In the securities industry, there are many key players. I’m sure you’ve heard the terms: broker, dealer, and broker-dealer. Although many may assume that the terms have the same meaning, there are in fact not the same. All three play a major role in the activity of the stock market. However, there are several key differences including how they are compensated, the disclosures they are required to make, and their relationship with clients.
What is a Broker?
The main function of a broker is to buy and sale securities on behalf of clients. The client does not assume a passive role but instructs the broker on what transactions to make. Any transaction made is made for the client’s account. Of course, brokers do not provide their services for free. Brokers are paid commissions for each order of securities they execute on a customer’s behalf. To protect investors, brokers are required to disclose the amount of the commission they will make.
What is a Dealer?
Unlike a broker, a dealer buys and sales securities on behalf of their own account. Therefore, dealers maintain stock holdings that are not in the name of clients but are in the name of the dealer. Dealers are considered market makers because they hold large volumes of a security and can fulfill customers’ orders on demand. If a customer has stock for sell, a dealer will buy the stock from the customer. If a customer has a demand for stock, a dealer will sell the customer stock. Dealers are not compensated with commissions, but charge a markup or markdown in order to make a profit. Regulations do not require that dealers disclose the amount of the markup or markdown. However, dealers must disclose the fact that they are a market maker.
What is a Broker-Dealer?
A broker-dealer is a person or firm that acts in dual capacities depending on the transaction. As broker-dealer is able to receive fees on either or both sides of a securities transaction. This means that broker-dealers execute trades on behalf of clients’ accounts and are compensated with commissions. They also initiate trades for their own accounts and are compensated by charging a markup or markdown. Additionally, broker-dealers act as underwriters of securities offerings.
Investors cannot do business with the stock exchange directly. They must use a person or business that has direct access to the stock exchange. This is why brokers, dealers, and broker-dealers are so important. Although the terms sound similar, the roles they play within the stock market are very different. They interact with clients differently, are compensated differently, and have different disclosure requirements.