What Is a Broker-Dealer?
Let me explain what a broker-dealer is. A broker-dealer, or B-D, is a person or firm in the business of buying and selling securities for its own account or on behalf of its customers. In U.S. securities regulation, this term describes stock brokerages because most act as both agents and principals.
When a brokerage acts as a broker or agent, it executes orders for its clients. When it acts as a dealer or principal, it trades for its own account.
Key Takeaways
You should know that a broker-dealer is a financial entity engaged in trading securities on behalf of clients, but it may also trade for itself. It acts as a broker or agent when executing client orders, and as a dealer or principal when trading for its own account.
There are thousands of broker-dealers, falling into two broad categories: wirehouses, which sell their own products, or independent broker-dealers, which sell products from outside sources.
Understanding a Broker-Dealer
Broker-dealers play several important roles in the financial industry. They provide investment advice to customers, supply liquidity through market-making activities, facilitate trading, publish investment research, and raise capital for companies. These firms range from small independent boutiques to large subsidiaries of giant commercial and investment banks.
As I mentioned, there are two types: wirehouses that sell their own products to customers, and independent broker-dealers that sell products from outside sources. According to a 2023 FINRA report, there are over 3,298 broker-dealers to choose from. Some of the largest include Fidelity Investments, Charles Schwab, and Edward Jones.
How a Broker-Dealer Works
By definition, broker-dealers are buyers and sellers of securities, and they also distribute other investment products. They perform a dual role: as dealers, they act on behalf of the brokerage firm, initiating transactions for the firm’s own account. As brokers, they handle transactions, buying and selling securities for their clients.
In these dual roles, they facilitate the free flow of securities on the open market and buy or sell securities in their own accounts to ensure a market exists for their clients. Broker-dealers are essential in this way, and they earn fees on either or both sides of a securities transaction.
Special Considerations
Broker-dealers tied to investment banking also engage in underwriting securities offerings. When acting as an agent for the issuing company—either as principal underwriter or part of the underwriting syndicate—they enter a contractual arrangement on a firm commitment basis. This obligates them to distribute a certain amount of the securities to the public in exchange for an underwriting fee.
They may acquire some of the securities for their own accounts and could be required to if they can't sell all of them. Once underwriting is complete and securities are issued, broker-dealers become distributors, targeting their clients through financial advisors who act as brokers to recommend purchases. In this process, they serve the issuer's interests, their own (via distribution fees), and their clients', though their only contractual obligation is to the issuer.
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