Broker-Dealer Definition & Capacity (Agent vs Principal)
Details the statutory definition of a broker-dealer, trading capacities (agency broker vs principal dealer), and compensation mechanics.
- Broker-dealer: Any person effecting securities transactions for the account of others (agent) or for its own account (principal).
- When acting as an agent (broker), the firm charges a disclosed commission.
- When acting as a principal (dealer), the firm trades from its own inventory and charges a markup or markdown.
Section 401(c) of the Uniform Securities Act defines a broker-dealer as any person engaged in the business of effecting transactions in securities for the account of others or for its own account.
A broker-dealer operates in two distinct capacities: (1) Broker (Agency Capacity): The firm acts as an intermediary, matching buyers and sellers in the secondary marketplace without taking securities into inventory. For this matchmaking service, the broker charges a commission. (2) Dealer (Principal Capacity): The firm buys securities from customers into its proprietary trading inventory or sells securities to customers out of its inventory. For assuming market inventory risk, the dealer charges a markup (when selling to customer) or markdown (when buying from customer).
Under SEC Rule 10b-10 and state blue sky laws, the firm's capacity (agent or principal) must be disclosed in writing to the customer at or before the completion of the transaction on the trade confirmation.
- Firms cannot act as both broker and dealer on the exact same transaction; capacity must be clearly disclosed on trade confirmations.
- Dealers charge markups when selling to clients and markdowns when buying from clients; they do not charge commissions.
Under the Uniform Securities Act, a broker-dealer is defined as any person engaged in the business of effecting transactions in securities for the account of others or for its own account. When a securities firm executes a transaction by buying shares directly from a client into its own inventory, in what capacity is the broker-dealer acting, and what form of compensation does it charge?