What Is a Broker-Dealer?

Any firm or professional that buys or sells securities on behalf of either clients or their own account is a broker-dealer (also known as a brokerage). Firms with this title must follow strict regulations set forth by the Financial Industry Regulatory Authority (FINRA) and the U.S. Securities and Exchange Commission (SEC). Often, a company will be this type of entity, while also being a registered investment advisor (RIA).

In this article, we’ll outline what a broker-dealer does and how it or its representatives serve clients. We’ll also break down the rules and regulations firms must follow to maintain compliance with the proper authorities. Finally, you’ll learn who might want to employ a company with the title.

Role of a Broker-Dealer

Broker-dealers are firms that engage in trading securities for their own account or on behalf of their clients. Typically, these are brokerage firms, investment or commercial banks, and advisory firms. Either way, companies that conduct these activities must register with the SEC and FINRA.

The term, broker, refers to the facilitation of trades on behalf of clients. In other words, a firm plays the role of a middleman or intermediary for clients looking to buy and sell securities. In return, the company typically charges a commission related to the transactions it carries out.

When a firm is a dealer, this means that it trades securities for its own account. In simpler terms, a firm may buy, sell, or hold assets to make money. Any profit a firm makes from this practice is based on the buy price vs. the sell price of a given security.

Types of Broker-Dealers

There are two major types of broker-dealers clients should be aware of – wirehouses and independent brokers. The former refers to full-service broker-dealers that sell their own products or securities to customers. Examples of these include firms like:

• Morgan Stanley
• Merrill Lynch
• Wells Fargo
• UBS

On the other hand, independent brokers are those that sell outside products or securities to customers, rather than their own. Edward Jones and Raymond James are both prominent examples of this type of firm because they only sell outside products to their clients.

Regulations and Ethics

Broker-dealers must register with the SEC and FINRA, as well as adhere to strict rules and regulations set forth by the two governing bodies. More specifically, firms must follow the suitability and regulatory best interest standards. Here’s what each term means:

• Suitability standard. With this rule, a broker-dealer may only recommend investments that are “suitable” for a client based on their investment profile. This generally refers to a client’s time horizon, risk tolerance, goals, and liquidity needs.
• Regulatory best interest. This means that a broker-dealer must act in a client’s best interest, rather than favoring the goals of the firm. For instance, if a security will net the company a large commission, they can’t recommend it if another is better for a given client.

Additionally, broker-dealers must report any legal events they’re involved in as a disclosure to both the SEC and FINRA. These are publicly available for anyone to view. If you’d like to inspect a firm’s (or a professional’s) legal history, you can use FINRA’s BrokerCheck or the SEC’s Investment Adviser Public Disclosure (IAPD) website to access this information.

Who They Serve

According to Shane Rodgers, CEO of PDX Global, “100% of all retail, corporate, and institutional investors and traders” should consider hiring a broker-dealer to help with their investments. In general, these types of firms serve two major types of clients:

• Individual investors. This refers to any person, no matter the net worth, who trades securities such as stocks, bonds, and mutual funds to build their portfolio. For these types of clients, broker-dealers are typically able to help execute trades, provide investment advice, and the ability to buy and sell securities that are exclusive to the firm.
• Institutional investors. These are large entities with vast resources that seek to invest to generate money for their stakeholders. Common examples include banks, insurance companies, pension plans, hedge funds, and government organizations.

How Broker-Dealers Get Paid

For the most part, brokers earn money via brokerage fees. In other words, when you make a trade through one of these firms, it’ll usually earn a commission based on a percentage of the transaction. Other firms may simply charge a flat rate for each transaction, which will make up the brokerage fee.

As mentioned, a firm is a dealer when it makes trades involving its own account. In this case, it makes money via profiting off of securities it buys, sells, or holds. Typically, a dealer makes money off of the spread, which is the difference between the purchase and sale price.

Broker-Dealer vs. Investment Advisor

Broker-dealers and investment advisors each operate in a similar capacity, which can be confusing for clients. However, there are significant differences between the two, including how each is regulated and the services they offer. Rodgers explains that these firms are primarily responsible for executing “buy and sell hedging orders in the marketplace,” but they don’t “necessarily offer investment advice.”

Investment advisors specialize in providing “advice about securities to their clients,” describes Rodgers. In this way, investment advisory firms and their representatives aren’t “licensed directly to execute trades in the marketplace.” Additionally, these firms must register with the SEC as registered investment advisors (RIAs) and adhere to a fiduciary duty.

Keep in mind that a firm can both be a broker-dealer and an RIA. This means it offers both brokerage and investment advisory and management services under one roof. If a company does so, it and its representatives must adhere to the standards and regulations corresponding with the activities they’re performing. For example, if a firm is acting as a broker, it must follow the suitability standard. On the other hand, if it’s offering you investment advice, it needs to be in a fiduciary capacity.

Frequently Asked Questions

Are broker-dealers fiduciaries?

Broker-dealers typically aren’t fiduciaries because they collect a commission, which could create a conflict of interest. However, they must follow the less strict suitability standard and the regulatory best interest rule, which is similar to the fiduciary duty.

Is Fidelity a broker-dealer?

Fidelity is a registered broker with the SEC and FINRA as Fidelity Brokerage Services LLC. Additionally, the firm sells its own securities to investors, such as its FXAIX index fund.

What does a broker-dealer do?

A broker-dealer specializes in assisting clients with executing buy and sell trades in exchange for a commission. It also may make trades involving its own account to earn a profit.

What’s the difference between a broker-dealer and an advisor?

Advisors primarily offer investment or financial advice in return for compensation. Typically, they must adhere to a fiduciary duty when assisting clients. Broker-dealers are firms that have a license to help clients with buying and selling securities. While they’re required to register with the SEC and FINRA, they follow the less-stringent suitability standard and regulatory best interest rule.