The 5-Percent Markup Policy and the Series 7 Exam

By Steven M. Rice

The 5-percent policy (FINRA 5 Percent Markup Policy) is more of a guideline than a rule. The policy was enacted to make sure that investors receive fair treatment and aren’t charged excessively for broker-dealer services in the over-the-counter (OTC) market. The guideline says that brokerage firms shouldn’t charge commissions, markups, or markdowns of more than 5 percent for standard trades.

The following trades are subject to the 5-percent markup policy:

  • Principal (dealer) transactions: A firm buys securities for or sells securities from its own inventory and charges a markdown or markup.

  • Agency (broker) transactions: A firm acts as a middleman (broker) and charges a commission.

  • Riskless (simultaneous) transactions: A firm buys a security for its own inventory for immediate resale to the customer (riskless to the firm).

  • Proceeds transactions: A firm sells a security and uses the money to immediately buy another security. You must treat this transaction as one trade (you can’t charge on the way out and on the way in).

The 5-percent markup policy covers over-the-counter trades of outstanding, nonexempt securities with public customers. If securities are exempt from SEC registration, they’re exempt from the 5-percent policy. Additionally, if a dealer pays $20 per share to have a security in inventory (dealer cost) and the market price is $8 per share, the dealer can’t charge customers $20 per share so that it doesn’t take a loss.

Under extenuating circumstances, the brokerage firm may charge more. Justifiable reasons for charging more (or less) than 5 percent include

  • Experiencing difficulty buying or selling the security because the market price is too low or too high

  • Handling a small trade — for example, if a customer was to place an order for $100 worth of securities, you’d lose your shirt if you were to charge only 5 percent ($5); in this case, you wouldn’t be out of line if you were to charge 100 percent (by the same token, if a customer was to purchase $1 million worth of securities, 5 percent [$50,000] would be considered excessive)

  • Encountering difficulty locating and purchasing a specific security

  • Incurring additional expenses involved in executing the trade

  • Dealing with odd lot trades

  • Trading nonliquid securities

  • Executing transactions on foreign markets