15.1 Broker-Dealer Definition

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:

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:

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:

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:

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

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:

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

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

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

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:

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

Primary Function: Broker-Dealer executes transactions; Investment Adviser provides investment advice.

Compensation: Broker-Dealer earns commissions, markups; Investment Adviser earns fees (asset-based or fixed).

Standard of Conduct: Broker-Dealer follows Reg BI (best interest at recommendation); Investment Adviser follows fiduciary (ongoing).

Federal Registration: Broker-Dealer registers with SEC + FINRA; Investment Adviser registers with SEC or State.

Primary Regulator: Broker-Dealer is regulated by SEC, FINRA, States; Investment Adviser is regulated by SEC or State.

Disclosure Document: Broker-Dealer uses Form CRS; Investment Adviser uses Form ADV Part 2.

Customer Relationship: Broker-Dealer relationship is transactional; Investment Adviser relationship is ongoing advisory.

Key Takeaways

1. Broker = agent (commissions); Dealer = principal (markups/markdowns).

2. Broker-dealers must register with SEC, join FINRA, and register with states.

3. Form BD is the registration form filed through CRD.

4. Net capital requirements range from $5,000 to $250,000+ based on activities.

5. Banks are generally excluded but must "push out" certain securities activities.