As an agent, a broker-dealer helps a customer buy or sell securities. As a dealer, a broker-dealer is one of the parties doing the buying or selling. In either role, broker-dealers are subject to extensive regulation. They are sometimes referred to as “registered broker-dealers” because they must register with the appropriate federal and state authorities. Broker-dealers cannot charge both commissions and a markup on the same transaction. They can act either in their capacity, as a broker/agency or as a dealer/principal, but they can’t simultaneously act as both. Broker-dealers can be any size business, from independent agents to large corporations. Large broker-dealers are often part of a financial conglomerate. These include the broker-dealer divisions of financial powerhouses such as:
Charles Schwab and CompanyTD AmeritradeFidelity InvestmentsScottradeInteractive Brokers
Acronym: BD
How Does a Broker-Dealer Work?
What a broker-dealer does depends on whether they are acting as a dealer or an agent in a given transaction.
A Broker-Dealer As Agent
The broker-dealer helps a customer buy or sell a security or securities when acting in an agency capacity. They undertake the actions necessary to facilitate the trade. The broker-dealer doesn’t have any of their own money at risk. They’re simply attempting to match a buyer and seller with other broker-dealers or through some other means. The broker-dealer is paid a commission in exchange for this service.
A Broker-Dealer As Dealer
The broker-dealer acts as a dealer when they’re one of the principals involved in a transaction. The broker-dealer is on the other side of a transaction and is buying or selling a security from a customer. A broker-dealer might have an inventory of municipal bonds acquired from customers who wanted to sell at some point in the past. The broker-dealer will mark up the bond and earn a spread between what they paid for it and what they charge the customer who ultimately purchases it.
Broker-Dealers vs. Investment Advisors
The other major classification of registration for an individual or a firm operating in the securities industry is the registered investment advisor (RIA). Broker-dealers and registered investment advisors can appear to do the same job, though there are some differences. Registered investment advisors, by contrast, have always been bound by the fiduciary standard. RIAs and the advice they offer are regulated by the U.S. Securities and Exchange Commission. Someone acting as a fiduciary must act in the best interests of the person they’re representing or serving. Under this standard, registered investment advisors must:
Disclose conflicts of interestHave impeccable standards of conductGive investment advice that is the best possible advice for the client, rather than just “suitable”
However, new rules passed by the Securities and Exchange Commission in 2019 attempt to change this. The rules established that, whether customers are working with a broker-dealer or investment advisor, they are entitled to advice or recommendations that are in the best interest of the customer, rather than the best interest of the firm or financial professional.
Do I Need a Broker-Dealer?
Before deciding to work with a broker-dealer, consider: Many private investors handle their own accounts. For some, however, the fees that come from working with a broker-dealer are worth the benefit of that agent’s expertise and attention.
How to Become a Broker-Dealer
Broker-dealers can either work as independent businesses or as part of large financial firms. To become a broker-dealer, you will need to follow several steps.
Licensing and Testing
To become a registered broker-dealer representative, you must pass one or more regulatory exams such as FINRA’s Securities Industry Essentials (SIE) exam and the Series 7 exam. Each exam lasts for several hours, covering a wide range of questions about securities trading, regulation, and other related topics. These exams are intended to ensure that broker-dealers have a minimum level of understanding and expertise before they begin practicing and working with clients.
Set Up a Firm
You must set up the firm itself if you don’t want to operate as a sole proprietorship, which would leave you with unlimited liability. This involves a series of steps:
Organize the business as a limited liability company. Get all necessary business licenses from your state and locality. Open bank accounts and fund those accounts with your initial capital. Write and sign an operating agreement. Set up your accounting system. Have an anti-money laundering system in place. Have agreements with clearing agents. File a New Member Application and other necessary forms with FINRA.
Be sure you meet the statutory capital requirements of a broker-dealer. They can vary depending upon the precise nature of your firm.
Submit to the Regulatory Bodies
Broker-dealer firms must register with a variety of regulatory bodies and in order to operate legally.
Submit Form BD, the Uniform Application for Broker-Dealer Registration to the Securities and Exchange Commission (SEC), self-regulatory organizations (SROs), and FINRA’s Central Registration Depository (CRD). Become a member of an SRO. Become a member of the Securities Investor Protection Corporation (SIPC). This non-profit membership corporation provides insurance for customers who hold their brokerage account with your business if you become bankrupt or run into other financial difficulties. Register your firm with FINRA’s Investment Advisor Registration Depository (IARD), an electronic system that facilitates registration, filing, review, and disclosure for firms.
States also have specific registration requirements, fees, and licensing that you will need to set up before your firm can operate.
