Prices for securities and compensationfor services to be fair and reasonable

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1

"Fairness" of mark-ups must be based on a consideration of all relevant factors

SRO rules generally require broker-dealer prices for securities and compensationfor services to be fair and reasonable taking into consideration all relevant circumstances. Generally, this requirement prohibits a member from entering into any transaction with a customer in any security at any price not reasonably related to thecurrent market price of the security or to charge a commission that is not reasonable.Recognizing that what may be "fair" (or reasonable) in one transaction could be "unfair"(or unreasonable) in another, FINRA has provided guidance on what may constitute a"fair" mark-up.

2

Broker-dealers must charge prices reasonably related to the prevailing market price.

The courts and the Commission have held that under the antifraud provisions of the federal securities laws, broker-dealers must charge prices reasonably related to the prevailing market price. The Commission has consistently held that undisclosed markups of equities of more than 10% above the prevailing market price are fraudulent .305 Markups of less than 10% may also be fraudulent in certain circumstances.306 For example, appropriate markups on debt securities are generally much lower, with the Commission even finding markups below 4 or 5% to be excessive and fraudulent

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The Mark Up Policy identifies the following factors that should be considered i

A determinationof the "fairness" of mark-ups must be based on a consideration of all relevant factors, of which thepercentage of mark-up is only one. IM-2440-1(a). Specifically, the Mark Up Policy identifies the following factors that should be considered in determining the fairness of a mark up: (1) the typeof security involved; (2) the availability of the security in the market; (3) the price of the security(e.g., the percentage of mark-up or rate of commission generally increases as the price of thesecurity decreases); (4) the amount of money involved in a transaction (e.g., a transaction involving a small amount of money may have a higher percentage of mark-up to cover theexpenses of handling); (5) disclosure to the customer of the commission or mark-up; (6) thepattern of a member's mark-ups; and (7) the nature of the member's business. IM-2440-1(b);NTM 92-16.

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Broker-dealers are also prohibited under FINRA rules from charging unfair or unreasonable fees

Broker-dealers are also prohibited under FINRA rules from charging unfair or unreasonable underwriting compensation in connection with the distribution of securities,and must disclose all items of underwriting compensation in the prospectus or similardocument.308 Similarly, under FINRA rules, a broker-dealer's charges and fees forservices performed (including miscellaneous services such as collection of moneys duefor principal, dividends, or interest; exchange or transfer of securities; appraisals, safe-keeping or custody of securities, and other services) must be "reasonable" and "notunfairly discriminatory between customers."309 As noted above, charging an unfaircommission would also violate a broker-dealer's obligation to observe just and equitableprinciples of trade pursuant to FINRA rules.

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FINRA rules also establish restrictions on the use of non-cash compensation

FINRA rules also establish restrictions on the use of non-cash compensation in connection with the sale and distribution of mutual funds, variable annuities, directparticipation program securities, public offerings of debt and equity securities, and realestate investment trust programs.311 These rules generally limit the manner in whichmembers can pay for or accept non-cash compensation and detail the types of non-cashcompensation that are permissible.

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compensation that is considered fair and reasonable generally varies directly with theamount of risk

FINRA Rule 5110(c). The following factors shall be considered in determining the currentlyeffective guideline on the maximum amount of underwriting compensation considered to be fairand reasonable: (1) the offering proceeds; (2) the amount of risk assumed by the underwriter andrelated persons, which is determined by (i) whether the offering is being underwritten on a "firmcommitment" or "best efforts" basis and (ii) whether the offering is an initial or secondaryoffering; and (3) the type of securities being offered. FINRA Rule 5110(c)(2)(D). The maximum amount of compensation that is considered fair and reasonable generally varies directly with theamount of risk to be assumed by participating members and inversely with the dollar amount ofthe offering proceeds. FINRA Rule 5110(c)(2)(E). This disclosure includes information about thefirm but does not break out compensation to the registered representative recommending thesecurity.

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a customer confirmation disclose the broker-dealer's commission, if acting as agent,

Exchange Act Rule 10b-10 generally requires that a customer confirmation disclose the broker-dealer's commission, if acting as agent, or its markup, if acting as principal.

Additional Resources

Howard Roitman 8921 W. Sahara Ave Las Vegas, NV (702) 647-8550

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