What Is a Broker-Dealer? Two Types, What They Do, and Regulation (2024)

For many investors, the financial services industry is a strange and mysterious place filled with a language all on its own. Terms like "alpha," "beta," and "Sharpe ratio" don’t exactly roll off the tongue, nor does their use by industry insiders serve to lift the veil and make things less opaque.

Of course, the language fits the medium, as the financial services arena is a complex world. To participate in that world, investors generally engage the services of a broker or dealer in some form or fashion, making a review of those terms an interesting place to begin exploring. Let's dive into the difference between brokers and dealers.

Key Takeaways

  • A broker executes orders on behalf of clients and can be either a full-service broker or a discount broker that only executes trades.
  • Meanwhile, a dealer facilitates trades on behalf of itself. Some dealers, also called primary dealers, also facilitate trades on behalf of the U.S. Federal Reserve to help implement monetary policy.
  • Broker-dealers are those that perform both responsibilities, such as traditional Wall Street organizations, as well as large commercial banks among others.

Brokers

"Broker"and "dealer" are U.S. regulatory terms and, as is often the case with legal terms, they are not very intuitive to many people. While the words are often seen together, they actually represent two different entities. A broker executes orders on behalf of clients. To the regulators, this means the entity through which investors hold a brokerage account.

To investors, it generally means the person who helps them buy and sell securities. A bit of confusion occurs here, as the industry also has lots of terms for a person who helps investors buy and sell securities, including "financial advisor,""investment advisor," and "registered representative." For the moment, we’ll stick with the strict legal definitions to provide a baseline for further exploration.

Think of the legal entity that facilitates security trading as an agentacting on behalf of investors. When you want to buy or sell a security, the entity (in the case of online brokerage accounts for example) that helps you make that transaction is your agent. When you pay a commission to make a trade, you are making that payment to an agent. The terms "agent" and "broker" can be used interchangeably.

Full-Service vs. Discount Brokers

Brokers come in two general types: full service and discount. Full-service brokers provide one-on-one personal service. This includes providing specific investment recommendations in addition to planning and advice services that range fromretirement planning, long-term care planning, and estate planning to the formulation of a personal investment strategy that will help cover the cost of a child’s education, a home purchase, or other financial goals.

Ongoing assistance can include face-to-face meetings and periodic checkups to revisit progress toward goals. For novice investors or those too busy to plan for themselves, full-service brokers offer an array of useful services and information.

Discount brokers, on the other hand, provide trade execution. Online brokers are perhaps the best example of this arrangement, as investors can log on, select a security, and purchase it without ever speaking to another person. Discount brokers offer an inexpensive way to purchase securities for investors who know exactly what they want to buy.

Some of these firms also offer online tools and research designed to help do-it-yourself investors generate ideas and research securitiesthey may be interested in purchasing. The limited service offering provided by discount brokers is significantly less expensive thanthe cost of working with a full-service broker. Still, it's wise to clarify any misconceptions about discount brokers before hiring one.

Dealers

While a broker facilitates security trades on behalf of investors, a dealer facilitates trades on behalf of itself. The terms “principal” and “dealer” can be used interchangeably. So, when you hear about big financial firms trading in their house accounts, they are acting as dealers.

Some of these dealers, known as primary dealers,also work closely with the U.S. Federal Reserve to help implement monetary policy. Primary dealers are obligated to participate in the auction of debt issued by the U.S. government. By bidding on Treasury bonds and other securities, these dealers facilitate trading by creating and maintaining liquid markets. They assist in the smooth functioning of domestic securities markets as well as transactions with foreign buyers.

Dealers' activates help to ensure the correct and smooth functioning of securities markets. They are regulated by the Financial Industry Regulatory Authority (FINRA), which is responsible for administering exams for investment professionals. Some of the better-known exams include Series 7, Series 6, and Series 63. The Series 7 permits financial services professionals to sell securities products, with the exception of commodities and futures.

In 2022, FINRA imposed fines of $54.5 million on brokerage firms.

The primary focus of the Series 7 exam is on investment risk, tax implications, equity and fixed-income securities, mutual funds, options, retirement plans, and working with investors to oversee their assets.

The Series 6 designation enables investment professionals to sell mutual funds, variable annuities, and variable life insurance. And the Series 63 enables them to sell any type of securities in a specific state. Obtaining these licenses is the first step financial services professionals need to taketo get into the securities business.

Putting It All Together

Most firms' investors would act as both brokers and dealers and are therefore referred to as broker-dealersby industry regulators. These firms include the primary dealers and other traditional Wall Street organizations, as well as large commercial banks, investment banks, and even small independent boutique firms that cater to the wealthy.

Broker-dealers play an important role in the financial markets, as these firms provide the infrastructure that facilitates stock trading. In fact, if you want to buy stock, you must open a brokerage account through a brokerage firm.

The brokerage firm makes sure you have enough money in your account to conduct a trade, facilitates the trade by interacting with the stock exchange where the stock is traded, provides the computer systems that enact the trade, and keeps records of the trade. It also handles the financial transaction between the buyer and the seller and facilitates future transactions (dividends, stock splits, corporate actions such as those that occur when preferred securities are called or stock splits take place).

What Are Examples of Brokers-Dealers?

Some of the most well-known broker-dealers are Charles-Schwab, E-Trade, and Fidelity. Some of these, like Charles-Schwab, are full-scale financial services firms, while E-Trade is primarily an online brokerage firm. Other examples of broker-dealers include LPL Financial, Northwestern Mutual Investment Services, and Lincoln Financial Network.

