Forty years ago, Wall Street reforms made it much more of a two-way street. Photo by Image Source/Getty Images.
Happy anniversary, lower commissions! Friday marks 40 years since the SEC enacted 1975’s May Day reforms eliminating fixed commissions on Wall Street. A shot heard ‘round the investment world unleashing an industry revolution that made Wall Street more investor-friendly than ever before. You dear readers, are the direct beneficiaries, and from a market access standpoint, you have never had it better. But, easier access simply doesn’t mean easier success.
For the roughly 180 years between 1792’s Buttonwood Agreement and May Day, brokerage firms acted as a virtual cartel—agreeing not to compete on price on trades ranging between $2,000 and $300,000 in total value.[i] Trading costs, therefore, were astronomically high by today’s standards. For example, if you purchased 100 shares of a $50 stock (a total of $5,000) based on the final fixed commission schedule that lasted from 1973 through May Day, the commission alone would run you $71.50 (1.4% of the value and $346 in 2015 dollars[ii]). That doesn’t even include other costs, like bid-ask spreads, which were far higher then and drove total costs above 2% of transaction value or more. The rule ending all that, technically known as SEC Rule 19b-3, was adopted January 23, 1975, with implementation slated for May 1.
Deregulation meant competing on price, and firms were not exactly on board. Many dubbed the SEC “the Soviet Economic Committee,”[iii] which seems to fixate on the fact May Day is a holiday often affiliated with communist countries. Or, maybe it’s the fact many brokers believed these changes would cause firms’ profits to plunge and doom the industry to destruction. Many argued May Day should be spelled Mayday, as in “…we’re going down.”[iv] Wall Street lobbied Congress forcefully seeking to prevent Rule 19b-3, but Congress already had its own movement to end fixed commissions, led by Rep. John E. Moss (D-CA). This, many argue, led the SEC to act in the first place, because Moss’s bill (which became law June 4, 1975) was introduced two-plus years earlier (amid lawmakers’ widespread dissatisfaction with the SEC). Opposition to the rule changes, therefore, was rather feckless.
When you add competition where none existed before, prices tend to fall fast. That, folks, is exactly what happened. Discount brokerage launched with May Day’s reforms, and trading costs, according to some accounts, halved within weeks. But contrary to the industry’s doomsday assertions, this triggered a boom in trading activity. Lower prices, you see, tend to encourage more activity.[v]
That increased activity furthered an innovation boom. Back then, trading required a vast array of paperwork—heck, your stocks were engraved pieces of paper. The increase in volume the 1960s’ long bull market triggered what some called, “the back office crisis” prior to May Day. Computerized trading was in its infancy when May Day hit, but with even bigger increases in volume, technology had to be harnessed, and it was. In the 1980s, more innovations brought automated telephonic trading, the precursor to online brokerage—itself driving more competition and even lower costs.
Competing on price lowered costs not only in commissions, but other areas. Around the same time, no-load funds were born, pressuring funds that charged an upfront sales load. Today, sales loads still exist, but they are becoming a relative rarity in the US.
Those are all positives in making the market more structurally investor-friendly, but don’t take that to mean investing is “easier.” In some ways, it’s harder. The democratization of financial markets has also spurred an explosion in financial media—some of it high quality and some less so. But all this information can easily overwhelm an investor, and spur fight-or-flight reactions. In Morgan Housel’s wonderful commentary, “This Was Never Easy,” published yesterday at The Motley Fool, he notes:
Stocks have surged since March 2009. It's been one of the strongest six-year rallies in history. But if you think any of that was perfectly foreseeable, or easy, you are utterly kidding yourself.
None of this was ever easy, which is verified by the fact that people have been saying "the easy money has been made" consistently since this bull market began six years ago.
At every step during the last six years there has been a persuasive argument that stocks had gone too far, were getting ahead of themselves, and bound to fall.
Read the whole thing. It’s worth it.
When you combine this tsunami of financial information available today with low costs, you find behavior errors. Like flipping in and out of stocks too much. Investor research firm DALBAR has documented the fact fund shareholders stay in their selected fund only about four years—far shorter than a typical market cycle. And even that is an increase from the last few years. In their words, “At no point in time have average investors remained invested for sufficiently long periods to derive the benefits of the investment markets.”[vi] For example, there is evidence no-load fund shareholders trade more because they don’t have high costs to recoup. Similarly, if you had to pay the equivalent of $350 to sell a stock, maybe—just maybe—you’d take a more patient approach than if it were $7?
May Day should be remembered and celebrated mostly for the fact it helped bring about today’s golden age for individual investors. But costs aren’t everything, and cheaper investing for individuals doesn’t necessarily mean better investing by individuals.
[i] Source: “Fixed Stock Fees Must be Ended by May 1, SEC Chief Says,” Robert J. Cole, The New York Times, 1/23/1975. The bandwidth of fixed-commission trade sizes changed over the years, as did the minimum rate.
[ii] Source: US Bureau of Labor Statistics. This figure is $71.50 adjusted for headline Consumer Price Index inflation for the period May 1975 – March 2015. Commission figures from “SEC Clears Increase in Rates; Sets End to Fixed Fees in 1975,” Edwin L. Dale, Jr., The New York Times, 9/12/1973.
[iii] This is a particularly odd accusation, considering competition is at the heart of capitalism, and collusion to fix prices more often associated with communism.
[v] A bit like the Laffer Curve, which argues lower tax rates encourage more economic activity causing revenues to rise, as applied to markets. Now, many argue the Laffer Curve doesn’t work in the tax arena, which we won’t get into here. But there is basically no arguing this didn’t apply in securities markets.
[vi] DALBAR, Inc. Quantitative Analysis of Investor Behavior, 2012 edition.