Commissions, Fees & Unregistered Parties

🔑 Numbers & deadlines

Broker-dealer compensation

Broker-dealers primarily facilitate securities transactions for their clients. If you need to buy or sell a particular investment, you typically use a broker-dealer. Because they’re providing a service, they’re compensated for it.

🔑 Primary broker-dealer compensation types

To best understand which type of transaction relates to each form of compensation, refresh yourself on agency and principal transactions.

Markups and markdowns are payments for acting as the contra party in a principal transaction.

🔑 Definitions — Contra party

Fee reasonableness and disclosure

• Generally speaking, transaction fees must be reasonable and fair. The state administrator can punish broker-dealers that charge exorbitant fees without justification.
• That said, there can be legitimate reasons for a higher-than-normal commission, markup, or markdown. For example, a broker-dealer could justify a significant commission if a security was thinly traded and took months to locate.
• ⚠️ Broker-dealers aren’t required to disclose typical transaction costs before a trade occurs, although this information is provided on trade confirmations sent after execution.
• ⚠️ However, a larger-than-normal commission, markup, or markdown must be disclosed and accepted by a client BEFORE the trade occurs.

Dual registration

In a previous chapter, we learned that broker-dealers and agents can provide securities advice while avoiding investment adviser and/or IAR registration if they don’t collect compensation for the advice. But what if a broker-dealer is dual-registered as both a broker-dealer and an investment adviser? In that case, the firm can charge advisory fees, which would be disclosed in the brochure (because it’s acting as an investment adviser in this example).

Non-transactional service fees

Broker-dealers can also earn fees from various non-transactional services. These include:

• Account maintenance fees
• Overnight mailing services
• Minimum balance fees
• Account closure fees
• Cash management fees (ATMs, checking, wire transfers)
• Transfer and shipping fees
• Safekeeping (of securities) fees

The non-transactional services listed above are typically disclosed in the broker-dealer’s fee schedule. NASAA provides a model fee disclosure template that most broker-dealers utilize.

⚠️ Excluded from the NASAA model fee disclosure template

Virtually all fees a broker-dealer charges are included in this template, except for:

• Commissions
• Markups
• Markdowns
• Advisory fees (for dual-registered broker-dealers)

Investment adviser compensation

Investment advisers are generally compensated with advisory fees for the securities advice they provide.

Three primary advisory fee structures

Other forms of compensation in specific circumstances

• Commissions
• Wrap account fees
• Soft dollar compensation
• Performance fees

Commissions

• Commissions are normally transaction fees paid to broker-dealers, but an investment adviser may receive a portion of a commission when there’s an affiliated broker-dealer. “Affiliated” usually means the broker-dealer and the investment adviser are owned by the same parent company.
• Example: ABC Advisers Company (the investment adviser) makes a recommendation to an investor and charges an advisory fee. The client agrees to the transaction, which is then executed by ABC Brokerage Company (the affiliated broker-dealer). Both are owned by ABC Financial Services Company. When a commission is charged on the trade, the commission is shared between ABC Brokerage Co. and ABC Advisers Co.
• ⚠️ If an investment adviser is not affiliated with the broker-dealer executing their trades, they cannot earn commissions.

Wrap account fees

🔑 Securities regulators define wrap fee programs (or wrap accounts) as:

A wrap fee program generally involves an investment account where you are charged a single, bundled, or “wrap” fee for investment advice, brokerage services, administrative expenses, and other fees and expenses.

• Instead of paying separate fees for different services, clients with wrap accounts are charged one bundled fee.
• ⚠️ Technically, these programs are considered advisory products that may only be offered by investment advisers.
• 🔑 The specifics of an adviser’s wrap fee program are disclosed in Form ADV Part 2A Appendix 1, also known as the wrap fee program brochure.

Wrap fee brochure disclosures

• ⚠️ Additionally, advisers must disclose whether the wrap fee program is less or more expensive than paying for each service separately.

Soft dollar compensation

• Most investment advisers, particularly smaller firms, pay broker-dealers to maintain custody of their clients’ assets and execute trades. This can be a profitable business for brokerage firms, which creates a competitive market. Broker-dealers may offer soft dollar compensation to advisers that send their clients’ business their way.
• Example: XYZ Broker-Dealer offers additional “compensation” to ABC Investment Adviser if ABC chooses XYZ’s platform to safekeep client assets and perform transactions.
• ⚠️ Soft dollar is a tricky term. Broker-dealers aren’t giving cash (known as “hard dollars”) to investment advisers. Instead, they typically provide intellectual property or services. Many broker-dealers employ analysts who examine the securities markets and create research reports. That research can be valuable to advisers providing securities advice to clients, so a broker-dealer may offer it in return for the adviser directing trades to the broker-dealer.

