From the May 2010 issue of Research Magazine • Subscribe!

The Great Unfixing

Thirty-five years ago, fixed commissions ended and a new Wall Street was born.

It was known as "May Day" or "Mayday," the latter spelling suggesting the distress with which it was regarded in some financial circles. On May 1, 1975, the era of fixed commissions for stock transactions ended. A comfortable albeit constraining arrangement gave way to heightened competition that would transform the brokerage industry -- indeed, ultimately remaking it such that the very term "broker" would seem old-school.

The old era lasted just shy of 183 years. It began with the Buttonwood Agreement of May 17, 1792 in which 24 brokers, reportedly meeting under a Wall Street buttonwood tree, resolved to trade on a commission basis and not to allow any commissions below a certain level. This loosely organized group evolved into the New York Stock Exchange.

The Buttonwood Agreement may have helped America's nascent financial markets survive. For one thing, it gave confidence that dealing in securities was a plausible way to make income. Plus, by showing that brokers could regulate themselves, it may have forestalled a political crackdown on the newfangled activity of stock trading.

But over time, fixed commissions, enshrined not only in New York but at exchanges throughout the country, also put limits on the stock market. The high costs of trading discouraged broad public participation, and the clubby arrangements among exchange members created a dubious environment for innovation in financial services.

Pressure Builds

By the 1960s, fixed commissions were generating a degree of investor discontent that was hard to ignore. Pension funds and other institutional investors had become big players in the market, creating a powerful constituency for lower trading costs. Brokerage firms competed for their lucrative business with "soft dollar" amenities such as research reports, and individual investors looked jealously at these special deals for institutions.

Moreover, a "third market" was emerging (the exchanges being the "first" market and unlisted stocks the "second"), consisting of over-the-counter trading of exchange-listed stocks. An avenue was opening for institutions to avoid paying fixed commissions.

Legal and regulatory changes were upping the pressure as well. In 1963, a court case called Silver v. New York Stock Exchange, involving a complaint by some over-the-counter dealers about NYSE policies on communications with non-members, established the principle that the Exchange was not exempt from antitrust laws. In 1968, the Justice Department asked why fixed commissions shouldn't be outlawed as an anticompetitive practice, and pressed the Securities and Exchange Commission to look into the matter.

The NYSE began pushing back, reflecting the views of most of its members that fixed commissions were needed to keep the industry profitable or at least couldn't be abandoned quickly without causing massive damage. For a while, the SEC sympathized with such counterarguments, though gradually the agency looked more sternly at fixed commissions, especially as the NYSE proposed increases in the rate structure.

In 1970, the controversy was plodding on, and little seemed likely to change anytime soon. A bear market was taking a deep bite out of brokerage revenues, and many on Wall Street were in no mood to experiment with sweeping commission reforms. However, a renegade NYSE president soon shook things up again.

Speaking Out

That executive, Robert Haack, speaking before the Economic Club of New York on November 17, 1970, astounded his audience and infuriated much of Wall Street by calling for an unfixing of commissions. Such a measure, he argued, was in the long-run interests of the Exchange and its members. "I am concerned lest we bask solely in the glory of the past, and in the process become oblivious to emerging trends," said Haack. "The New York Stock Exchange, to put it crassly, no longer has the only game in town."

Haack's speech made the front page of the next day's New York Times and much negative reaction followed. "It's a pretty sick patient to be performing major surgery on," complained Richard Jenrette, co-founder of Donaldson, Lufkin & Jenrette. Clifford Michel, CEO of Loeb Rhoades, called Haack's initiative "ridiculous."

Few people, if any, were angrier than Bernard "Bunny" Lasker, chairman of the New York Stock Exchange, who pointed out to the Times that policy was set by the Exchange's board of governors, not its president. But despite expectations that Haack would be fired, the Exchange avoided such a bad public-relations move. Instead, Haack left in 1971 and a reorganization of the NYSE eliminated the president's job until 1980.

