Brokerage Firm (Broker-Dealer)

Definition

A Brokerage Firm (or Broker-Dealer) is a financial institution that facilitates the buying and selling of financial securities between a buyer and a seller. * Since stock exchanges typically only accept orders from members of the exchange, individual investors need the services of a brokerage firm to execute trades.

Key Business Models

They serve two masters: the client and themselves. * Broker (Agency Trading): Acts as an agent for a client (you), executing orders to buy or sell stocks. They earn money through Commissions or fees. * Dealer (Principal Trading): Trades for its own account and risk. They act as a counterparty to the client. They make money on the Spread (the difference between the Bid and Ask price). * Underwriting (Investment Banking): Helps companies raise capital by issuing stocks (IPO) or bonds. The firm buys the securities from the issuer and sells them to the public.

Types of Brokers

1. Full-Service Brokers: Provide a wide range of services including investment advice, research, and retirement planning. Fees are higher. (e.g., Morgan Stanley, Goldman Sachs).
2. Discount Brokers: Allow clients to buy and sell securities on their own (DIY) with low or zero commissions. They offer fewer services/advice. (e.g., Robinhood, Charles Schwab, E-Trade).

The Conflict of Interest

Because they act as both brokers (for you) and dealers (for themselves), there can be conflicts. For example, a firm might recommend a stock that they hold in their own inventory and want to sell off.