It’s
difficult from this vantage point to grasp the arrogance of Wall Street
traders before Mayday, the name assigned to the day when, after 183 years
of price fixing, the New York Stock Exchange was forced to give up a
system of fixed brokerage commissions.
How audacious.
Here was an industry celebrating the purest expression of free market
enterprise and competition in the world, but embracing for itself government-sanctioned
regulation. Ever since it was founded in 1792, the public face of the
New York Stock Exchange extolled the virtues of competition and the American
Dream, where any kid can grow up to the chairman of the board or, lacking
that, the president of the United States.
Now the industry
acted as if the reformers had proposed Karl Marx as the president of
the New York Stock Exchange. The most sober industry spokesmen warned
that American free enterprise would all but collapse if competition were
allowed to be the arbiter of trading commissions. SEC hearings were
filled with testimony such as, “May Day is a great holiday in Russia.
And Russia has said there is no need to fight democracy; it will burn
itself out. Well, Commissioners, you have the candle and matches, and
it will be a short fuse.”
Behind the Apple
pie veneer of good old American free enterprise, the New York Stock Exchange
represented just another cynical conspiracy against the public. Except
this cartel—for that’s what it was—managed to thrive for 183 years, reaping
untold riches on its beneficiaries. The group of New York brokers who
secretly met in what must have been the original smoke-filled hotel room
contrived a monopoly to fix commissions and to keep all the trading business
for itself. For almost the entire history of the country, these essential
terms remained unchanged. Commissions went up, of course, but they were
always non-negotiable. Take it or leave it. But if you decided to leave
it, you were confronted by Rule 390, the sweetest provision of all.
Rule 390 dictated that all stocks listed on the New York Stock Exchange
could be bought and sold only through a member firm.
At first, the government
had neither the mechanism nor the will to do much about it. Thus the
New York Stock Exchange prospered, and its monopoly acquired the respectable
veneer of tradition. It didn’t help that, in the wake of the Depression,
Congress gave the federal government’s imprimatur to the tradition of
fixed trading commissions. The Securities Acts of 1933 and 1934, which
in addition to requiring brokerages to be licensed by the SEC, officially
sanctioned the NYSE’s price fixing for its member firms—a practice that
effectively set commissions rates for the entire industry. “In short,”
says Los Angeles-based financial writer Benjamin Mark Cole, “if you wanted
to buy or sell stock, you had to do it through a licensed brokerage.
And they all charged the same rate. End of story.”
There were two big
problems. First, customers, especially retail customers, were being
raped. The NYSE member firms were essentially charging the same commission
to a retail customer trading 25 shares of IBM as it did for an insurance
company trading 10,000 shares. There was no relationship between commissions
and true costs of executing trades. A second problem was that innovation
suffered. With everyone fat and happy and virtually guaranteed profits,
there was little incentive for the NYSE wire houses to automate, introduce
new products, or improve customer service.
A typical pre-Mayday
retail trade would generate commissions anywhere from $200 to several
hundreds of dollars. For example, a trade of 100 shares of IBM at $60
per share would cost an investor approximately $400. Today, by contrast,
even a full service trade would charge between $75 and $150 for such
a trade. Schwab’s charge would be $29.95, while deep discounters would
charge even less. “While trading volumes increased, brokers now found
that the only way they could get a piece of the new business was to cut
their commissions. Taking inflation into account, full-service brokerages
slashed their rates by fully 95 percent between 1975 and 1998. And still
the discount houses continued to undercut them,” Cole reports. The Street
learned to its dismay that the competition that the brokers so earnestly
encouraged for others didn’t make exceptions for brokers.
