I am pleased to welcome a new author to Broker-Dealer Law Corner, my partner in Ulmer’s Boca Raton office, Michael Gross.  Like myself, Michael returned to private practice after a stint at FINRA, specifically, with the Department of Enforcement, where he handled big, litigated cases all over the US.  There is no substitute for the perspective one gains from having worked on that side of the table.  I look forward to sharing with you many more posts with Michael’s unique slant on things. – Alan, editor


  It is well settled – indeed, it is a FINRA rule – that broker-dealers need to charge “fair” prices when they buy securities from, and sell securities to, their retail customers.  This, of course, begs the question of what is a “fair” price.  The lawyer answer to the question is: “It depends.”  Unfortunately, that is the same guidance that regulators and courts have provided to the securities industry for nearly 75 years. FINRA examined this issue in 1943 and has since revisited it several times, only to conclude in the Supplementary Material to Rule 2121 that: “No definitive answer can be given and no interpretation can be all-inclusive for the obvious reason that what might be considered fair in one transaction could be unfair in another transaction because of different circumstances.” Notwithstanding this murky guidance, FINRA reaffirmed its “5% Policy” based on its finding that the large majority of transactions with customers are effected at mark-ups under that threshold.  Consonant with that guidance, FINRA has historically taken a mathematical approach to mark-ups/downs.

Securities Fraud Requires More than Math

A recent Decision by FINRA’s Office of Hearing Officers (“OHO”) rejected the pure mathematical approach to mark-ups/downs in the securities fraud context.[1] In the Singh case, FINRA’s Department of Market Regulation alleged that Bharminder Singh committed securities fraud and violated FINRA’s fair pricing rule by charging unfair and excessive mark-downs of 10% or more in 384 transactions involving distressed debt instruments.  Market Regulation calculated the mark-down percentage by comparing Mr. Singh’s prices to the lowest inter-dealer price for the same security on the same day.  In support of its fraud charge, Market Regulation argued, among other things, that mark-downs in excess of 10% are fraudulent as a matter of law. OHO squarely rejected the argument:

To the extent that Market Regulation is arguing that the size of the markdowns alone is sufficient to establish fraud, we reject that proposition. A case concerning alleged fraudulent markups or markdowns is no different with regard to scienter from any other securities fraud case.[2]

In finding that Mr. Singh did not act with scienter (i.e., intent to deceive or recklessness), and thus did not commit securities fraud, OHO noted numerous factors, including Mr. Singh’s lack of appropriate training and guidance, the highly volatile nature of the distressed securities, and the lack of any significant benefit from the mark-downs to him.  OHO, however, did find that Mr. Singh violated FINRA’s fair pricing rule by charging prices substantially in excess of the “5% Policy” memorialized in IM-2440-1 (n/k/a FINRA Rule 2121.01).

Real World Mathematical Guidance

Needless to say, broker-dealers do not want to find themselves in the same boat as Mr. Singh. They also should know that the “5% Policy” is not a safe harbor, as tribunals have found mark-ups/downs below that threshold to be excessive.  While FINRA Rule 2121.01 identifies a number of factors to consider in determining the fairness of mark-ups/downs, it offers no mathematical guidance on how to apply or account for the subjective factors.[3]  One veteran trader with whom I recently spoke believes that the industry standard is well below the “5% Policy.”  He said that the norm is 2% to 3% on fixed income securities, 1% percent on equities, and 3% to 4% on low-priced and/or illiquid securities.  Broker-dealers, of course, may charge more than those percentages and still provide “fair” prices (and/or prices that do not draw regulatory scrutiny).  It, however, is clear that the 5% bar has been lowered considerably.

[1] The Decision may still be appealed by either party or called for review by FINRA’s National Adjudicatory Council.  In the interest of full disclosure, before returning to private practice, the author of this article represented Market Regulation in the case.

[2] OHO also observed that: “The case cited by Market Regulation for the proposition that a 10% markup on an equity security is fraudulent per se states the proposition but does not actually stand for it.”

[3] The factors include: the type of security involved; the availability of the security in the market; the price of the security; the amount of the transaction; the disclosures provided; the pattern of mark-ups; and the nature of the firm’s business. FINRA Rule 2121.01.