Quick Answer
A single firm can act as broker (agent, earns commissions) or dealer (principal, earns markups/markdowns), but never both in the same trade. Market makers are dealers; associated persons are BD staff and control-related persons beyond clerical roles; underwriters bridge issuers and the public. Agents, issuers, and banks fall outside the BD definition entirely.
Understanding who is (and who isn't) a broker-dealer (BD), the key roles BDs play in the securities markets, and how underwriting works is essential for the Series 65 exam.
What Is the Difference Between a Broker and a Dealer?
- Broker-dealer - any person engaged in the business of effecting transactions in securities for the account of others or for such person's own account
- The term encompasses two distinct roles that are often combined in a single firm
Broker (agency capacity):
- Acts as an agent or intermediary; matches buyers and sellers
- Does not trade from the firm's own inventory
- Earns compensation through commissions
- Transactions are called agency transactions
Dealer (principal capacity):
- Trades securities from the firm's own inventory (own account)
- Buys from and sells to customers directly
- Earns compensation through markups (on purchases by customers) and markdowns (on sales by customers), plus the bid-ask spread
- Transactions are called principal transactions
Think of it this way: A broker-dealer is like a middleman in the securities market. Sometimes they help you buy shares from someone else (acting as broker, charging a commission). Other times they sell you shares from their own inventory (acting as dealer, making a markup).
Can a Firm Act as Both Broker and Dealer in One Trade?
- A broker-dealer cannot act as both broker and dealer in the same transaction
- In any single trade, the firm must disclose whether it is acting in an agency capacity (broker) or principal capacity (dealer)
- A firm may act as broker in one transaction and dealer in another
Exam Tip: Gotchas
The exam tests the compensation difference. Brokers earn commissions (agency). Dealers earn markups/markdowns (principal). A firm that charges both a commission AND a markup on the same transaction is violating the dual-capacity prohibition.
What Is a Market Maker?
- A market maker is a dealer that stands ready to buy and sell a particular security on a regular and continuous basis at publicly quoted prices
- Defined under the Securities Exchange Act of 1934 (SEA)
- Acts in a principal capacity: profits from the spread between bid and ask prices
- Provides liquidity to the market by maintaining an inventory
Exam Tip: Gotchas
Market makers act as principals (dealing from their own inventory), NOT as agents.
Who Counts as an Associated Person of a BD?
- Associated person of a broker-dealer: any partner, officer, director, branch manager, or employee of a broker-dealer, or any person directly or indirectly controlling, controlled by, or under common control with the broker-dealer
- Includes any person occupying a similar status or performing similar functions
- Excludes persons whose functions are solely clerical or ministerial
- Associated persons who effect securities transactions must register as agents (see Unit 33)
Exam Tip: Gotchas
A person performing purely clerical or administrative duties at a broker-dealer is NOT an associated person. But if that person discusses the merits of a specific security with a customer, they cross the line and must register.
Who Is an Underwriter?
- Underwriter - any person who:
- Has purchased from an issuer with a view to distribution of a security, OR
- Offers or sells for an issuer in connection with a distribution, OR
- Participates (directly or indirectly) in the underwriting of a distribution
- The underwriter is the intermediary between the issuer and the investing public in a primary offering
- Excludes a person whose interest is limited to receiving the usual and customary distributor's or seller's commission from an underwriter or dealer
Types of Underwriting Commitments
| Type | Risk to Underwriter | Description |
|---|---|---|
| Firm commitment | Highest | Underwriter purchases the entire issue and resells to the public; bears full risk of unsold shares |
| Best efforts | None | Underwriter acts as agent; sells as much as possible but does not guarantee the full amount |
| All-or-none | None until triggered | Offering is canceled if the entire issue is not sold; funds held in escrow |
| Mini-max | None until triggered | Sets a minimum amount that must be sold; offering proceeds only if minimum is met |
Exam Tip: Gotchas
In a firm commitment underwriting, the underwriter acts as a dealer (principal) because it purchases the securities from the issuer for its own account before reselling. In a best efforts underwriting, the underwriter acts as a broker (agent) because it never takes ownership of the securities.
Which Entities Are Excluded from the BD Definition?
The following are excluded from the definition of broker-dealer under the Uniform Securities Act (USA) (they are simply not broker-dealers and need not register):
| Excluded Entity | Rationale |
|---|---|
| Agents (natural persons) | Agents represent broker-dealers; they are not broker-dealers themselves |
| Issuers | Companies selling their own securities are issuers, not broker-dealers |
| Banks, savings institutions, and trust companies | Subject to separate banking regulations; excluded under the USA definitions provision and the Exchange Act definitions of broker and dealer as modified by the Gramm-Leach-Bliley Act |
Banks: Important Nuances
- Under the Gramm-Leach-Bliley Act (1999), banks lost their blanket exclusion from federal broker-dealer registration
- Banks can still avoid broker-dealer registration if their securities activities are limited to enumerated exceptions (trust activities, certain sweep accounts, municipal securities, etc.)
- Bank holding companies are NOT automatically excluded; if a holding company operates a brokerage subsidiary, the subsidiary must register as a broker-dealer
Exam Tip: Gotchas
An excluded entity does not meet the definition and never needs to register. An exempt entity meets the definition but is released from the obligation to register. Banks are excluded from the broker-dealer definition (not exempt). This distinction is tested.
What Should You Check on Exam Day?
- A broker acts as agent and earns commissions; a dealer trades from its own inventory and earns markups, markdowns, and the bid-ask spread. A firm cannot act as both in the same transaction.
- A market maker is a dealer that stands ready to buy and sell a security continuously at quoted prices, acting in a principal capacity.
- An associated person includes partners, officers, directors, branch managers, and employees, but excludes purely clerical or ministerial staff.
- An underwriter buys from an issuer with a view to distribution, sells for an issuer, or participates in a distribution. Firm commitment underwriting is a dealer role; best efforts underwriting is a broker role.
- Agents, issuers, and banks/savings institutions/trust companies are excluded from the broker-dealer definition, not merely exempt from registering.
- Bank holding companies are not automatically excluded; a brokerage subsidiary must still register as a broker-dealer.