Broker-Dealer (B-D) Explained: Roles, Types & Functions

What Is a Broker-Dealer?

A broker-dealer (B-D) is an entity in the financial industry that helps clients trade securities. They can act as an agent and execute trades for clients, or as a principal and trade for their own account. Broker-dealers offer investment advice, research, trade execution, and market access. They can be large companies or smaller independent firms. They are an important part of the market because they facilitate transactions and support investors.

Key Functions and Roles of a Broker-Dealer

Broker-dealers have vital roles in finance, such as advising customers, providing market liquidity, facilitating trades, publishing research, and raising capital for companies. Broker-dealers range in size from small independent boutiques to large subsidiaries of giant commercial and investment banks.

There are two types of broker-dealers:

1. A wirehouse, or a firm that sells its own products to customers; and
2. An independent broker-dealer, or a firm that sells products from outside sources. 

According to a 2023 FINRA report, there are over 3,298 broker-dealers, including major ones like Fidelity, Charles Schwab, and Edward Jones.

The Operational Dynamics of Broker-Dealers

By definition, broker-dealers are buyers and sellers of securities, and they are also distributors of other investment products. As the name implies, they perform a dual role in carrying out their responsibilities. As dealers, they act on behalf of the brokerage firm, initiating transactions for the firm’s own account. As brokers, they handle transactions, buying and selling securities on behalf of their clients.

In their dual roles, they perform a couple of vital functions; they facilitate the free flow of securities on the open market, and they buy or sell securities in their own accounts to ensure there is a market in those securities for their clients. In this regard, broker-dealers are essential, and they are also well-compensated, earning a fee on either or both sides of a securities transaction.

Insights into Brokerage and Underwriting Strategies

Broker-dealers that are tied directly to investment banking operations also engage in the underwriting of securities offerings. When a broker-dealer acts as an agent of the issuing company, either as a principal underwriter of the stock or bond offering, or as a member of the underwriting syndicate, they enter into a contractual arrangement, acting on a “firm commitment” with the issuer that obligates them to distribute a certain amount of the securities offered to the public in exchange for an underwriting fee.

They may also acquire a piece of the securities offering for their own accounts and may be required to do so if they are unable to sell all of the securities.

Once the underwriting process is completed and the securities are issued, the broker-dealers then become distributors, and their clients are typically the target of their distribution efforts. In that effort, the financial advisors of the firms then act as brokers to solicit their clients and recommend the purchase of the security for their accounts. In this regard, the broker-dealers are facilitating the interests of the issuer, themselves (in the collection of a distribution fee), and their clients, although their only contractual obligation is to the issuer.

The Bottom Line

A broker-dealer is a firm that buys and sells securities for its own account or on behalf of clients, which helps keep markets liquid. Some broker-dealers sell their own products, while independent broker-dealers offer outside products. Firms range from small boutiques to large companies like Fidelity and Charles Schwab. Firms provide investment advice, distribute products, support capital formation through underwriting, and help maintain market operations.