a sizeable inventory of this stock which he wants to reduce, he gives his retail broker a price of 10; 1/4 point below the lowest ask price of any other market maker. The ABA stated that if the retail broker-dealer added a 3/8 point mark-up "the customers confirmation would show execution at 10 and a relatively high mark-up of 3/8. Since the confirmation would not inform the customer of the inside spread... at the time the transaction was executed, the confirmation would not inform the customer that he received a good price in relation to the market or that the retail brokers 3/8 mark-up, set in contemplation of the good price from the trader, could have been less without the very favorable wholesale price."
29 See, e.g., Merrill, SIA letters, supra notes 11 and 14.
30 See, e.g., Charter letter, supra note 11.
31 See, e.g., Greenfield, Revere Fund, Merrill, and Midwest supra.
32 See, e.g., Greenfield letter, supra note 12.
33 Merrill letter, supra note 11.
34 A.G. Edwards argued that even for firms that have automated systems, the amendment could impose operational burdens where those firms confirmation and transaction reporting functions are not integrated. Thus, costs would be imposed by having to duplicate reporting information on confirmation systems, or from integrating trade reporting and confirmation systems. A.G. Edwards letter, supra note 11.
35 Alex. Brown letter, supra note 11.
36 See, e.g., Revere Fund, and Merrill Letters, supra notes 10 and 11.
37 See Carolina Securities letter, supra note 11.
38 Confirmation disclosure of mark-ups obviously will deter the possibility for fraud or confusion by registered representatives who might suggest to their customers that principal transactions are "commission-free," thereby implying that transaction costs have not been factored into the price of the trade to the customer.
39 Although the Commission recognizes that the enforcement of the NASDs mark-up policy has been valuable in reducing incidents of excessive mark-ups, observers have long notes that improving investor disclosures concerning these mark-ups would be an important adjunct to self-regulatory organization activity. See The Special Study of the Securities Markets of the Securities and Exchange Commission, H.R. Doc. No. 95, Pt.2, 88th Cong., 1st Sess., 673 (1963).
40 In this connection, the Midwest argued in its comment that because "NASD rules do not provide any enforceable objective standard for determining the reported price... the best method of providing an independent check against the possibility of abuse in this area is the customer himself." Midwest letter, supra note 13.
41 See Article IX of Schedule D of the NASD By-Laws, Section 2(d)(3).
42 See generally, Sullivan & Cromwell letter, supra note 12.
43 NASD By-Laws Schedule D, Article IX, Section (2)(d)(3).
44 Some commentators raised questions concerning the relation between mark-ups and internal sales credits under the amendment. Specifically, it was claimed that the traders will at times offer a larger sales credit to retail salespersons, providing an extra incentive to sell securities the firm wishes to liquidate from its inventory, by lowering the trade price while keeping the net price to the customer the same. Commentators suggested that if these prices were disclosed as the trade price, customers would be confused by the appearance of higher mark-ups without understanding that they received a superior execution price in relation to the market.
The Commission believes that this problem is overstated. If in these circumstances the firm wishes to allocate an extra sales credit to the salesperson without reducing its inter-dealer price, the firm can use internal systems to credit the salesperson without reducing the reported trade price and hence increasing the mark-up--the difference between the prevailing market price and the price to the customer--charged by the firm and displayed on the confirmation.
45 For instance, in small trades executed routinely at the inside NASDAQ quote, the appropriate reported price would be the NASDAQ quote price. Given that the NASDs automated Small Order Execution System ("SOES") provides automated executions in all NASDAQ stocks at the quote for orders up to 500 shares (with a proposal to increase that ceiling to 1,000 shares) and other automated execution systems already provide quote executions up to 1,000 shares, there is little question that at least the inside NASDAQ quote price would be the objectively determinable market price for OTC orders of this size. Moreover, for OTC institutional orders executed on a net basis without any retail mark-up, the appropriate reported price for these trades is obvious.
46 In addition, standardized confirmation forms currently used by many integrated broker-dealers already provide column space for printing the commission charged in agency transactions, and would require little alteration to also provide mark-up information.
47 See Merrill letter, supra note 11, at page 2.
48 See Carolina Securities letter, supra note 11.
49 Indeed, it would appear that greater costs would be imposed on brokers by having to earmark institutional transactions for exclusion from the disclosure requirement than simply providing confirmation disclosures across the board. In the absence of comments suggesting any harms from providing confirmation disclosure of mark-ups to institutions, the Commission believes that the actual benefits provided to institutions in instances where mark-ups are currently charged, coupled with the potential benefits provided should that practice expand, warrant extending the rule to cover institutional transactions.
50 See Big Block Trading Pits Institutions, Dealers in Fast Tough Game, Wall Street Journal, December 20, 1984, at 1.
51 A similar scenario involving mark-downs could also be utilized by a trader to create an artificial decline in the reported price of a security.
52 See infra page 10.
53 The Commission notes that the definition of "mark-up" as used in the amendment is not intended to control traditional determinations of whether a broker-dealer has charged an illegally excessive mark-up to a customer. Generally, determining mark-ups for compliance with the NASDs mark-up policy or the antifraud provisions of the federal securities laws involves comparing the price charged to the customer with the prevailing market price at the time of the transaction, as determined in a variety of ways. See, e.g., In re, Alstead, Dempsey & Company, Incorporated, Securities Exchange Act Release No. 20825 (April 15, 1984).
54 15 U.S.C. §78w(a)(2).
55 5 U.S.C. §§604.
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