Fixed Rates in Securities Trading

Prior to 1975, the U.S. securities industry operated under a fixed commission rate structure that traced it roots to the signing of the Buttonwood Agreement that created the New York Stock Exchange. The agreement included two basic principles; a monopoly on all listed securities trading and a fixed-price commission schedule yielding roughly one percent to the broker.
This system mandated that all broker-dealers charge their clients the same set fee for transactions, irrespective of the size or nature of the trade. This arrangement was enforced by the New York Stock Exchange (NYSE) and other exchanges, with the rationale being to maintain fairness and orderliness in the markets. However, this also meant that investors had little flexibility or incentive to negotiate better rates, and smaller investors, in particular, were disadvantaged by relatively high transaction costs.
Investor dissatisfaction grew due to fixed commissions, particularly among pension funds and other institutional investors who sought lower trading costs. To bypass the minimum prices set by the NYSE, institutional investors started negotiating trades in the "third market" by dealing with NYSE-listed stocks over-the-counter (OTC). Additionally, they engaged in direct trades among themselves, known as the "fourth market." Brokerage firms courted these institutional investors with perks like research reports through "soft dollar" arrangements, causing envy among individual investors. 
Following the Securities Exchange Act of 1934, the NYSE could only register under the Act by adopting rules that needed submission and approval by the SEC. The SEC was empowered to modify or add to these rules if the exchange did not make requested changes independently. Among the areas for rule-making was the establishment of reasonable rates for commissions, interest, listing fees, and other charges.
The SEC utilized its authority to oversee commission rates set by the NYSE, implementing a systematic process for gathering relevant information through regular reports from exchange members.
== Legal Challenges ==
In a 1967 case before the U.S. Supreme Court, the case questioned the legality under the Sherman Act of the practice of the New York Stock Exchange in adopting rules fixing minimum rates for the commissions charged by dxchange members for the purchase and sale of securities on the exchange. Petitioners brought this action pursuant to 4 of the Clayton Act, 15 U.S.C. 15, derivatively on behalf of five mutual fund investment companies of which they were shareholders and representatively on behalf of other shareholders against the New York Stock Exchange and five of its member firms. At the time, embers of the New York Stock Exchange transacted over 90% of all brokerage business in stocks in the United States. Based on that trading volume, the investing public paid over $1,200,000,000 annually, at the uniform minimum rate, for the privilege of trading on the exchange. The Supreme Court denied a hearing for the case.
== SEC Leadership ==
In 1965, the SEC recommended the NYSE unfix commission rates, but the dominant exchange known as "The Big Board" successfully resisted implementing the change.
In 1968, the Justice Department questioned the legality of fixed commissions as an anti-competitive practice and urged the Securities and Exchange Commission to investigate the issue. In 1970, the president of the NYSE, Robert Haack, speaking to the Economic Club of New York called for an unfixing of commissions, which astounded the audience and infuriated many on Wall Street, including the Governors of the NYSE. Haack was not fired, but left the position in 1971 and a reorganization of the NYSE eliminated the president position until 1980. One executive who supported Haack was Donald Regan, then CEO of Merrill Lynch, who criticized Wall Street's capitalists for practicing “cartelism” in keeping rates fixed. 
In 1968, the SEC initiated efforts to tackle the issue of fixed commissions through administrative hearings. Stemming from these hearings, the SEC released a policy statement in February 1972 titled "Future Structure of the Securities Markets." This document outlined significant policy concerns within the U.S. capital market system and delineated the Commission's intended direction. A notable inclusion was the lowering of the threshold for negotiable commission rates from $500,000 to $300,000.
In 1971, under the leadership of Chairman Hamer H. Budge, the SEC implemented a relatively modest policy change by mandating that commissions on transactions exceeding $500,000 be negotiable. The SEC move to eliminate fixed commissions on transactions over $500,000 came amid debates about their economic value and the equity of stock exchange membership. This debate was fueled by concerns over preferential rates for large institutional investors and the disadvantage this posed to small investors. Concurrently, Congress considered legislation to end fixed rates to benefit the investing public and the securities industry. The New York Stock Exchange, through the Martin Report led by William McChesney Martin, concurrently studied the issue. The report advocated centralizing trading of NYSE-listed stocks on the exchange floor, eliminating third-market trading, and suggested the SEC limit regional exchanges to trading non-New York listings, amidst political concerns about fixed rates hindering market competition for small investors. The Martin Report faced widespread criticism, with the SEC reiterating its commitment to competition, particularly from off-board market makers. It advocated for the ultimate removal of the fixed commission system.
