A broker-dealer (B-D) is a person or firm in the business of buying and selling securities for its account or on behalf of its customers. The term broker-dealer is used in U.S. securities regulation parlance to describe stock brokerages because most of them act as both agents and principals.
A brokerage acts as a broker (or agent) when it executes orders on behalf of its clients, whereas it acts as a dealer, or principal when it trades for its account.
Understanding a Broker-Dealer
Broker-dealers fulfill several important functions in the financial industry. These include providing investment advice to customers, supplying liquidity through market-making activities, facilitating trading activities, publishing investment research, and raising capital for companies. Broker-dealers range in size from small independent boutiques to large subsidiaries of giant commercial and investment banks.
There are two types of broker-dealers:
- A wirehouse, or a firm that sells its products to customers; and
- An independent broker-dealer, or a firm that sells products from outside sources.
There are over 3,975 broker-dealers to choose from, according to the Financial Industry Regulatory Authority (FINRA). Some of the largest broker-dealers 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 are also distributors of other investment products. 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 account. As brokers, they handle transactions, buying and selling securities on behalf of their clients.
In their dual roles, they perform a couple of vital functions; they facilitate the free flow of securities on the open market, and they buy or sell securities in their accounts to ensure there is a market in those securities for their clients. In this regard, broker-dealers are essential, and they are also well-compensated, earning a fee on either or both sides of a securities transaction.
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