Securities broker and dealer
Individuals who buy and sell securities for themselves generally are considered traders and not dealers. Sometimes you can easily tell if someone is a broker or dealer.
For example, a person who executes transactions for others on a securities exchange clearly is a broker. And a firm that advertises publicly it makes a market in securities is obviously a dealer. Other situations can be less clear. Please note that special provisions apply to broker and dealer activity by banks.
For more information, please see guidance for Banks and Other Depository Institutions. If you are doing, or may do, any of the activities of a broker or dealer, you should find out if you need to register. If you aren't certain, you may want to review SEC interpretations, consult with your attorney, or ask for our advice.
For more information, read our Guide to Broker-Dealer Registration. Each state's securities regulator can provide you with information about that state's requirements.
You can obtain contact information for these regulators from the North American Securities Administrators Association, Inc. The Act defines an "associated person" of a broker-dealer as any partner, officer, director, branch manager, or employee of the broker-dealer, any person performing similar functions, or any person controlling, controlled by, or under common control with, the broker-dealer.
A broker-dealer must file a Form U-4 with the applicable SRO for each associated person who will effect transactions in securities when that person is hired or otherwise becomes associated. Form U-4 is used to register individuals and to record these individuals' prior employment and disciplinary history. An associated person who effects or is involved in effecting securities transactions also must meet qualification requirements. These include passing an SRO securities qualification examination.
Many individuals take the comprehensive "Series 7" exam. If individuals engage only in activities involving sales of particular types of securities, such as municipal securities, direct participation programs limited partnerships or mutual funds, they may wish to take a specialized examination focused on that type of security, instead of the general securities examination. There is also a special exam for assistant representatives, whose activities are limited to accepting unsolicited customer orders for execution by the firm.
Supervisory personnel, and those who engage in specialized activities such as options trading, must take additional exams that cover those areas. These examinations require the Series 7 exam as a prerequisite. You can obtain copies of Form U-4, as well as information on securities qualification examinations, from an SRO.
FINRA's website at www. Also note that individual states have their own licensing and registration requirements, so you should consult with the applicable state securities regulators for further information. If you hold a series license, you must be properly associated with a registered broker-dealer to effect securities transactions. It is not sufficient merely to hold a series license when engaging in securities business. If you hold a series license and wish to start an independent securities business, or otherwise wish to effect securities transactions outside of an "associated person" relationship, you would first need to register as a broker-dealer.
A successor broker-dealer assumes substantially all of the assets and liabilities, and continues the business, of a registered predecessor broker-dealer. A successor broker-dealer must file a new Form BD or, in special instances, amend the predecessor broker-dealer's Form BD within 30 days after such succession. The filing should indicate that the applicant is a successor. See also, the instructions to Form BD. When a registered broker-dealer stops doing business, it must file a Form BDW http: This form requires the broker-dealer to disclose the amount of any funds or securities it owes customers, and whether it is the subject of any proceedings, unsatisfied judgments, liens, or customer claims.
These disclosures help to ensure that a broker-dealer's business is concluded in an orderly manner and that customers' funds and securities are protected. Form BDW may also be used by a broker-dealer to withdraw from membership with particular SROs, or to withdraw from registration with particular states, without withdrawing all of its registrations and memberships. The SEC may also cancel a broker-dealer's registration if it finds that the firm is no longer in existence or has ceased doing business as a broker-dealer.
Security futures, which are contracts of sale for future delivery of a single security or a narrow-based security index, are regulated as both securities by the SEC and as futures by the Commodity Futures Trading Commission "CFTC".
Federal law permits firms already registered with either the SEC or the CFTC to register with the other agency, for the limited purpose of trading security futures, by filing a notice. Specifically, firms registered as general purpose broker-dealers under Section 15 b of the Act may "notice" register with the CFTC. Section 15 b 12 of the Act provides a limited exception to this notice registration requirement for certain natural persons who are members of security futures exchanges.