What Is the Difference Between a Broker and a Dealer?

A broker is an individual or financial services company that enables the trading of securities for other individuals. A dealer is an individual or financial services company that enables the trading of securities for themselves.

How Does a Broker-Dealer Get Paid?

Broker primarily get paid via brokerage fees. Brokerage fees are charged for executing a trade. A broker will charge either a flat fee per transaction or will charge a fee based on a percentage of sales. Dealers, on the other hand, are executing trades for themselves and making money on the bid-ask spread. This involves buying a security and then selling it at a higher price.

The Bottom Line

With the depth and complexity of industry offerings and the ever-changing nature of the industry itself, knowledge is power. While there are pros and cons of partnering with a broker-dealer, the greater your grasp of the industry’s vocabulary, the better your starting point for understanding how the industry functions.

This includes developing a better sense of how your investments work, the services you get in exchange for the fees that you pay, who or what provides those services, and what you can expect should a dispute end up in court.

What Is a Broker-Dealer? Two Types, What They Do, and Regulation (2024)

FAQs

What Is a Broker-Dealer? Two Types, What They Do, and Regulation? ›

As the name implies, they perform a dual role in carrying out their responsibilities. 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 on behalf of their clients.

What are the different types of broker-dealers? ›

The two main types of broker-dealers are wirehouses and independent broker-dealers. Broker-dealers facilitate client transactions by sourcing and acquiring stocks and charging brokerage fees and commissions for trades, negotiations, and consultations.

How are broker-dealers regulated? ›

Securities Exchange Commission (SEC)

The SEC enforces federal securities laws, regulates key market participants, such as exchanges and broker-dealers, and ensures compliance with disclosure requirements.

What is the role of a broker-dealer? ›

A broker-dealer buys securities, such as bonds and stocks. They then sell the securities to another investor at a price higher than the buying price. The difference between the two prices is known as the dealer's spread, and it represents the profit that the broker-dealer makes on the transactions.

What are the different types of dealers? ›

Types of dealers are: Bull, Bear, Jobber, Pig, etc. Types of Brokers are: Traditional Brokers and Discount Brokers.

What is broker regulation? ›

Broker Regulation

In serving their clients, brokers are held to a standard of conduct based on the “suitability rule,” which requires there be reasonable grounds for recommending a specific product or investment.

What are the two most common types of brokers? ›

Brokers come in two general types: full service and discount.

How many broker-dealers are there? ›

The number of brokerage firms that Finra oversees fell for the fourth-straight year in 2022 to a total of 3,378.

What is the difference between a broker-dealer and a dealer? ›

A broker is any person engaged in the business of buying or selling securities for the account of others. A dealer is any person engaged in the business of buying or selling securities, but for their own account.

Who governs broker-dealers? ›

FINRA Regulates Broker-Dealers, Capital Acquisition Brokers and Funding Portals. A Broker-Dealer is in the business of buying or selling securities on behalf of its customers or its own account or both.

What is a broker-dealer vs. Ria? ›

Independent broker-dealers function as full-service brokerage firms but remain free from the constraints and demands of a large Wall Street company. RIAs are independent fiduciaries who may associate with several broker-dealers, selling a range of products and services.

Who are the authorized dealers? ›

An authorized retailer is a retailer who has official permission from a brand or manufacturer to sell its products or services. They're also known as authorized dealers, authorized sellers, and authorized distributors.

What are the functions of a dealer? ›

A dealer acts as a principal in trading for its own account, as opposed to a broker who acts as an agent who executes orders on behalf of its clients. Dealers are important figures in the market. They make markets in securities, underwrite securities, and provide investment services to investors.

How do dealers make money? ›

Dealerships typically buy cars from manufacturers at a wholesale price and then sell them to customers at the manufacturer's suggested retail price. The new car sales are the difference between the wholesale price and the retail price is the dealer's profit.

Which act regulates broker-dealers? ›

The Securities Exchange Act of 1934 ("Exchange Act" or "Act") governs the way in which the nation's securities markets and its brokers and dealers operate.

What is the role of a broker? ›

A broker is a person that facilitates transactions between traders, sellers, or buyers. Think of a broker as a middleman who ensures transactions can run smoothly and that each party has the necessary information. Brokers exist in many industries, including insurance, real estate, finance, and trade.

How do I know if a broker is regulated? ›

Verify that your broker is regulated by a recognised financial authority locally or globally. This regulation ensures that the broker operates within established guidelines and safeguards your investments. Check their registration number and cross-reference it with the regulator's website for confirmation.

What are the different types of market brokers? ›

There are four main types of broker – a stock broker, forex broker, full-service broker and discount broker. While they all act as a facilitator between you and another party, they operate differently from each other.

Who are the largest broker-dealers? ›

What Are the Big 4 Brokerage Firms? The biggest firms in the U.S. are Charles Schwab, Fidelity, Vanguard, and JPMorgan. These companies provide brokerage services to millions of clients.

How do I choose a broker-dealer? ›

How to Select a Stockbroker
  1. Review your personal finances.
  2. Determine your financial goals.
  3. Know the risks you are willing to take.
  4. Determine the type of broker-dealer that best suits your needs.
  5. Interview a number of broker-dealers and agents.
  6. Meet each agent in his office and ask the following questions:

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