Yet amid the backlash, one important player was conspicuously in line with Haack's position. This was Donald Regan, who as CEO of Merrill Lynch pressed the Exchange to get rid of fixed commissions. The future Treasury secretary and White House chief of staff said he was appalled that Wall Street's capitalists practiced "cartelism" by keeping rates rigid. He also had Merrill Lynch's interests in mind. The firm was more focused on the mass market than were its competitors. Regan was betting Merrill would do quite well in a new era of competitive scrambling and higher volume.

Toward May Day

Some kind of loosening of the rate structure now seemed likely. But opponents hoped to keep any such measures incremental and delay them as long as possible. In 1971, under Chairman Hamer H. Budge, the SEC took a relatively modest step in requiring negotiated commissions on transactions larger than $500,000.

The NYSE in 1972 hired former SEC commissioner James Needham to be its new chairman. Although as a regulator he had been amenable to moving toward unfixed commissions, as NYSE chairman he saw his job as making sure such movement didn't go too far or fast, warning he would fight such measures "on the courthouse steps."

But the momentum was on the other side. Congressman John Moss (D.-Calif.) held hearings on fixed commissions and introduced a bill that would eliminate them. The SEC continued its reform push, despite the distractions of some unrelated political imbroglios. (See sidebar "Tumult at the SEC.") In 1972, the agency lowered the upper limit on fixed-commission transactions to $300,000.

Ray Garrett, who became SEC chairman in September 1973, was a Battle of the Budge veteran who had little interest in higher political office. Shrugging off diehard opposition from the brokerage industry, he pressed for a complete shift to negotiated commissions. The agency ordered an end to all fixed rates as of May 1, 1975. As an interim step, in April 1974, commissions on orders under $2,000 were unfixed.

The Fallout

May Day is often described as a "deregulation," and it was that. But it was a curious kind of deregulation, eliminating private-sector rules rather than governmental ones. In any event, the transformation it brought to the financial industry was not immediately obvious. Brokerages generally kept their commissions fairly stable at first. Indeed, the initial response of some firms was to raise the rates they charged small investors.

Over time, though, the changes would prove dramatic. Commissions, which had averaged over 80 cents per share in the early 1970s, dropped to some four cents per share in the early 21st century. While full-service brokers lowered their rates, discount brokers emerged to lower commissions more. In the 1990s, Internet trading furthered that trend.

Public participation in the stock market skyrocketed. Some 15 percent of households had some degree of exposure to equities in 1975, a figure that would rise to around 50 percent three decades later.

Concerns that the brokerage industry would be crippled were overblown. But it did have to change. Fee-based arrangements became increasingly common as commissions plunged. Brokers who had focused on stock transactions increasingly took on a broader mission of financial advice and planning. Research magazine's shifting tagline reflected this trend, going from "All a broker needs to succeed" to "Helping advisors help their clients."

From the perspective of three and a half decades, May Day was a success.

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Tumult at the SEC

During the early 1970s, the Securities and Exchange Commission faced several episodes of political controversy. While these likely diverted some of the agency's energy from the fight over fixed commissions, they may ultimately have helped spur the agency toward May Day, as a way of boosting the SEC's image.

William Casey, who would go on to head the Central Intelligence Agency in the 1980s, was chairman of the SEC from 1971 to 1973. His tenure included a reorganization of the SEC's enforcement apparatus, as well as a lowering of the threshold on fixed commissions.

However, shortly before leaving the SEC, Casey got into a contretemps with Congress over files from an investigation of International Telephone & Telegraph. Casey forwarded those files to the Justice Department, placing them out of the reach of congressional investigators looking into campaign finance allegations that fed into the Watergate scandal.

The next SEC chairman, G. Bradford Cook, was in office only 74 days before being tripped up in the growing Watergate mess. Cook resigned after admitting that, at the behest of Nixon aides John Mitchell and Maurice Stans, he had omitted from an SEC document any mention of campaign contributions from fugitive financier Robert Vesco. This admission, damaging in itself, also contradicted Cook's earlier testimony.

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