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Brokerage Anatomy™

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An investment firm that acts both as a broker (or agent) when it executes orders on behalf of clients, and also as a dealer (or principal), when it trades for its own account.

The term broker-dealer is used in US securities regulation (and in ISDA netting) parlance to describe stock brokerages, because most of them act as both agents and principals.


Foreign broker-dealers and registered broker-dealers

A foreign broker-dealer (foreign being from the perspective — is there another? — of the United States of America), means that poor, huddled mass of international brokers and dealers who were turned away, or never arrived, at Ellis Island and have not subsequently been registered with the Securities and Exchange Commission. A registered broker-dealer denotes one of those blessed souls who have.

Rule 15 (a)(1) provides in the gummed up lingo of a securities legistlator scarred by the Crash of 1929, as follows:

15 U.S. Code § 780 - Registration and regulation of brokers and dealers

(a) Registration of all persons utilizing exchange facilities to effect transactions; exemptions

(1) It shall be unlawful for any broker or dealer which is either a person other than a natural person or a natural person not associated with a broker or dealer which is a person other than a natural person (other than such a broker or dealer whose business is exclusively intrastate and who does not make use of any facility of a national securities exchange) to make use of the mails or any means or instrumentality of interstate commerce to effect any transactions in, or to induce or attempt to induce the purchase or sale of, any security (other than an exempted security or commercial paper, bankers’ acceptances, or commercial bills) unless such broker or dealer is registered in accordance with subsection (b) of this section.

This boils down, to the JC’s unqualified eye, to say: “it is illegal for any broker/dealer to effect any transaction in a security or of induce any purchase or sale, if it is not a registered broker-dealer under Section 15(b) of the Securities Exchange Act of 1934

Of much interest to those wanting to handle or “effect” transactions in securities with US persons. The SEC has lots of rules about this, and as you can probably imagine they’re all simple, clear and easy to understand.

See in particular

Do not confuse with

Client money and cash brokerage

Should an investment manager ask an executing broker bank to offer it client money protection, consider the following:

  • regulated credit institutions (Banks, to you and me) are not required to hold customer cash as client money under the CASS rules (CASS 7.10.16) – banks hold “as banker” and not as trustee for their clients.
  • If a bank were to treat cash as client money (it could in theory do this, though it doesn't make a lot of sense):
    • The bank would have to deposit the cash with another bank — in practice a diversified network of them — cue operational mayhem.
    • The client would still, ultimately, be exposed to those other banks, just not the immediate one. Cash is always presents a credit risk to whoever holds it for the time being.
  • Brokers generally settle cash equities transactions delivery versus payment under their terms of business. Clients will not pay any money in advance receiving their settlement securities. Therefore the client’s payment obligation is in discharge of its contractual liability to the broker, so is not a “client money” obligation in the first place (see CASS 7.11.25);
  • When an investment manager instructs a broker to execute an order for a client it does so as agent for the client, but in the client’s own name.