🔑 Two general requirements for compliant/legal soft dollars

⚠️ Safe harbor vs. NOT safe harbor

• 📌 Generally speaking, it’s safe harbor if the intellectual property (or access to meetings/conferences) better equips the adviser to make suitable recommendations to clients.

Performance fees

• If working with a specific type of client, an adviser may be able to retain some of the portfolio’s gains. For example, assume an adviser makes a net annual return of $100,000 for a client under a 2% performance fee structure. The adviser would keep $2,000 of the gains, in addition to the advisory fees already collected.
• Performance fees can also be structured as fulcrum fees, where performance is judged against a benchmark. Stock indexes like the S&P 500 are commonly used as benchmarks. For example, if an adviser’s performance fee is based on how much a portfolio outperforms the S&P 500 and the S&P 500 had annual returns of 10%, the adviser would be paid escalating fees once a client’s portfolio exceeded a 10% return.

🔑 Qualified clients (NASAA rules)

NASAA rules allow performance fees to be collected from qualified clients, defined as any client with:

• Performance fees are sometimes described as giving the adviser “skin in the game”: the more the adviser makes for the client, the more the adviser may earn.
• ⚠️ This structure also creates an incentive to take on more risk in hopes of higher pay.

🔑 Required NASAA disclosures when charging performance fees

Clients must be made aware of these added risks. Each is a discrete required disclosure:

1. The fee structure provides an incentive to the adviser to take more risk
2. Performance fees may be based on both unrealized and realized gains
3. The time period for calculating performance
4. How the fee is calculated
5. What index is utilized for fulcrum fees
6. How security values are assigned

Unrealized gains are gains on unsold securities. For example, assume an investor purchases stock for $50. If the stock price rises to $70 but the shares are unsold, there’s a $20 unrealized gain. Once the shares are sold, the gain is realized. Investors must be aware if unrealized gains are considered when computing performance fees (they usually are).

Sidenote: Compensation to unregistered parties

• 📌 You may encounter a test question involving payment of securities-related compensation (e.g., commissions, AUM fees) to unregistered parties.
• ⚠️ In general, a person may only collect these forms of compensation if they are properly registered.

Key points

Broker-dealer compensation types

• Agency transactions → commissions; principal transactions → markups (selling to client) or markdowns (buying from client)
• Markups: sell from inventory above market value; markdowns: buy from client below market value
• Fees must be reasonable; larger-than-normal fees must be disclosed and accepted before the trade

Broker-dealer fee disclosure

• Non-transactional fees (maintenance, safekeeping, wire transfers, etc.) disclosed in the fee schedule using NASAA’s model template
• Commissions, markups, markdowns, and advisory fees are excluded from the fee schedule template
• Typical transaction costs disclosed on trade confirmations after execution (not required beforehand)

Investment adviser fee structures

• Primary structures: AUM fees, fixed fees, hourly fees
• Additional compensation types: commissions (only if affiliated broker-dealer), wrap fees, soft dollars, performance fees

Commissions for investment advisers

• Only collectible if adviser is affiliated with the executing broker-dealer (same parent company)
• Non-affiliated advisers cannot earn commissions

Wrap fee programs

• Single bundled fee covers advice, brokerage, and administrative services
• Disclosed in Form ADV Part 2A Appendix 1 (wrap fee program brochure)
• Must disclose whether wrap fee is more or less expensive than paying services separately

Soft dollar compensation

• Broker-dealers provide non-cash benefits (research, analyst access, data, software) in exchange for trade referrals
• Two requirements: adviser must believe broker-dealer fees are reasonable, and compensation must fall within safe harbor
• Safe harbor: research reports, market/economic data, analytical software, analyst/conference access
• Not safe harbor: office equipment, hardware, non-investment software, travel, meals, marketing

Performance fees

• Adviser retains a share of portfolio gains; can be structured as fulcrum fees benchmarked against an index (e.g., S&P 500)
• Only collectible from qualified clients: net worth ≥ $2.7M (excluding primary residence) or ≥ $1.4M invested with adviser
• IARs employed ≥ 1 year qualify automatically
• Required disclosures: incentive for added risk, whether unrealized gains are included, calculation method, time period, index used

Sources

Primary/official references for the material in this chapter. Every link was fetched and returned HTTP 200 on 2026-08-15.