BBS: May Day 1975
While at UVA in 1982 I wrote my Master’s thesis about the day the SEC deregulated stock commissions on May 1, 1975 known by the nickname, “May Day.” Prior to this date all brokerage firms charged the same commission based on the industry rate schedule. So whether you bought a stock from Paine Webber, Dean Witter, Merrill Lynch, or others, you paid the same dollar amount of commission. The argument for keeping commission rates fixed was to help brokerage firms cope with extreme volumes of trading and have excess staff to handle the spikes in stock trading whenever they occurred.
However, the SEC determined the brokerage industry would have to cope with market cycles just like other industries, hiring and laying off staff as economic cycles expanded and contracted.
My thesis was an evaluation of the welfare impact to society by deregulating commissions. The second seat for my thesis was Thomas Wake Epps, who developed the demand curve for brokerage services, which Westinghouse had hired him to do prior to May Day. My conclusion was that deregulation was a huge welfare gain for society.
Competition rapidly brought commissions down and introduced the concept of discount brokerage firms. The windfall from lower commissions was that institutions, as well as individuals, could make more frequent adjustments as needed, since the cost of rearranging the securities positions dropped dramatically.
I also projected that discount houses would not gain a whole lot more than 10% of investors, because the average investor needs a wide variety of services, and not just stock trading with low commissions with little to no advice. The last statistics I heard was that discount firms had 11% to 12% of investors as clients. However, with the introduction of the Internet many more investors are doing their own research even when working with full-service financial advisors. The lines are somewhat distorted with full-service firms like Morgan Stanley owning Charles Schwab, and the merger was a little turbulent in the early years and has blurred the lines between full and discount firms.
You may wonder why full-service commissions are higher than discount brokerage commissions. The primary answer is risk. If a full-service advisor makes an error executing a transaction, the advisor personally has the error withheld from his future pay. If an error is made by a discount broker executing the trade, usually unsolicited from the client, the error is absorbed by the client, not the brokerage firm. In addition, research and advice by a full-service advisor are multifaceted services not provided by discount firms.
Financial markets and the AI revolution are opening new horizons for many types of financial firms, and these trends have not been experienced in our history.