What is a Broker-Dealer?

A broker-dealer is an individual or company that buys and sells securities for its clients and for itself. Broker-dealers differ from plain-vanilla brokers, which can only buy and sell for their clients. Most brokerage firms are broker-dealers.

How Does a Broker-Dealer Work?

A broker-dealer can execute trades for its own account, not just for a client's account. When the broker-dealer is buying or selling securities for its own account, it is acting as a principal.

If the broker-dealer is a market maker in a particular stock, sometimes the broker-dealer is required to purchase stock that the client is selling. It is required to do this because the market maker's job is to facilitate liquidity for that particular security. In some cases, the broker-dealer will simply sell this stock to another buyer and make a small profit, or it might keep the shares in its private portfolio.

For example, if you are interested in selling your shares of Company XYZ, which hardly ever have any buyers, a broker would effect the transaction for you if it had a readily available buyer. But a broker-dealer would effect the transaction even if it had to buy your shares and hold them in its own portfolio for a while -- especially if the broker-dealer were a market maker in Company XYZ stock and was responsible for making sure Company XYZ stock was 'tradeable.'

The Securities and Exchange Commission (SEC), The Financial Industry Regulatory Authority and the exchanges are responsible for licensing and regulating the activities of broker-dealers. Broker-dealers who physically operate within the United States must register with the SEC even if their activities are directed only to foreign investors outside the United States.

Why Does a Broker-Dealer Matter?

Broker-dealers are incredibly important because they facilitate liquid -- and thus efficient -- markets. Without them, buyers and sellers would have trouble finding each other, transactions would be more cumbersome to complete and inactive stocks would become even harder if not impossible to trade.

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Paul Tracy
Paul Tracy

Paul has been a respected figure in the financial markets for more than two decades. Prior to starting InvestingAnswers, Paul founded and managed one of the most influential investment research firms in America, with more than 3 million monthly readers.

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