The fixed commission rates were set by the NYSE with approval by the SEC. The SEC issued a rule ending these fixed rates under pressure from congress, the Justice Department and the courts.
Source: The Wall Street Journal, 11 July 2006 page D1. I have deleted two companies from the graphic in order to make it fit.
Technically, the SIPC insurance covers insolvency of only clearing firms. In some cases, two firms are involved: the introducing broker (which employs the broker who deals directly with the customer) and the clearing firm (which actually maintains the account and executes the trades). Larger firms typically clear their own trades.
Note that this bid/ask spread is a cost of your trade just as much as the commission is. Suppose that you purchased the above stock at 45.15. If you then turn around and sell it immediately, you will get a price of 45. In other words, you lose $0.15 per share, which is $15 per 100 shares. That’s more than the commission that many deep discount brokerage firms would charge. Even if you don’t sell immediately, you’ll always be selling at the best bid which is lower than the best ask. Therefore, you’ll always have to bear this cost, no matter when you sell.
Note: The margin I am discussing here is not the same as margin in the futures markets. Futures market margins are good faith deposits, they do not in any way represent collateral for a loan.
Notes: Pattern Day Traders are defined in NASD Rule 2520 which went into effect on 28 September 2001. In addition to having 4 day trades in 5 days, those trades must amount to more than 6% of trading activity in those 5 days. Day-trading buying power is limited to four (4) times maintenance margin excess.
Derivation of margin call formula: Definitions: P 0 = Value of portfolio at the time borrowed funds are initially used E 0 = Portfolio equity at time period 0 P 1 = Value of portfolio at time period 1 (some arbitrary amount of time in the future) E 1 = Portfolio equity at time period 1 P M = Value of portfolio that will trigger a margin call E M = Portfolio equity when a margin call is made IM% = The amount of equity at time period 0 divided by P 0 MM% = The required minimum equity as a percent of the portfolio value Note that at time period 0 your equity (dollars) is given by: E 0 = IM% x P 0 and, if the portfolio value has fallen, then your equity has fallen by: Loss = P 0 – P 1 So that your equity at period 1 is: E 1 = IM% x P 0 – (P 0 – P 1 ) Now, a margin call will be triggered when E 1 falls to E M , and your equity as a percentage of portfolio value is: CM% = E 1 /P 1 If we set CM% equal to MM%, we will know what your equity (in dollars) will be when a margin call is made: MM% = E M /P M Now, substituting in for E M , we find that: MM% = [IM% x P 0 – (P 0 – P M )]/P M Solve for P M : MM% x P M = IM% x P 0 – P 0 + P M MM% x P M = P 0 (IM% - 1) + P M MM% x P M - P M = P 0 (IM% - 1) P M (MM% - 1) = P 0 (IM% - 1) P M = (IM% - 1)/(MM% - 1) P 0 QED.
When you open a margin account, among the forms you will have to sign is one called a “Hypothecation” agreement. This allows your broker to lend any shares held in your margin account. If you don’t wish you shares to be loaned out, you must either hold the shares in a separate cash account, or have the certificates in your possession.
Here’s a quote from the NYSE Web site about market surveillance (http://www.nyse.com/regulation/howregworks/1022221394213.html): Sophisticated technology and pattern recognition systems are used by the staff to detect and investigate activity that may violate Exchange rules or federal securities laws. Such activity may involve: 1) insider trading 2) market manipulation 3) breaches of fiduciary duties 4) violation of agency responsibility and investor protection rules 5) failure by specialists to maintain fair and orderly markets in listed securities and products, and 6) violation of rules governing members’ on-Floor trading and auction market procedures. When Market Surveillance detects possible insider trading that involves corporate employees, officers or directors of a listed company, or members of the public, it refers these cases to the SEC. If cases are prosecuted by the SEC or the U.S. Attorney's office, Market Surveillance staff provides expertise, trading data and may even serve as expert witnesses.
Investor Participation in the Markets Timothy R. Mayes, Ph.D. FIN 3600: Chapter 6
Full-service brokerage firms provide exactly that, full-service.
They offer clients professional research reports and advice on what/when to buy and sell. They may also offer the opportunity to participate in IPOs, unit investment trusts, financial planning, and other investment products.
Examples of full-service brokers would include Merrill Lynch , Morgan Stanley Dean Witter , Salomon Smith Barney , and many others.
Full-service firms charge high commissions and sometimes account maintenance fees to cover the cost of their services.
Deep discount brokerage firms offer commissions much lower than even discount brokers. Some are as low as $5 per trade ( Brown & Co ). Some “direct access” brokers are as low as $0.01 per share ( Interactive Brokers ).
Deep discounters offer few services and many offer only stock trading (no bonds, mutual funds, etc).
Most deep discount firms are Internet-only, offering no local branch offices and little human contact.
Examples would include Scottrade , E-Trade , Ameritrade , and many others.
Bid – This is the price that someone is willing to pay at a given point in time.
Ask (Offer) – This is the price that someone is offering to sell the security.
Normally, when you get a price quote you will be given the best bid and best ask (known as the “inside market”).
Assume a stock is trading at 45 – 45.15. The bid is 45 and the ask is 45.15. This is the highest bid price and lowest ask price at the moment. If you enter a market order to buy you will pay 45.15. If you enter a market order to sell the price you will receive is 45.
