As an investor, you need to be familiar with the different players in the investment arena and how they buy and sell securities. Broker-dealers, registered representatives and the others have specific roles in clearing the way for commerce in securities.
This tutorial will cover the following topics:
BROKER-DEALERS
A broker is a person or firm that facilitates trades between customers. A broker acts as a go-between and, in doing so, does not assume any risk for the trade. The broker does, however, charge a commission. A dealer is a person or firm that buys and sells for his or her own inventory of securities and for others. A dealer therefore assumes risk for the transactions. Dealers may mark securities up or down to make a profit on their transactions.
Many publications or web sites use the term broker-dealer. A broker-dealer is allowed to operate in either role, but never as both at the same time.
To be involved in the buying, selling or trading of securities, a person or firm must be registered with the National Association of Securities Dealers (NASD). The NASD is a self-regulatory organization created by the Securities and Exchange Commission (SEC). Brokers and dealers must follow all rules of the NASD and SEC, including the NASD's Conduct Rules and its rules for arbitration, complaints and dealings with the public.
Broker-dealer status can be revoked for freely breaking securities rules; for having been expelled or suspended from any self-regulatory organization; for making misleading statements to the SEC or the NASD; or for having committed felonies or misdemeanors in the securities industry.
WHAT
BROKER-DEALERS ARE NOT ALLOWED TO DO
The following are practices that broker-dealers are forbidden
to do:
- Churning: Excessive trading of a client's discretionary account
to increase the broker's commissions.
- Use deception or manipulation to trade securities, or failing
to state material facts
- Recommending low-priced, speculative securities without determining
whether they are suitable for the customer
- Make unauthorized transactions
- Guarantee that loss will not occur
- Try to talk clients into buying mutual funds inappropriate for
their means and goals
- Use fictitious accounts to disguise trades
- State that the SEC has approved or judged positively either
the security or the broker
- Not promptly transmitting the client's money or securities
Broker-dealers convicted of any of these actions may be expelled
or suspended by the NASD.
Because brokers have so much control over other people's money,
their activities are highly regulated.
OTHER
BROKER SERVICES
Brokers, when authorized by the client, may set up discretionary
accounts. These accounts allow brokers to buy and sell securities
for a client's account without contacting the client for each transaction.
The authorized broker may determine the security traded, how much
of it may be traded, the price and the time of transaction.
Brokers may lend funds to customers who have margin accounts.
With margin accounts, customers can buy additional securities with
money borrowed from a broker. The broker makes a commission from
each trade.
Brokers may share in accounts with customers. Brokers sharing
in accounts may keep profits, but only if the profits are proportional
to their contributions. The customers must give written consent
to the agreement and have a certain amount of money or equity in
their accounts.
REGISTERED
REPRESENTATIVES, MARKET MAKERS AND SPECIALISTS
A registered representative is an individual who has passed the
NASD's registration process and is therefore licensed to work in
the securities industry. The process includes an examination that
tests the candidate's knowledge of securities and markets. Further,
the registration agreement requires that the candidate agree to
follow the rules of the NASD.
Registered representatives sell to the public; they do not work
on exchange floors.
MARKET MAKERS
Market makers are dealers who specialize in particular securities
traded on the over-the-counter market. They hold large inventories
of their securities, and they attempt to make markets for those
securities by buying and selling from them. Market makers publish
bid and asked quotes, known as inter-dealer quotes, for other firms
in the hope of making sales.
SPECIALISTS
Specialists keep markets for securities orderly and continuous.
This means they must buy when there are others selling without buyers,
and they must sell when others are buying without sellers. They
must maintain their own inventories of securities that are large
enough for sizable trades. Specialists both buy and sell out of
these inventories and mediate between other customers.
Specialists work on the exchanges where they hold seats. Among
their duties is buying and selling odd-lots (trades of less than
100 shares) for exchange members. To trade a security, a specialist
must be able to keep a position on it with at least 5,000 shares.
Specialists, like others, who buy and sell for the public, are subject
to rules and regulations. Specialists often choose to keep inventories
in multiple securities, often in more than one market sector.
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