What Is a Broker-Dealer?
Definition & Examples of a Broker-Dealer
A broker-dealer is an individual or a firm that's in the business of buying and selling securities. The firm might be a general partnership, limited partnership, limited liability company, or corporation.
Learn about types of broker-dealers, as well as how they are regulated and licensed.
What Is a Broker-Dealer?
A broker-dealer conducts the business of buying and selling securities by filling one of two roles in a transaction, as either an agent or a dealer.
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.
The requirement to register arose from Section 15 of the Securities Exchange Act of 1934 following reforms that emerged in the aftermath of the 1929-1933 collapse of both the economy and capital markets.
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 Company
- TD Ameritrade
- Fidelity Investments
- Interactive Brokers
Companies like Charles Schwab also own banks and other subsidiaries to enable them to provide all-encompassing service to do-it-yourself investors.
- Alternate name: Broker dealer
- 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.
The broker-dealer/buyer or seller relationship works much the same as a real estate broker/agent might help a client buy or sell a home.
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 must disclose in writing that they're acting as a dealer in this situation. They must explain all charges and compensation.
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.
|Regulated under the Securities Exchange Act of 1934||Established by Investment Advisers Act of 1940|
|Suitability standard||Fiduciary standard|
|Can act as dealer or agent||Advise customers on managing portfolio of assets|
|Paid by commission or by making a profit on selling securities to clients||Paid by fees as a percentage of assets under management|
For many years, broker-dealers were bound by a lesser standard of conduct toward their customers. They needed to justify recommendations based only upon suitability for a client's needs and goals. This allowed broker-dealers to make recommendations that were in their financial interests but still suitable for clients.
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 interest
- Have impeccable standards of conduct
- Give investment advice that is the best possible advice for the client, rather than just "suitable"
An RIA's fees are often charged as a percentage of assets under management for something like an individually managed account. They're paid to the firm directly by the client.
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.
A dually-registered broker-dealer is an individual or firm that's registered both as a broker-dealer and as an RIA. Firms that fall into this category of being dually registered are sometimes referred to as “hybrid” advisors.
Do I Need a Broker-Dealer?
Before deciding to work with a broker-dealer, consider:
- Communication: Does the broker-dealer representative listen to you? Do they understand your circumstances, needs, preferences, and values?
- Benefit: Are the disclosure documents clear? Do you understand what you'll be getting and what you'll be paying for it?
- Expertise: Does the broker-dealer have the proper regulatory and other credentials? What do you know about their investment expertise and outcomes?
- Integrity: Does the broker-dealer or the broker-dealer representative have a criminal history, a history of allegations of misconduct, or other material facts about which you should be aware? You can use the FINRA BrokerCheck system to investigate complaints filed against anyone you're considering entrusting with your money.
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
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.
FINRA, or the Financial Industry Regulatory Authority, oversees broker-dealers in the U.S., protecting investors and ensuring safe and fair practices. It's a not-for-profit authorized by the U.S. government.
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. As the name suggests, these organizations police and set rules within their industry.
- 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.
- A broker-dealer is an individual or a firm that's in the business of buying and selling securities. They can act as either agents or dealers.
- 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.
- To become a broker-dealer, you must be licensed and pass several qualifying exams.
- Broker-dealer firms must register with a variety of regulatory bodies and in order to operate legally, including FINRA and state regulatory bodies.
U.S. Securities and Exchange Commission. "Uniform Application for Broker-Dealer Registration," Page 2. Accessed July 3, 2020.
FINRA. "Investment Advisors." Accessed July 3, 2020.
North Dakota Securities Department. "Broker-Dealers and Agents." Accessed July 3, 2020.
U.S. Securities and Exchange Commission. "Investor Publications: Guide to Broker-Dealer Registration." Accessed July 3, 2020.
Guide to Broker-Dealer Registration
Federal Register. "Regulation Best Interest: The Broker-Dealer Standard of Conduct." Accessed July 3, 2020.
FINRA. "Qualification Exams." Accessed July 3, 2020.
FINRA. "About FINRA." Accessed July 3, 2020.
FINRA. "Register a New Broker-Dealer Firm." Accessed July 3, 2020.
SIPC. "Mission." Accessed July 3, 2020.
Investment Advisor Registration Depository. "Welcome to the Investment Advisor Registration Depository." Accessed July 3, 2020.