There is usually a long list of lower bids and higher asks for each stock in the limit order book.
In the stock market, the two most common modifiers are GTC and Day. These are used only with limit and stop orders.
GTC – Good ‘Till Canceled. These orders remain in effect until they are executed or you cancel them. Most brokers actually require that they be renewed monthly or quarterly, or they will be automatically canceled.
Day – A day order is good until it is executed, or until the end of the trading day. If it is not executed by the end of trading, it will be canceled. Some brokers will allow day orders to extend into the “after hours” session if so instructed.
MOC/LOC – These are orders that are executed at or near the close of the market. MOC is market on close, and LOC is limit on close.
Approved customers (those with margin accounts, as opposed to cash accounts) are allowed to buy stocks “on margin,” that is, on credit.
Margin is the amount of money that you put up (collateral), the balance of the cost of the position constitutes your margin loan
The Federal Reserve Board’s Regulation T requires that your initial margin is 50% of the value of the trade. So a trade of $5,000 would require at least $2,500 in equity (cash or marginable securities).
The Fed does not regulate maintenance margin, but the NYSE and NASD require maintenance margin of at least 25%, though many brokerage firms require more. The NYSE (Rule 431) also requires that customers opening margin accounts must deposit at least $2,000.
Since 1934, the initial margin requirement has never been below 40% (it was 100% in 1946), but before 1934 it was set by brokerage firms and was sometimes as low as 10%. It has been 50% since 1974.
During 1999, many brokers began requiring 100% margin on certain very volatile stocks, especially Internet stocks. Brokerage firms can set margin requirements higher than those required by Reg T or the NYSE.
You cannot borrow against stocks trading for less than $4 per share.
In 2001, the NASD and NYSE approved new rules for “Pattern Day Traders.” A person who makes 4 or more day trades in 5 days is now called a pattern day trader. These investors are required to have minimum account equity of $25,000 (which must be maintained at all times).
If your account equity falls below the maintenance requirement, you will receive a “margin call” requiring you to deposit funds to bring your account into compliance.
You will normally have at least three trading days to meet a margin call, but some brokers (especially deep discounters) will sell you out if you don’t wire funds immediately.
To determine the minimum amount of equity that you may have before receiving a margin call, use the following formula:
Where P M is the price that will trigger a margin call, P 0 is the initial price of the stock, IM% is the initial margin as a percentage of portfolio value, and MM% is the maintenance margin requirement.
As an example, suppose that you open a margin account with $2,000 (the required minimum). You buy 100 shares of a $40 stock. What price will trigger a margin call if the maintenance margin is set at 30%?
Note that if the stock falls to $28.57, your equity will be $857 (you’ve lost $11.43 per share, or $1143) which is 30% of the total value of the position ($2,857)
Short selling is the process of selling securities that you don’t own (hoping they decline in value).
In order to short a stock, you must have a margin account and your broker must be able to borrow shares from another broker and lend them to you.
Obviously, you will eventually need to buy back the shares. You will profit if the shares are repurchased at a lower price.
Note that stocks may only be shorted on an “uptick,” though some other types of securities (ETFs and futures for example) may be shorted at any time. The uptick rule (10a-1 of the Securities Exchange Act of 1934) is currently under review by the SEC and may be eliminated (http://www.sec.gov/rules/concept/34-42037.htm).
Prior to 1933 there was very little regulation of the securities markets and the market manipulators often engaged in “bull raids” and “bear raids” on stocks. These and other tactics were used to take advantage of other investors.
After the great crash of 1929, congress began to look seriously at regulating the markets and eventually passed several major laws.
The most important of these are:
The Securities Act of 1933
The Securities Exchange Act of 1934
The Investment Company Act of 1940
The Securities Investor Protection Act of 1970
The Securities Acts Amendments of 1975
A summary of these and other laws is available at http:// www.sec.gov/about/laws.shtml
The Securities Act of 1933 required that all new securities sold to the public be registered with the federal government.
The act requires that a registration statement (usually Form S-1) be filed with the government at least 20 days before the securities are sold, and that the securities cannot be sold until the statement is approved.
The Act also allows distribution of the preliminary prospectus (“Red Herring”), and publication of a “tombstone” ad. The final prospectus must be sent to all purchasers of the new security.
The Act allows for criminal penalties, and for investors to sue, in the event of fraud or misrepresentation in the prospectus.
The Securities Exchange Act of 1934 extended regulation to the secondary markets.
Among other things, it:
Created the SEC (Securities Exchange Commission) and gave it the power to regulate securities markets and establish trading policies for the exchanges and self-regulatory organizations (such as the NASD)
Requires firms to file an annual report (Form 10-K), quarterly reports (Form 10-Q), and various other reports such as 8-K which disclose material events
Prohibits “insider trading”
Requires disclosure of tender offers for 5% or more of the outstanding shares of a public corporation
Effective 23 October 2000, Regulation FD (Fair Disclosure) requires that when companies disclose material, non-public information to certain parties (generally analysts or shareholders who may profit from the information) they must immediately disclose the same information to the public.
Usually, the disclosure takes the form of a press release and Form 8-K.
Previously, information was frequently given to analysts but not to the public which created an unfair advantage.
More detail on Regulation FD may be found at http://www.sec.gov/rules/final/33-7881.htm