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, though solely clerical staff are excluded for BD registration; 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
- The Uniform Securities Act (USA) defines only the combined term "broker-dealer"; the separate terms "broker" (for the account of others) and "dealer" (buying and selling for its own account) come from the Securities Exchange Act of 1934 (SEA)
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 holds itself out, by publishing quotations or otherwise, as willing to buy and sell a particular security for its own account on a regular or continuous basis
- 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
- Defined under the SEA
- The definition excludes a person whose functions are solely clerical or ministerial, but only for the SEA's broker-dealer registration provisions; it is not a general exclusion from the term
- Associated persons who effect securities transactions must register as agents (see Unit 33)
Exam Tip: Gotchas
For broker-dealer registration purposes, a person whose functions are solely clerical or ministerial is not treated as an associated person; the exclusion reaches only that purpose. What actually requires agent registration is effecting securities transactions or discussing the merits of a specific security with a customer. That is the line clerical staff must not cross; cross it and the "solely clerical" exclusion no longer applies.
Who Is an Underwriter?
- Underwriter (defined in the Securities Act of 1933): 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
What Types of Underwriting Commitments Are Used?
| Type | Capacity | Description |
|---|---|---|
| Firm commitment | Dealer (principal) | Underwriter purchases the entire issue for its own account and resells it to the public |
| Best efforts | Broker (agent) | Underwriter sells as much as possible on the issuer's behalf but does not guarantee the full amount |
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 outright, with no conditions attached, under the USA's state-law definition |
When Do Banks Need Broker-Dealer Registration?
- The table above is the state-law picture tested directly on the Series 65: the Uniform Securities Act excludes banks, savings institutions, and trust companies from the state broker-dealer definition unconditionally, regardless of what securities activities the bank conducts
- Federal law is stricter and works differently. Under the Gramm-Leach-Bliley Act (1999), banks lost their blanket exclusion from the federal Securities Exchange Act definitions of broker and dealer
- A bank now avoids federal broker-dealer registration only if its securities activities are limited to enumerated exceptions (trust activities, certain sweep accounts, municipal securities, etc.); activity outside those exceptions can trigger federal registration
- 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
The state exclusion and the federal Gramm-Leach-Bliley exceptions are two different rules, not one: the USA exclusion for banks is unconditional, while the federal exclusion is conditional on staying within enumerated activities. Don't read the federal enumerated-exceptions test back into the state-law exclusion.
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.
Which Exempt Securities Exclude an Issuer Representative From Agent Status?
The USA excludes an individual representing an issuer from the agent definition when the transaction involves one of five selected exempt-security categories:
- U.S., state, or municipal government securities
- Canadian or other foreign government securities from a nation with which the United States maintains diplomatic relations
- Bank, savings institution, or trust company securities
- Qualifying commercial paper: it matures within 9 months, is issued in denominations of at least $50,000, and is rated in one of the 3 highest rating categories
- Qualifying employee benefit plan securities
This exempt-security route is narrower than the full list of securities exempt from registration. Insurance company securities are exempt securities, but they appear under a different statutory clause and do not by themselves support this issuer-representative exclusion from agent status.
An issuer representative has a separate exempt-transaction route. An offer or sale to a bank for its own investment portfolio qualifies because the transaction is exempt based on the purchaser, even if the issuer's security is not in the five-category list above. An ordinary sale of the same security to an individual does not gain that exclusion from the bank sale.
Two more routes complete the issuer-representative list:
- Federal covered securities, two categories only. The representative effects transactions in covered securities sold to qualified purchasers or in qualifying Regulation D private placements. Exchange-listed securities do not count.
- Sales to existing employees, partners, or directors of the issuer. The exclusion applies only if no commission or other remuneration is paid or given, directly or indirectly, for soliciting any person in the state.
The employee route turns on the pay, not on the buyer. A commission or a percentage of each completed sale is pay for soliciting, so it ends the exclusion even when the representative also draws a fixed salary. Postponing the payment until after the offering closes, or having the buyer pay it, does not help, because the rule bars indirect remuneration too.
When May the Administrator Act Against a Registration?
Denial, suspension, or revocation under the USA requires both a statutory ground and a finding that the action is in the public interest. A recent felony conviction can provide a statutory ground, but it does not make adverse action automatic; the Administrator decides whether action also serves the public interest.
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. Solely clerical or ministerial staff are excluded for BD registration purposes only, until they effect transactions or discuss a security's merits with a customer.
- 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.