Ferrell study inspires FINRA rule changes: ‘The Law and Finance of Broker-Dealer Mark-Ups’

Professor Alan Ferrell

Professor Alan Ferrell

The Financial Industry Regulatory Authority (FINRA) has proposed changes to its rules governing markups, commissions and fees, partly in response to a study by Harvard Law School Professor Allen Ferrell. The study, published April 7, is titled “The Law and Finance of Broker-Dealer Mark-Ups.”

On FINRA’s behalf, Ferrell conducted an analysis of more than 161,000 equity transactions in order to assess the mark-ups and mark-downs that broker dealers charge when customers buy and sell securities. Ferrell examined the distribution of these mark-ups and mark-downs, as well as their determinants.

“Professor Ferrell’s study was an important component in the formulation of FINRA’s policy and regulatory position,” FINRA commented.

The abstract follows. The full study is available here. The proposed FINRA changes are available here (pdf). 

The Law and Finance of Broker-Dealer Mark-Ups

By Allen Ferrell

The prices charged retail customers by broker-dealers for less-liquid, lower-priced securities have been of long-standing regulatory concern. In particular, the Financial Industry Regulatory Authority has long had regulations prohibiting broker-dealers from charging excessive “mark-ups” and “mark-downs.”

This paper, using a unique dataset generously provided by FINRA tracking some 161,635 equity transactions involving fourteen broker-dealers and retail customers in largely less liquid, lower-priced securities over the course of the 2003-2005 period, provides the first comprehensive analysis of the determinants of the mark-ups and mark-downs charged by broker-dealers.

In particular, the effect of broker-dealer solicitation, broker-dealer participation in the trade as a principal, stock price volatility, stock price level, trade volume and the bid-ask spread are examined on the size of mark-ups and mark-downs charged. This analysis is placed in the context of the law on mark-ups and mark-downs. … Read the full study on the Social Science Research Network »