G. Bradford Cook, chairman of the SEC in 1973 in a speech to the Securities Industry Association called for the securities industry to transition from fixed schedules of brokerage fees to a more flexible system. The issue of commissions and who had jurisdiction over them was the first one Cook dealt with on his second day at the SEC while he was serving as general council under then SEC Chairman William Casey. The issue at the time was whether the SEC or the anti-trust department had jurisdiction over commission rates and Cook declared the SEC had sole jurisdiction. 
The issue of commission rates continued to arise because of the loses occurring at many NYSE member firms. At the time of Cook's speech, nearly half of all member firms of the NYSE had losing money. The process to raise commission rates industry-wide was cumbersome and would take nearly a year to complete, but which time market conditions had changed. 
Protected by fixed rates from competitive pressures, numerous brokerage firms had grown inefficient. The surge in trading volume in 1968 overwhelmed brokers to such an extent that the NYSE had to close every Wednesday, leading to the failure of around 160 brokerage firms between 1968 and 1970.
In March 1973, the Commission declared it would pause any further reductions in the commission breakpoint until April 1974, planning to lower it from $300,000 to $100,000. However, on September 11, 1973, it revised its stance, deciding against a further breakpoint reduction in April 1974. Instead, the Commission aimed to end the practice of commission rate fixing by stock exchanges by April 30, 1975, unless the exchanges implemented rule changes to achieve this outcome themselves. SEC Chairman Ray Garrett, Jr., in 1973 told the Securities Industry Association that "applicable to the member firm community and to the seriouslosses incurred during the first quarter of 1973, therewould not be an intermediate step taken during that year towards the $100,000 goal." 
The NYSE and the AMEX both introduced negotiated commissions for transactions under $2,000 on a trial basis.
== The 1971 Shift and May Day ==
The first significant crack in the fixed commission regime appeared in 1971, when the SEC allowed negotiated commission rates for transactions exceeding $300,000. This move was aimed at benefiting institutional investors who conducted large trades, recognizing that the cost and effort involved in executing these large transactions did not necessarily scale linearly with their size.
The real watershed moment, however, came on May 1, 1975, colloquially known as "May Day," when the SEC mandated the complete abolition of fixed commission rates. From this point forward, broker-dealers were free to negotiate commission rates directly with their clients for all trades, regardless of size. This radical change was driven by the broader push for deregulation in the financial industry, aiming to foster competition, reduce costs for investors, and stimulate market activity.
After commission rates decreased, trading volume surged to an average of 100 million shares a day, a fivefold increase. This led to increases in brokerage profits and NYSE membership prices, as well as an increase in capital committed to the firms. Capital dealing with the public increased to $17 billion ten-years, a five-fold increase since May Day.
== Unbundling of Commissions and Rise of Discount Brokers ==
The move to negotiated commissions set the stage for further transformations, most notably the unbundling of commissions from research services and the rise of discount brokerage firms. By the early 21st century, commissions, which were over 80 cents per share in the early 1970s, had fallen to around four cents per share. Previously, the commission fees charged by brokerages often included the cost of investment research, advice, and other services. The competitive pressures unleashed by deregulation led to the separation (or "unbundling") of these services, allowing investors to pay separately for trades and research, if they so chose.
This era also saw the emergence and rapid growth of discount brokers, epitomized by firms like The Charles Schwab Corporation.. These firms leveraged technology and scale to offer significantly lower commission rates for executing trades, foregoing the traditional model of providing comprehensive investment advice and research as part of the commission fee. This model appealed to a new generation of self-directed investors, who preferred to do their own research or rely on independent sources. In 1975, approximately 15 percent of households had some exposure to equities, a figure that increased to about 50 percent over the following three decades.
== References ==
Category:Securities and Exchange Commission
Category:Commissions
Category:Brokers