11.5 Market Participants & Trading Venues
Broker-dealers operate in dual capacities. FINRA strictly enforces disclosure of broker vs. dealer capacity and fair mark-up pricing under the 5% Policy.
Key FINRA Exam Takeaways
- Broker (Agent): Acts as middleman between buyer and seller; does NOT own inventory; charges a COMMISSION (ABC: Agent - Broker - Commission).
- Dealer (Principal): Buys and sells for its OWN inventory; assumes market risk; charges a MARK-UP or MARK-DOWN (PDM: Principal - Dealer - Markup).
- A firm cannot act as both broker and dealer in the same transaction.
- Third Market: Exchange-listed securities traded Over-The-Counter (OTC).
- Fourth Market: Direct institutional trading without broker-dealers via Electronic Communication Networks (ECNs) and Dark Pools.
FINRA 5% Policy Guidelines
The 5% Mark-Up Policy is a guidance guideline, not an absolute rule. Fair mark-ups/commissions depend on security type, availability, total dollar size, and service provided. Highly liquid common stock markups should generally be well below 5%.
Knowledge Checkpoint • Section 11.5
A broker-dealer executes a customer buy order by selling shares directly from its own firm inventory. In what capacity is the broker-dealer acting, and how is the firm compensated?