What Is a Broker-Dealer B-D and How Does It Work
Contents
What Is a Broker-Dealer (B-D), and How Does It Work?
What Is a Broker-Dealer?
A broker-dealer is a person or firm that buys and sells securities for its own account or on behalf of customers. The term broker-dealer is used to describe stock brokerages because they act as both agents and principals.
A brokerage acts as a broker when it executes orders for clients, and as a dealer when it trades for its own account.
Key Takeaways
- A broker-dealer is a financial entity that trades securities for clients, and may also trade for itself.
- A broker-dealer acts as a broker when it executes orders for clients, and as a dealer when it trades for its own account.
- There are two broad categories of broker-dealers: wirehouse, which sells its own products, and independent broker-dealer, which sells products from outside sources.
Understanding a Broker-Dealer
Broker-dealers have several important functions in the financial industry. These include providing investment advice, supplying liquidity through market-making, facilitating trading, publishing investment research, and raising capital. Broker-dealers range in size from small independent boutiques to large subsidiaries of commercial and investment banks.
There are two types of broker-dealers:
- Wirehouse, which sells its own products.
- Independent broker-dealer, which sells products from outside sources.
According to a 2022 report from the Financial Industry Regulatory Authority (FINRA), there are over 3,378 broker-dealers to choose from. Some of the largest broker-dealers include Fidelity Investments, Charles Schwab, and Edward Jones.
How a Broker-Dealer Works
Broker-dealers are buyers and sellers of securities and distributors of other investment products. 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 for clients.
They facilitate the free flow of securities on the open market and buy or sell securities in their own accounts to ensure a market for their clients. Broker-dealers earn fees on securities transactions.
Special Considerations
Broker-dealers tied to investment banking operations also underwrite securities offerings. When a broker-dealer acts as an agent of the issuing company, they enter into a contractual arrangement and distribute a certain amount of the securities offered to the public in exchange for an underwriting fee.
They may also acquire a piece of the securities offering for their own accounts if they are unable to sell all of the securities.
After the underwriting process is completed and the securities are issued, broker-dealers become distributors, with their clients as the target of their distribution efforts. The financial advisors of the firms act as brokers to solicit clients and recommend the purchase of the security for their accounts. Broker-dealers facilitate the interests of the issuer, themselves (in the collection of a distribution fee), and their clients, although their only contractual obligation is to the issuer.
