15.1 Broker-Dealer Definition
Key Takeaways
A broker acts as an agent and earns commissions; a dealer acts as a principal and earns markups or markdowns.
Broker-dealers must register with the SEC, join FINRA, and register with states.
Form BD is filed through the CRD system.
Net capital requirements vary based on business activities.
Banks are generally excluded but must push out certain securities activities.
Broker-Dealer Definition & Registration
Understanding the distinction between brokers, dealers, and broker-dealers is fundamental to securities regulation. This knowledge helps differentiate the roles and standards that apply to broker-dealers versus investment advisers.
Definitions
Broker
A broker is any person engaged in the business of effecting transactions in securities for the account of others:
| Characteristic | Details |
|---|---|
| Role | Agent—acts on behalf of customers |
| Compensation | Earns commissions |
| Function | Executes customer orders |
| Risk | Does not take principal risk |
| Inventory | Does not hold securities inventory |
Dealer
A dealer is any person engaged in the business of buying and selling securities for their own account:
| Characteristic | Details |
|---|---|
| Role | Principal—trades for own account |
| Compensation | Earns markup (selling) or markdown (buying) |
| Function | Trades from inventory |
| Risk | Takes principal risk |
| Market Making | May provide liquidity as market maker |
Broker-Dealer
Most firms are registered as both broker and dealer:
| Capability | Requirement |
|---|---|
| Dual Capacity | Can act as agent OR principal |
| Disclosure | Must disclose capacity in each transaction |
| Flexibility | Can execute for customers or trade for own account |
| Registration | Single registration covers both functions |
On the Exam: When a firm acts as a broker (agent), it earns commissions. When acting as dealer (principal), it earns markups/markdowns. The customer must be told in which capacity the firm is acting.
Federal Registration
SEC Registration
All broker-dealers must register with the SEC under the Securities Exchange Act of 1934:
| Requirement | Details |
|---|---|
| Form BD | Uniform Application for Broker-Dealer Registration |
| Filing System | Central Registration Depository (CRD) |
| Notification | Electronic filing, then signed/notarized copy to FINRA |
| Updates | Must amend promptly when information becomes inaccurate |
FINRA Membership
| Requirement | Details |
|---|---|
| SRO Membership | Must join FINRA (or a national securities exchange) |
| Form NMA | New Member Application |
| Approval Required | Cannot conduct business until approved |
| Ongoing Oversight | Subject to FINRA rules and examinations |
Net Capital Requirements
SEC Rule 15c3-1 establishes minimum net capital requirements:
| Type of Firm | Minimum Net Capital |
|---|---|
| Carrying Firm (holds customer funds/securities) | $250,000 |
| Introducing Firm | $50,000 - $100,000 |
| Limited Operations | $5,000 |
| Market Makers | Based on positions held |
Additional Requirements
| Requirement | Purpose |
|---|---|
| SIPC Membership | Securities Investor Protection Corporation |
| Fidelity Bond | Protection against employee dishonesty |
| Written Supervisory Procedures | Compliance framework |
| Anti-Money Laundering Program | SAR filing, customer identification |
State Registration
Requirements
| Element | Details |
|---|---|
| Form BD Filing | Filed with each state through CRD |
| State-Specific Requirements | Some states have additional rules |
| Fees | State registration fees required |
| Notice Filing | Some exemptions for notice filing only |
Effective Registration
- Registration effective when state processes application
- May require additional documentation
- Annual renewal required (typically December 31)
Exclusions from Broker-Dealer Definition
Persons NOT Considered Broker-Dealers
| Exclusion | Reason |
|---|---|
| Agents | Individuals work FOR broker-dealers |
| Issuers | Selling own securities (certain transactions) |
| Banks | Banking activities (with limitations) |
| Isolated Transactions | Not "engaged in the business" |
Bank Exclusion Limitations
The Gramm-Leach-Bliley Act limits bank securities activities:
| Activity | Bank Status |
|---|---|
| Trust Activities | Generally excluded |
| Traditional Banking | Excluded |
| Third-Party Brokerage | Must use broker-dealer affiliate |
| Private Placement Sales | Must "push out" to BD |
Broker-Dealer vs. Investment Adviser
| Feature | Broker-Dealer | Investment Adviser |
|---|---|---|
| Primary Function | Execute transactions | Provide investment advice |
| Compensation | Commissions, markups | Fees (asset-based or fixed) |
| Standard of Conduct | Reg BI (best interest at recommendation) | Fiduciary (ongoing) |
| Federal Registration | SEC + FINRA | SEC or State |
| Primary Regulator | SEC, FINRA, States | SEC or State |
| Disclosure Document | Form CRS | Form ADV Part 2 |
| Customer Relationship | Transactional | Ongoing advisory |
Key Takeaways
- Broker = agent (commissions); Dealer = principal (markups/markdowns)
- Broker-dealers must register with SEC, join FINRA, and register with states
- Form BD is the registration form filed through CRD
- Net capital requirements range from $5,000 to $250,000+ based on activities
- Banks are generally excluded but must "push out" certain securities activities
When a broker-dealer acts as a dealer in a transaction, it:
Earns a commission for executing the customer's order
Acts as principal, trading from its own inventory and earning a markup or markdown
Provides investment advice for a fee
Acts only as an intermediary without taking any risk
Broker-dealers must register with:
Only the SEC
Only FINRA
The SEC and FINRA, and with each state where they conduct business
Only the states where they have a physical office
A "carrying firm" (one that holds customer funds and securities) must maintain minimum net capital of:
$5,000
$50,000
$100,000
$250,000
Sections you finish are checked off in the contents.