What Is a Broker-Dealer Firm?
The broker-dealer (b-d) serves one of the more critical roles in all of finance and is regulated by the Securities and Exchange Commission (SEC) to preserve confidence. The broker-dealer carries a fiduciary responsibility to serve as the financial intermediary between corporations seeking to raise capital and the buyers and sellers of stock. Identifying the function of the broker-dealer firm as it pertains to investments requires that investors first understand the separate responsibilities of brokers and dealers.
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Broker Definition
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The broker is best described as a "middle man" or "order taker." Brokers match buyers to sellers and earn commissions for their services. The broker does not own the asset at any time. Stockbrokers will fill orders to buy or sell investments for clients and will sometimes offer advisory services.
Dealer Definition
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Dealers will purchase assets for their own account and carry inventory that is to be sold at a later date. Automobile dealerships operate in this same manner. In terms of dealing stock, financial intermediaries may purchase shares of companies at an initial public offering (IPO) and proceed to sell those shares to clients well into the future. All banking institutions feature trading desks that allow the firm to buy assets for itself and sell the investments back into the market for a profit.
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Financial Intermediary
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The financial marketplace is best described as an exchange that integrates corporate and municipal entities looking to raise capital alongside individuals seeking to lend or invest excess capital for a suitable return on investment. Entities raise capital by selling shares and debt within the primary market, which is often referred to as the initial public offering, or IPO. Stocks and bonds are then traded between investors at the secondary market, beginning on the trading floor of organized exchanges, such as the New York Stock Exchange.
Financial intermediaries and broker-dealer firms perform the virtual legwork to match these disparate groups at the market. Buyers and sellers do not have the time or the interest to solicit each other individually to transact business.
Broker-dealers are often independent units that are attached to insurance, investment advising and banking affiliates. Broker-dealers carry a fiduciary responsibility to disclose any conflicts of interest between their unit and the attached affiliate.
Fiduciary Responsibilty
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Broker-dealers handle cash and investments on behalf of clients and therefore carry a fiduciary responsibility to those individuals. Fiduciary responsibility requires that broker-dealer firms operate in good faith and for the benefit of the client. Financial institutions are to subordinate their own best interests beneath the well-being of all customers. This legal relationship is based upon trust and is "the highest standard of care at either equity or law."
Broker-dealers are required to only provide "suitable investments" and are forbidden from churning accounts, which refers to excessive trading activity that is set up for the sake of earning high commissions.
Regulation
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The SEC and the Securities Exchange Act of 1934 regulate broker-dealers within the United States. The Securities Exchange Act of 1934 oversees the secondary market, which again relates to the buying and selling of stock between individual investors, beyond the original initial public offerings.
Broker-dealer firms must register themselves and pass examinations with the Financial Industry Regulatory Authority (FINRA), which is a self-regulatory organization. FINRA and the SEC share information to regulate all broker-dealers.
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References
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