Broker-Dealer (B-D)

A broker-dealer is a person or firm that buys and sells securities both on behalf of clients and for its own account. When acting as a broker, it executes trades for customers and charges a commission. When acting as a dealer, it trades from its own inventory and profits from the spread between what it pays and what it receives. The Securities Exchange Act of 1934 defines both roles and requires registration with the Securities and Exchange Commission for anyone performing either function as a business.

Think of a broker-dealer like a car dealership that also operates a taxi service: sometimes it drives you somewhere, and sometimes it sells you the vehicle from its own lot.

SEC Registration and FINRA Membership Are Both Required

Any firm engaging in broker-dealer activity must register with the SEC by filing Form BD. Beyond that federal registration, most broker-dealers must join the Financial Industry Regulatory Authority, the self-regulatory organization that handles day-to-day oversight of broker-dealer operations. FINRA examines member firms, administers licensing exams, and enforces the conduct rules governing how broker-dealers treat their clients.

The individuals who work for a broker-dealer and interact directly with customers are called registered representatives. They must pass the General Securities Representative Exam, known as the Series 7, and most states also require the Series 63 exam. Since October 2018, the Securities Industry Essentials exam is a mandatory prerequisite before taking the Series 7.

The Net Capital Rule Protects Customer Assets If a Firm Fails

SEC Rule 15c3-1 requires every registered broker-dealer to maintain minimum levels of liquid capital relative to its liabilities. The rule exists so that if a firm fails, it has enough liquid assets to pay customers before shutting down. The required minimum varies depending on how the firm operates.

Beyond net capital, broker-dealers must be members of the Securities Investor Protection Corporation. SIPC provides limited protection to customers up to $500,000 per account, including up to $250,000 in cash, if a broker-dealer fails and customer assets are missing. SIPC coverage is not insurance against investment losses. It only protects against losses caused by a firm's failure to return assets it was holding on your behalf.

Regulation Best Interest Changed the Standard of Care in 2020

Before 2020, broker-dealers were required to recommend suitable investments but were not required to act in their clients' best interest. The SEC's Regulation Best Interest, which took effect June 30, 2020, raised that standard. Broker-dealers must now act in the best interest of retail customers when making investment recommendations and must disclose material conflicts of interest.

State securities laws, known as blue sky laws, add a second layer of regulation. Broker-dealers must comply with each state's requirements wherever they do business. The Central Registration Depository handles the multistate registration process so firms can file a single application that covers multiple state registrations simultaneously.

Sources:
https://www.sec.gov/resources-small-businesses/capital-raising-building-blocks/broker-dealers
https://en.wikipedia.org/wiki/Broker-dealer
https://www.finra.org/about/entities-we-regulate
https://katten.com/sec-significantly-broadens-dealer-definition