Let’s define both a Broker and a Dealer so that we’re on a level playing field.

What is a Broker?

According to the Securities Exchange Act of 1934 (the ”Exchange Act”), a Broker is “any person engaged in the business of effecting transactions in Securities for the account of others.”

The definition goes on to specify three activities.  The Broker must be engaged in the business of effecting transactions in Securities for the account of others.

Without getting too wrapped up into legal definitions, a Broker is:

1. Engaged in the business if it (the brokerage firm) conducts Securities transactions on a regular basis and the compensation for such activities is significant;
2. Effecting transactions in Securities when, among other actions, it is structuring an investment, helping identify potential Investors, soliciting Investors, negotiating between Issuer and Investor, and executing the investment; and
3. Doing so for the account of others.  Simply stated, that means that it is effecting transactions not for its own account, but on others’ behalf. This is also known as an Agency Transaction.

What is a Dealer?

A Dealer, as defined by the Exchange Act, is “any person engaged in the business of buying and selling Securities . . . for such person’s own account through a Broker or otherwise.”  Therefore, a Dealer must both buy and sell Securities for its own account and be doing so on a regular basis.

A Principal Transaction is one in which a Dealer purchases a Security for its own account or sells it to its customers.  This definition does not include Investors who buy and sell a Security for investment purposes but sometimes hold the position for only a short amount of time.

As referenced above, if buying and selling Securities on a regular basis is part of an entity’s activities, it is deemed to be a Dealer.

Broker-Dealer

One can surmise from the above definitions what is a Broker-Dealer: a brokerage firm that buys and sells Securities regularly as a principal before selling the Securities to Investors.

Federal Regulatory Oversight

The Exchange Act is the principal federal legislation that governs Brokers and Dealers in Securities.  The Securities Exchange Commission (“SEC”), the rules of self-regulatory organizations (“SROs”), and the Exchange Act itself lay out extensive provisions for all Broker-Dealers.

Oversight includes a long list of items, including periodic inspections, investigations and disciplinary actions by the SEC, compliance with minimum net capital requirements, customer protection rules, financial reporting requirements, and others.

Registered Broker-Dealers are, as one would expect, subject to anti-fraud, anti-manipulation, and anti-money laundering provisions of the federal Securities laws.  Other requirements involve Insider Trading and extending credit to customers.

As noted in other articles, with minor exceptions, they are required to belong to a Self-Regulatory Organization (“SRO”), which includes national Securities Exchanges and registered Securities Associations, as well as the Securities Investor Protection Corporation (“SIPC”).  The Financial Industry Regulatory Authority (“FINRA”) is currently the only registered national Securities association.

Anyone who wishes may review a firm’s or an individual registered representative’s record through BrokerCheck (brokercheck.finra.org).  In it one can find an individual Broker’s employment history, professional qualifications, and disciplinary actions, criminal convictions, civil judgements and arbitration awards, if any.  This information comes from FINRA’s Central Registration Depository (“CRD”).  

FINRA and national Securities exchanges have enforcement powers and examination authority over their members and their members’ Associated Persons.

State Regulatory Oversight

In addition to the federal regulatory system, Broker-Dealers are subject to state Securities laws, known as the Blue Sky Laws, as well as, in most states, either to the Uniform Securities Act of 1956 (the ”1956 Act”) or the Uniform Securities Act of 2002 (the ”2002 Act”).   Both the 1956 Act and 2002 Act make it unlawful for any person to transact business in a state as a Broker-Dealer or agent without registration.  See “Rule 506(b) Offerings” for more information.

What happens if an unregistered Broker-Dealer conducts business illegally?

If you are approached by an entity in the business of selling Securities, and it is not a registered Broker-Dealer, be on your guard.  Acting as a Broker-Dealer without registering (unless under an exemption) may subject the Broker-Dealer to consequences by the SEC, state enforcement agencies as well as private actions.  Such actions may include: (i) cease-and-desist orders from the SEC or relevant state regulator or court injunctions; (ii) civil penalties including fines and disgorgement; (iii) criminal liabilities; (iv) potential rescission rights of Investors under federal or state law; and (v) reputational harm.

Conclusion

Brokers and Dealers are tightly regulated entities with extensive and growing oversight by federal Securities agencies, national SROs and state Securities agencies or commissions.

Operating “under the radar” is extremely risky for the operator.  A registered Broker-Dealer, such as CFG, collects, provides to regulators, and maintains extensive records, expending significant resources to ensure that Investors are treated in accordance with federal and state regulations, but, most importantly, according to our own standards of professionalism, transparency, honesty and integrity.    

For more information about regulatory oversight in private market investments, please see “What Securities Laws and Regulation Govern Private Placements?”