Market Participants and Their Roles
With the regulatory framework in place (the SEC at the top, self-regulatory organizations (SROs) enforcing rules, and the Securities Investor Protection Corporation (SIPC) backing customers), you can now understand the participants who operate within this structure.
Investor Types
| Type | Definition | Key Facts |
|---|---|---|
| Retail investors | Individual, non-professional investors | Receive the most regulatory protections |
| Institutional investors | Large entities (pension funds, mutual funds, insurance companies, banks) | Trade in larger volumes; may receive fewer disclosure protections due to their sophistication |
| Accredited investors | Meet specific financial thresholds per SEC Rule 501(a) of Regulation D | Can participate in private placements and other exempt offerings |
Accredited investor thresholds:
- Net worth: Over $1 million (excluding primary residence), individually or jointly with a spouse
- Income: Over $200,000 individually (or $300,000 jointly with a spouse) in each of the last two years, with a reasonable expectation of the same in the current year
- Certain professional certifications (Series 7, Series 65, Series 82) also qualify an individual
Exam Tip: Gotchas
- Accredited investor net worth excludes the primary residence. Questions often include home equity in the net worth calculation to see if you subtract it.
Broker-Dealers
A firm registered as a broker-dealer can act in two distinct capacities:
| Capacity | Role | Compensation | Acting As |
|---|---|---|---|
| Broker | Executes trades on behalf of customers | Commission | Agent |
| Dealer | Trades for its own account | Markup (buying from dealer) or markdown (selling to dealer) | Principal |
- Most firms are registered as both broker and dealer
- Must register with the SEC under Section 15 of the Securities Exchange Act of 1934 and become members of the Financial Industry Regulatory Authority (FINRA)
Exam Tip: Gotchas
- Broker = agent = commission. Dealer = principal = markup/markdown. On the SIE, watch for questions that describe the compensation type and ask you to identify the capacity. If the firm earned a commission, it acted as agent (broker). If it earned a markup, it acted as principal (dealer).
Types of Broker-Dealers
| Type | Function |
|---|---|
| Introducing broker | Takes customer orders but does not hold customer funds or securities; clears through another firm |
| Clearing broker | Holds customer assets, executes settlements, and provides back-office functions |
| Prime broker | Provides specialized services to hedge funds and institutional clients (lending, custody, clearing) |
Exam Tip: Gotchas
- An introducing broker does not hold customer funds. It routes orders through a clearing broker, which handles custody and settlement.
Other Key Market Participants
Investment Advisers
- Provide investment advice for compensation
- Must register with the SEC (if managing $100 million or more in assets) or the state (if below that threshold)
- Owe a fiduciary duty to clients: must act in the client's best interest
Exam Tip: Gotchas
- Investment advisers owe a fiduciary duty; broker-dealers are held to a suitability standard (Reg BI). Do not confuse the two. Fiduciary = must put the client's interest first. Suitability = recommendation must be appropriate, but does not require the best option.
Issuers
- Entities (corporations, municipalities, governments) that create and sell securities to raise capital
- An issuer brings new securities to the market through an offering
Underwriters
- Investment banks that help issuers bring securities to market
- Buy securities from the issuer and resell them to the public
- Per FINRA Rule 2269, broker-dealers must disclose their participation or interest in a primary or secondary distribution
- Per FINRA Rule 5250, payments for market making are prohibited
Municipal Advisors
- Advise state and local governments on municipal bond issuances and financial products
- Regulated by the Municipal Securities Rulemaking Board (MSRB) (rulemaking) and the SEC (enforcement)
Traders and Market Makers
- Market makers are dealers that stand ready to buy and sell specific securities at all times
- They provide liquidity by maintaining a two-sided market (both a bid price and an ask price)
- Market makers profit from the spread between the bid and ask prices
Custodians and Trustees
- Custodians hold and safeguard financial assets on behalf of clients
- Trustees have a fiduciary responsibility to act in the beneficiary's interest
Transfer Agents
- Maintain records of securities ownership
- Process ownership transfers between buyers and sellers
- Issue and cancel certificates
- Distribute dividends to shareholders
Market Infrastructure
Depositories and Clearing Corporations
| Entity | Full Name | Role |
|---|---|---|
| DTCC | Depository Trust & Clearing Corporation | Provides clearing, settlement, and information services for equities, bonds, and mutual funds |
| OCC | Options Clearing Corporation | Central clearinghouse for all listed options; guarantees performance of options contracts |
- The DTCC was formed in 1999 from the merger of the Depository Trust Company (DTC) and the National Securities Clearing Corporation (NSCC)
- The DTCC settles the vast majority of securities transactions in the United States
- The OCC acts as a central counterparty: it stands between the buyer and seller of every options contract, guaranteeing that the contract will be fulfilled
Exam Tip: Gotchas
- The OCC guarantees options contracts, not equity trades. The DTCC handles clearing and settlement for equities, bonds, and mutual funds.
- The DTCC was formed from the merger of the DTC and NSCC. Questions may reference these predecessor organizations.