Disclosure of Compensation to Brokers or Dealers

Instructor: Yusuf Abdullah

Yusuf has taught Science and Mathematics at school level and Finance and Economics at University level. He has recently earned his Ph.D in Financial Econometrics.

This lesson deals with the disclosure of compensation to brokers or dealers as per SEC Rules and Regulation 15g-4 related to the penny stocks. Learn about characteristics of penny stocks, the disclosures regarding compensation and the timing of disclosure. Updated: 02/20/2020

Brokers & Dealers

Anse Hatfield is a young lawyer in Manhattan and has recently been made a partner at Hatfield and McCoy. He has approached Sarah for investment advice at a nearby firm. Anse is interested in investing in penny stocks as a small portion of his portfolio to increase his returns.

Sarah informs him that penny stocks are highly risky and very susceptible to manipulation by the market participants including brokers and dealers. Anse is surprised because he thought penny stocks were regulated too. Anse wonders, are brokers and dealers are the same? Sarah notes that there is a subtle difference.

  • A broker is an individual or a firm that matches buyers to the sellers and allows trade. The broker charges fees for just arranging buyers and sellers to meet. A broker would not own securities at a given time.
  • A dealer, on the other hand, sells and purchases securities and maintains a ready inventory in case buyers approach them. Various investment firms act as brokers as well as dealers in many different functions.

A penny stock is a stock of a small company that has to meet some characteristics. It must be:

  • Priced under $5.
  • Not traded on an exchange or NASDAQ.
  • Listed in pink sheets, i.e., the National Association of Securities Dealers (NASD) OTC bulletin board.
  • Issued by a company with less than $5 million in tangible net assets and with less than 3 years of existence.

Disclosure Of Compensation To Brokers Or Dealers

Anse is worried ever since Sarah told him that penny stocks can be manipulated. He is particularly worried about the fact that the investment firm and/or broker may come together at the expense of the investor.

Sarah doesn't blame him for being skeptical as there have been several such instances in the past. She draws his attention to section 15g-4, a section in the Securities Exchange Act of 1934 that deals with compensation to brokers and dealers from the investment firm or advisor. To allay Anse's fears, Sarah shows him some of the important points of the act:

  • Disclosure Requirement

The broker or dealer shall disclose to the investor the total compensation details for carrying out the transaction of the customer. Without this disclosure, it's illegal for the broker to carry out the trade for the penny stocks.

  • Timing

The disclosure should be made orally or in written form (including electronic) before any transaction occurs. In case the investor directly orders a transaction without prior communication, the disclosure shall be made before confirmation and/or execution of the trade. The broker or the dealer shall also keep a record of how and when the disclosures were made.

  • Compensation

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