Legal Definitions - broker-dealer

A broker-dealer is a financial professional or firm that operates in the securities market, performing two distinct but often combined roles. As a broker, they act as an agent, executing buy and sell orders for their clients and typically earning a commission for this service. In this capacity, they connect buyers and sellers without taking ownership of the securities themselves. As a dealer, they buy and sell securities for their own account, taking ownership of the securities with the aim of profiting from price fluctuations. Many financial institutions operate in both capacities, serving clients while also trading from their own inventory. Broker-dealers are heavily regulated to protect investors and maintain fair markets.

• Example 1: An Individual Investor's Stock Purchase
  Imagine Sarah, an individual investor, wants to buy 100 shares of "Tech Innovations Inc." stock. She places an order through her online investment platform, "Global Wealth Securities." When Global Wealth Securities executes Sarah's order on an exchange, finding a seller for those shares and charging Sarah a small transaction fee, it is acting as a broker. If, however, Global Wealth Securities had already purchased a large block of "Tech Innovations Inc." shares and sold 100 of them directly from its own inventory to Sarah at a slightly higher price, it would be acting as a dealer.

  How this illustrates the term: This scenario demonstrates how a single firm can fulfill both roles. It acts as a broker by facilitating a client's trade for a commission, and as a dealer by selling securities it owns directly to a client, aiming to profit from the sale.

• Example 2: A Pension Fund's Bond Sale
  A large pension fund needs to sell a significant amount of government bonds to rebalance its portfolio. It approaches "Capital Markets Group," a major financial institution. Capital Markets Group might act as a broker by searching for other institutional investors willing to buy the bonds from the pension fund, earning a fee for arranging the transaction. Alternatively, Capital Markets Group might decide to purchase the entire block of bonds directly from the pension fund itself, adding them to its own investment portfolio with the intention of reselling them later at a higher price. In this latter case, Capital Markets Group is acting as a dealer.

  How this illustrates the term: This example shows the dual function in the context of large-scale institutional trading. The firm can either act as an intermediary (broker) or take on the risk and ownership of the securities itself (dealer).

• Example 3: Market Making for a New Public Company
  When "Green Energy Solutions" goes public, "First Street Investments" agrees to be a market maker for its stock. This means First Street Investments continuously stands ready to buy and sell Green Energy Solutions shares, quoting both a "bid" price (what it's willing to pay) and an "ask" price (what it's willing to sell for). When First Street Investments buys shares from one investor and immediately sells them to another, using its own capital to bridge the transaction and profiting from the small difference between the bid and ask prices, it is primarily acting as a dealer. While facilitating trades, its core function here is trading from its own inventory to provide liquidity to the market.

  How this illustrates the term: This example highlights the dealer function, where the firm uses its own capital and inventory to facilitate continuous trading and provide liquidity in the market, profiting from the spread.