Broker-Dealer Regulation

The whole unit on one sheet: who counts as a broker-dealer, who is excluded, the underwriter and market-maker roles, dual registration, post-registration duties, and supervision.

Definition of a Broker-Dealer

• Broker: effects transactions in securities for the account of others (agent capacity), earns a commission.
• Dealer: buys and sells securities for its own account (principal capacity), earns a markup (on sales) or markdown (on purchases).
• Most firms do both and are called broker-dealers; the label describes the capacity on a given trade, not a permanent title.
• One test: whose account is the trade for? Customer's = broker, firm's = dealer.

Who Is Excluded

• Agents: the individual (natural person) representing a broker-dealer or issuer; registers separately, not a broker-dealer.
• Issuers: a company selling its own securities in a one-time offering is not a broker-dealer (unless regularly in the business, like a mutual fund company).
• Banks: generally excluded under federal law; can sell government securities and provide trust services without broker-dealer (BD) registration.

Definition of an Underwriter

• An underwriter purchases from an issuer with a view to distribution, offers or sells for an issuer in a distribution, or participates in such an undertaking.
• Defined by the role in distribution, not by title; distribution is the sale of newly issued securities to the public (not ordinary secondary trading).
• Firm commitment: underwriter buys the entire issue, bears the risk of unsold shares.
• Best efforts: underwriter acts as agent, unsold shares return to the issuer (issuer bears risk).
• All-or-none: a type of best efforts; the entire offering must sell or the deal is canceled and funds returned.
• Managing (lead) underwriter forms the syndicate (shares the financial risk); a selling group helps distribute but takes on no underwriting liability.

Market Makers and Associated Persons

• Market maker: a dealer that maintains a continuous two-sided market (both a bid AND an ask) at publicly quoted prices, provides liquidity, and profits from the spread.
• A market maker is a type of dealer, but not all dealers are market makers; a dealer willing to quote only one side is not a market maker.
• Associated person: any partner, officer, director, or employee of a broker-dealer, plus anyone controlling, controlled by, or under common control with it.
• Clerical and administrative staff are excluded from the associated-person definition.
• Every agent is an associated person, but not every associated person is an agent (an agent actually effects transactions).

Registration and Post-Registration

• Dual registration: broker-dealers register BOTH federally (Securities and Exchange Commission (SEC) plus self-regulatory-organization membership) AND in every state where they do business (unlike investment advisers, who register with one or the other).
• The uniform broker-dealer application is filed electronically through the Central Registration Depository at the federal and state levels; it discloses business activities, ownership, disciplinary history, and affiliations.
• State registration adds consent to service of process, state fees, and state net capital and bonding requirements.
• Books-and-records creation rule: make and keep current trade blotters, general ledgers, customer account records, order tickets, and written communications.
• Books-and-records preservation rule: sets each record's shelf life (see the numbers table).
• Confirmation rule: send a written confirmation at or before completion of each trade, disclosing date and time, security, quantity, price, capacity (agent or principal), commission or markup/markdown, settlement date, payment for order flow, and Securities Investor Protection Corporation (SIPC) membership.

Agent Supervision

• Broker-dealers must supervise the activities of their agents; a firm can be held liable for an agent's violations even without knowledge if it lacked reasonable supervisory procedures.
• Designate a registered principal to supervise each office of supervisory jurisdiction (OSJ) and each type of business.
• Written supervisory procedures must be established, maintained, AND enforced (having them on paper is not enough).
• Advertising and sales literature must be reviewed and approved BEFORE use, not after; correspondence is also reviewed.
• Branch office inspections at least annually (a minimum, not a maximum), reasonably designed to detect and prevent violations, including handling of written customer complaints.

The One-Liners That Win Points

• Broker = for others (commission); dealer = own account (markup/markdown). Same firm can switch capacities trade to trade.
• Broker-dealer is the firm; agent is the individual. Both register, but separately.
• Banks are excluded from the broker-dealer definition, but not from all securities regulation.
• Selling group members are not underwriters: they distribute but bear no underwriting liability.
• All-or-none is a type of best efforts, not firm commitment.
• Clerical staff are NOT associated persons.
• Broker-dealers register both federally and at the state level; investment advisers do not.
• Written supervisory procedures must be established, maintained, AND enforced.
• Ads and sales literature get reviewed BEFORE use.

Numbers to Lock In

Top Gotchas

• "Broker" and "dealer" are capacities, not permanent labels; what matters is whose account the trade is for.
• A broker-dealer is the entity; an agent is the natural person. Both register, but with different obligations.
• An issuer selling its own stock in a one-time offering is not a broker-dealer; one that regularly buys and sells its own securities may be.
• A market maker must quote both a bid AND an ask; a one-sided quoter is not a market maker.
• Broker-dealers must register BOTH federally AND at the state level, unlike investment advisers who register with one or the other.
• Two separate books-and-records rules: one says WHAT to create, the other says HOW LONG to keep it.
• 6-year records need the first 2 years "readily accessible" (the exam may phrase this as "immediately available").
• A firm can be liable for an agent's violation even without knowledge; missing reasonable supervisory procedures is enough.
• Advertising is reviewed and approved BEFORE use, not after.

One-Breath Recap

A broker effects trades for others and earns a commission, a dealer trades from its own account and earns a markup or markdown, and most firms do both, so the label just describes the capacity on a given trade; agents, issuers in one-time offerings, and banks are excluded from the definition. Underwriters bring new securities to the public under firm commitment (underwriter bears the risk), best efforts (issuer bears it), or all-or-none (a type of best efforts), while market makers are dealers that hold a continuous two-sided market and associated persons are anyone connected to the firm except clerical staff. Broker-dealers register both federally and in every state where they do business through the uniform application, then keep books and records on set retention schedules, confirm every trade in writing, and supervise their agents. Supervision means designated principals, written procedures that are established, maintained, and enforced, advertising approved before use, and branch inspections at least annually. Nail the broker-versus-dealer capacity test, the exclusions, dual registration, and the supervision duties and this unit answers itself.

Need more than the recap? This is a condensed summary. If it is not enough, read the full Broker-Dealer Regulation unit for the complete lesson.