In financial services, a broker-dealer is a natural person, a company or other organization that engages in the business of trading securities for its own account or on behalf of its customers. Broker-dealers are at the heart of the securities and derivatives trading process.
Although many broker-dealers are "independent" firms solely involved in broker-dealer services, many others are business units or subsidiaries of commercial banks, investment banks or investment companies.
When executing trade orders on behalf of a customer, the institution is said to be acting as a broker. When executing trades for its own account, the institution is said to be acting as a dealer. Securities bought from clients or other firms in the capacity of dealer may be sold to clients or other firms acting again in the capacity of dealer, or they may become a part of the firm's holdings.
In addition to execution of securities transactions, broker-dealers are also the main sellers and distributors of mutual fund shares.
Main points of activity
- Professional participant in securities market who carries out dealer activity shall be called dealer.
- Announcing the price, the dealer is committed to announce other essential conditions of the buy-sell contract of securities: minimum and maximum number of securities subject to purchase and/or sale, as well as the term of announced prices validity.
- All the functions of broker including financial consulting
- Organization and support of turnover (liquidity), or so-called market-making (price announcing, duty of sell and buy of security at announced price, announcing of min and max number of securities that can be bought/sold at announced price, implementing time periods when announced prices are available)
In the United States, broker-dealers are regulated under the Securities Exchange Act of 1934 by the Securities and Exchange Commission (SEC), a unit of the U.S. government. All brokers and dealers that are registered with the SEC (pursuant to 15 U.S.C. § 78o), with a number of exceptions, are required to be members of the Securities Investor Protection Corporation (SIPC) (pursuant to 15 U.S.C. § 78ccc) and are subject to its regulations. Some regulatory authority is further delegated to the Financial Industry Regulatory Authority (FINRA), a self-regulatory organization. Many states also regulate broker-dealers under separate state securities laws (called "blue sky laws").
The 1934 Act defines "broker" as "any person engaged in the business of effecting transactions in securities for the account of others," and defines "dealer" as "any person engaged in the business of buying and selling securities for his own account, through a broker or otherwise." Under either definition, the person must be performing these functions as a business; if conducting similar transactions on a private basis, they are considered a trader and subject to different requirements. When acting on behalf of customers, broker-dealers have a duty to obtain "best execution" of transactions, which generally means achieving the best economic price under the circumstances.
On April 28, 2004, the SEC voted unanimously to change the net capital rule which applies to broker-dealers, thus allowing those with "tentative net capital" of more than $5 billion to increase their leverage ratios. Many commentators have cited this rule change as an important factor in the financial crisis that began in 2007. The rule change remains in effect, though subject to modifications.
Although broker-dealers often provide investment advice to their clients, in many situations they are exempt from registration under the U.S. Investment Advisers Act of 1940, so long as (i) the investment advice is "solely incidental" to brokerage activities; and (ii) the broker-dealer receives no "special compensation" for providing the investment advice. Both elements of this exemption must be met to rely on it.
Many broker-dealers also serve primarily as distribors for mutual fund shares. These broker-dealers may be compensated in numerous ways and, like all broker-dealers, are subject to compliance with requirements of the Securities and Exchange Commission and one or more self-regulatory organizations, such as the Financial Industry Regulatory Authority (FINRA). The forms of compensation may be sales loads from investors, or Rule 12b-1 fees or servicing fees paid by the mutual funds.
UK securities law uses the term intermediary to refer to businesses involved in the purchase and sale of securities for the account of others.
The common Japanese term for a broker-dealer is "securities company" (証券会社 shōken-gaisha?). Securities companies are regulated by the Financial Services Agency under the Financial Instruments and Exchange Law. The "big three" are Nomura Holdings, Daiwa Securities Group and Nikko Cordial (a subsidiary of Sumitomo Mitsui Financial Group). Most major commercial banks in Japan also maintain broker-dealer subsidiaries, as do many foreign commercial banks and investment banks.
- Lemke and Lins, Soft Dollars and Other Trading Activities (Thomson West, 2013-2014 ed.).
- Lemke and Lins, Mutual Fund Sales Practices (Thomson West, 2013).
- NASAA Broker-Dealer Resources
- Guide to Broker-Dealer Registration, Division of Trading and Markets, U.S. Securities and Exchange Commission, April 2008.
- Lemke and Lins, Soft Dollars and Other Trading Activities, §9:3 (Thomson West, 2013-2014 ed.).
- General Accounting Office, Major Rule Report: Alternative Net Capital Requirements for Broker-Dealers That Are Part of Consolidated Supervised Entities (B-294184), June 25, 2004. (“GAO Major Rule Report”)
- Lemke and Lins, Regulation of Investment Advisers, §§1:19 - 1:21 (Thomson West, 2013).
- Lemke and Lins, Mutual Fund Sales Practices (Thomson West, 2013 ed.).
- Lemke, Lins and Smith, Regulation of Investment Companies, §7.05 (Matthew Bender, 2013 ed.).
- Financial Services and Markets Act 2000, schedule 2