Image Credit: “Floor of the New York Stock Exchange,” Thomas J. O’Halloran, 1963, Library of Congress
By Jason Zweig |10:35 am ET Apr. 30, 2015
Friday, May 1, is the 40th anniversary of what may well have been the most momentous day on Wall Street since the predecessor of the New York Stock Exchange was formed in 1792.
On May Day 1975, fixed-rate commissions were abolished by regulators. Until then, a broker who tried to charge customers less than the fixed rate to trade shares ran the risk of being expelled from the stock exchange. With some minor exceptions, for 183 years it had cost the same amount per share to trade 100 shares as it did to trade 1,000 or 100,000—and brokers regularly shaved 2% or more for themselves off the typical trade.
May Day blew that cozy world to smithereens.
One of its lessons for today’s investors is obvious; another is more subtle.
The obvious lesson is that when brokers treat their customers more fairly, the customers prosper. May Day smashed Wall Street’s monopoly, unleashing the discount-brokerage industry, fostering independent research and democratizing the world of investing.
The subtle lesson is that when brokers treat their customers more fairly, everyone prospers. May Day, which brokers at the time expected to be the most apocalyptic event in their industry’s long history, turned out to be the best thing that ever happened to them. Trading boomed, investors flocked back to the markets and brokerages minted money for decades.
To understand the changes wrought by May Day, consider what it cost to buy 100 shares trading at $25 on the New York Stock Exchange before May 1, 1975.
You would have paid a minimum commission of $49 and a bid-ask spread (the difference between the selling price and purchase price) of $13, reckons Charles M. Jones, an economist at Columbia Business School who studies brokerage costs. That totaled 2.5% of the $2,500 transaction.
Today, you could buy 100 shares of a $25 stock for a commission of $10 or less at an online broker and perhaps $1 in total bid-ask spread, a combined cost of 0.4%.
So the cost of trading has fallen by more than 80%—without adjusting for inflation.
How did May Day come about?
With fixed rates sheltering them from the discipline of competition, many brokerage firms had become inefficient. When volume surged in 1968, brokers were so unable to keep up with the paperwork that the NYSE had to shut down every Wednesday—and some 160 brokerage firms went bust between 1968 and 1970.
Meanwhile, institutional investors wanted to know why it cost the same rate to trade tens of thousands of shares as it cost to trade 100 shares.
Prompted partly by trustbusters at President Richard Nixon’s Justice Department, the Securities and Exchange Commission announced in September 1973 that it would eliminate fixed commissions a year-and-a-half later.
As May Day—or “Black Thursday”—loomed, the rhetoric on Wall Street turned red-hot. James Needham, chairman of the NYSE, predicted that negotiable commissions would bring “disaster to the majority.” Brokers sneered that the SEC was an acronym for “Soviet Economic Committee.” Summarizing the industry’s positions against deregulation, SEC commissioner John Evans recited a litany of doom; critics, he said, claimed that it would “create confusion and chaos” and “bring about the downfall of our free enterprise system.”
The opponents of deregulation “had a sense of entitlement that they somehow deserved a certain level of profits,” recalls Lee Pickard, then the head of market regulation at the SEC and now a partner at the securities-law firm of Pickard Djinis and Pisarri in Washington. “They also had a kind of arrogance that this [change] is never going to happen.”
The NYSE threatened to sue the U.S. government; brokerage executives marshaled what SEC Chairman Ray Garrett Jr. called “a parade of horrors” to arm-twist congressional committees into stalling the reform.
But May Day went ahead—and Wall Street’s world didn’t end.
“The exact opposite happened,” says Donald Weeden, former chairman of Weeden & Co., one of the earliest firms to support the end of fixed commissions. “Getting rid of those monopolistic restrictions led to the most explosive profitability ever.”
When May Day came, brokers cut commissions, often by 50% or more—and business boomed.
“Deregulation provided the window for people to begin to innovate,” says Charles Schwab, who in September 1975 opened the first brokerage office of the firm that bears his name and that now oversees $2.5 trillion in assets. “It turned the whole industry upside down and led to this great mass flourishing of services and pricing and technology.”
Fast-forward to 2015, when much of the brokerage industry vehemently opposes the idea that brokers should be required to put their clients’ interests ahead of their own.
If such a “fiduciary duty” became standard practice, would it—as many brokers argue—bring disaster by making financial advice too expensive for the masses? Or would it instead encourage more consumers than ever to seek advice, now that they could finally be assured that it would be in their best interest to do so?
Those who oppose the extension of fiduciary duty should look back at May Day and ask whether they are on the right side of history.
Source: The Wall Street Journal