For many investors, the financial services industry is a strange and mysterious place filled with a language all in its own. Terms like “alpha,” “beta” and “Sharpe-Ratio” don’t exactly roll off the tongue with ease, nor does their use by industry insiders serve to lift the veil and make industry less opaque. Of course, the language fits the medium, as the financial services arena is a complex word. To participate in that world, investors generally engage the services of a broker or dealer in some form or fashion, making a review of those terms an interesting place to begin exploring.

Brokers
Broker” and “dealer” are U.S. regulatory terms and, as is often the case with legal terms, they are not very intuitive to many people. While the words are often seen together, they actually represent two different entities. A broker executes orders on behalf of clients. To the regulators, this means the entity through which investors hold a brokerage account. To investors, it generally means the person who helps them buy and sell securities. A bit of confusion occurs here, as the industry also has lots of terms for a person who helps investors buy and sell securities, including “financial advisor,” “investment advisor,” and “registered representative,” For the moment, we’ll stick with the strict legal definitions to provide a baseline for further exploration.

Confused yet? Let’s try this one more time. Think of the legal entity that facilitates security trading as an “agent” acting on behalf of investors. When you want to buy or sell a security, the entity (in the case of online brokerage accounts for example) that helps you make that transaction is your agent. When you pay a commission to make a trade, you are making that payment to an agent. The terms agent and broker can be used interchangeably.

Brokers come in two general types, full service and discount. Full-service brokers provide one-on-one personal service. This includes providing specific investment recommendations in addition to planning and advice services that range from retirement planning, long-term care planning and estate planning to the formulation of personal investment strategy that will help cover the cost of child’s education, a home purchase or other financial goals. Ongoing assistance can include face-to-face meetings and periodic checkups to revisit progress toward goals. For novice investors or those too busy to plan for themselves, full service brokers offer an array of useful services and information.

Discount brokers, on the other hand, provide trade execution. Online brokers are perhaps the best example of this arrangement, as investors can log on, select a security and purchase it without ever speaking to another person. Discount brokers offer an inexpensive way to purchase securities for investors who know exactly what they what to buy. Some of these firms also offer online tool and research designed to help do-it-yourself investors generate ideas and research securities that they may be interested in purchasing. The limited service offering provided by discount brokers is significantly less expensive that the cost of working with a full-service broker.

Dealers
While a broker facilitates security trades on behalf of investors, a dealer facilitates trades on behalf of itself. The terms “principal” and “dealer” can be used interchangeably. So, when you hear about big financial firms trading in their “house” accounts, they are acting as dealers.

Some of these dealers, known as “primary dealers” also work closely with the U.S. Federal Reserve to help implement monetary policy. Primary dealers are obligated to participate in the auction of debt issued by the U.S. government. By bidding on Treasury bonds and other securities, these dealers facilitate trading by creating and maintaining liquid markets. They assist in the smooth functioning of domestic securities markets as well as transactions with foreign buyers. The list of primary dealers includes some familiar names and perhaps some surprises:

  • Bank of Nova Scotia, New York Agency
  • BMO Capital Markets Corp.
  • BNP Paribas Securities Corp.
  • Barclays Capital Inc.
  • Cantor Fitzgerald & Co.
  • Citigroup Global Markets Inc.
  • Credit Suisse Securities (USA) LLC
  • Daiwa Capital Markets America Inc.
  • Deutsche Bank Securities Inc.
  • Goldman, Sachs & Co.
  • HSBC Securities (USA) Inc.
  • Jefferies LLC
  • J.P. Morgan Securities LLC
  • Merrill Lynch, Pierce, Fenner & Smith Incorporated
  • Mizuho Securities USA Inc.
  • Morgan Stanley & Co. LLC
  • Nomura Securities International, Inc.
  • RBC Capital Markets, LLC
  • RBS Securities Inc.
  • SG Americas Securities, LLC
  • UBS Securities LLC.

Dealers also play a self-governing role, to ensure correct functioning of securities markets. They are regulated by the Financial Industry Regulatory Authority (FINRA), which is responsible for administering exams for investment professionals. Some of the better-known exams include the Series 7, the Series 6 and Series 63. The Series 7 permits financial services professionals to sell securities products, with the exception of commodities and futures. The primary focus of the Series 7 exam is on investment risk, tax implications, equity and fixed-income securities, mutual funds, options, retirement plans and working investors to oversee their assets. The Series 6 designation enables investment professionals to sell mutual funds, variable annuities and insurance products. And the Series 63 enable them to sell any type of securities in a specific state. Obtaining these licenses is the first step financial services professionals need to take in order to get into the securities business.

Putting it All Together
Most firms that investors envision when the words “stock brokerage” come to mind act as both brokers and dealers, and are therefore referred to as “broker-dealers” by industry regulators. These firms include the primary dealers and other traditional Wall Street organizations, as well as large commercial banks, investment banks and even small independent boutique firms that cater to the wealthy.

Broker-dealers play an important role in the financial markets, as these firms provide the infrastructure that facilitates stock trading. In fact, if you want to buy stock, you must open a brokerage account through a brokerage firm. The brokerage firm makes sure you have enough money in your account to conduct a trade, facilitates the trade by interacting with stock exchange where the stock is traded, provides the computer systems that enact the trade and keep records of the trade. It also handles the financial transaction between the buyer and the seller. And it facilitates future transactions (dividends, stock splits, corporate actions such as those that occur when preferred securities are called or stock splits take place).

The Bottom Line
With the depth and complexity of industry offerings and ever-changing nature of the industry itself, knowledge is power. The greater your grasp of the industry’s vocabulary, the more you can be sure you understand how the industry functions. This includes developing a better sense of how your investments work, the services you get in exchange for the fees that you pay, who or what provides those services and what you can expect should a dispute end up in court.

Related Articles
  1. Investing Basics

    Picking Your First Broker

    If you're a rookie investor, your first big investment decision should be an informed one.
  2. Professionals

    Broker Commissions Are Here To Stay

    With two developed nations adopting a firm anti-commission stance, questions have arisen over whether or not the United States should follow suit. Find out why such a development is unlikely.
  3. Investing Basics

    Do You Dare Sue Your Broker?

    A financial damages claim is not for the fainthearted, but it may be worth it in the end.
  4. Forex Education

    Is Your Forex Broker A Scam?

    While the forex market is slowly becoming more regulated, there are many unscrupulous brokers who should not be in business.
  5. Insurance

    Full-Service Brokerage Or DIY?

    Determine what you are getting for your fees and commissions and how to get your money's worth.
  6. Products and Investments

    There's a Reason They're Called Junk Bonds

    The closing of Third Avenue Managemet's Focused Credit Fund is a warning to investors and advisors. Beware the junk.
  7. Investing Basics

    5 Questions First Time Investors Should Ask in 2016

    Learn five of the most important questions you need to ask if you are a new investor planning on starting an investment program in 2016.
  8. Investing Basics

    The Top 4 Income Investments for Retirees in 2016

    These four investment types should mitigate risk in 2016 for retirees seeking income.
  9. Your Practice

    Advisors: $240B in Fees Up for Grabs by 2030

    Advisors have an opportunity to win generational assets over the next 15 years. Here are some tips on how to cater to different demographics.
  10. Financial Advisor Technology

    Vanguard's Robo-Advisor vs. Flagship Select

    An in depth comparison of Vanguard’s robo-advisor and high-net-worth platforms.
RELATED FAQS
  1. What barriers to entry exist in the financial services sector?

    Barriers to entry in financial services markets include licensure laws, capital requirements, access to financing, regulatory ... Read Full Answer >>
  2. What are the SEC (Securities And Exchange Commission) rules about OTC (over-the-counter) ...

    Market trades that occur over the counter (OTC) are less regulated by the Securities and Exchange Commission than those that ... Read Full Answer >>
  3. Do financial advisors charge VATs?

    The Personal Finance Society (PFS) and with Her Majesty's Revenue and Customs (HMRC) have outlined when a value-added tax ... Read Full Answer >>
  4. How do financial advisors execute trades?

    Today, almost every investor invests through online brokerage accounts. Investors often believe that their trades are directly ... Read Full Answer >>
  5. How do financial advisors help you avoid escheatment?

    Financial advisors can help you avoid the escheatment of your financial assets by regularly reviewing all of your accounts, ... Read Full Answer >>
  6. Why do financial advisors dislike target-date funds?

    Financial advisors dislike target-date funds because these funds tend to charge high fees and have limited histories. It ... Read Full Answer >>
Hot Definitions
  1. Super Bowl Indicator

    An indicator based on the belief that a Super Bowl win for a team from the old AFL (AFC division) foretells a decline in ...
  2. Flight To Quality

    The action of investors moving their capital away from riskier investments to the safest possible investment vehicles. This ...
  3. Discouraged Worker

    A person who is eligible for employment and is able to work, but is currently unemployed and has not attempted to find employment ...
  4. Ponzimonium

    After Bernard Madoff's $65 billion Ponzi scheme was revealed, many new (smaller-scale) Ponzi schemers became exposed. Ponzimonium ...
  5. Quarterly Earnings Report

    A quarterly filing made by public companies to report their performance. Included in earnings reports are items such as net ...
Trading Center