However, futures commission merchants or introducing brokers that conduct a business in securities other than security futures must be registered as general-purpose broker-dealers. Broker-dealers, like other securities market participants, must comply with the general "antifraud" provisions of the federal securities laws. Broker-dealers must also comply with many requirements that are designed to maintain high industry standards. We discuss some of these provisions below. The "antifraud" provisions prohibit misstatements or misleading omissions of material facts, and fraudulent or manipulative acts and practices, in connection with the purchase or sale of securities.
Broker-dealers owe their customers a duty of fair dealing. This fundamental duty derives from the Act's antifraud provisions mentioned above. Under the so-called "shingle" theory, by virtue of engaging in the brokerage profession e. Based on this important representation, the SEC, through interpretive statements and enforcement actions, and the courts, through case law, have set forth over time certain duties for broker-dealers.
These include the duties to execute orders promptly, disclose certain material information i. SRO rules also reflect the importance of fair dealing. These rules generally require broker-dealers to observe high standards of commercial honor and just and equitable principles of trade in conducting their business.
The exchanges and the MSRB have similar rules. Broker-dealers generally have an obligation to recommend only those specific investments or overall investment strategies that are suitable for their customers. The concept of suitability appears in specific SRO rules such as NASD Rule and has been interpreted as an obligation under the antifraud provisions of the federal securities laws.
Under suitability requirements, a broker-dealer must have an "adequate and reasonable basis" for any recommendation that it makes. Reasonable basis suitability, or the reasonable basis test, relates to the particular security or strategy recommended. Therefore, the broker-dealer has an obligation to investigate and obtain adequate information about the security it is recommending.
A broker-dealer also has an obligation to determine customer-specific suitability. In particular, a broker-dealer must make recommendations based on a customer's financial situation, needs, and other security holdings. This requirement has been construed to impose a duty of inquiry on broker-dealers to obtain relevant information from customers relating to their financial situations and to keep such information current.
SROs consider recommendations to be unsuitable when they are inconsistent with the customer's investment objectives. The duty of best execution, which also stems from the Act's antifraud provisions, requires a broker-dealer to seek to obtain the most favorable terms available under the circumstances for its customer orders. This applies whether the broker-dealer is acting as agent or as principal.
The SRO rules also include a duty of best execution. For example, FINRA members must use "reasonable diligence" to determine the best market for a security and buy or sell the security in that market, so that the price to the customer is as favorable as possible under prevailing market conditions. A broker-dealer must provide its customers, at or before the completion of a transaction, with certain information, including:.
A broker-dealer may also be obligated under the antifraud provisions of the Act to disclose additional information to the customer at the time of his or her investment decision. Broker-dealers must notify customers purchasing securities on credit about the credit terms and the status of their accounts. A broker-dealer must establish procedures for disclosing this information before it extends credit to a customer for the purchase of securities. A broker-dealer must give the customer this information at the time the account is opened, and must also provide credit customers with account statements at least quarterly.
A "short sale" is generally a sale of a security that the seller doesn't own or for which the seller delivers borrowed shares. Regulation SHO was adopted in to update short sale regulation in light of numerous market developments since short sale regulation was first adopted in Some of the goals of Regulation SHO include:. Establishing uniform "locate" and "close-out" requirements in order to address problems associated with failures to deliver, including potentially abusive "naked" short selling.
Regulation SHO requires a broker-dealer to have reasonable grounds to believe that the security can be borrowed so that it can be delivered on the date delivery is due before effecting a short sale order in any equity security.
This "locate" must be made and documented prior to effecting the short sale. Market makers engaged in bona fide market making are exempted from the "locate" requirement. Regulation SHO imposes additional delivery requirements on broker-dealers for securities in which there are a relatively substantial number of extended delivery failures at a registered clearing agency "threshold securities".
For instance, with limited exception, Regulation SHO requires brokers and dealers that are participants of a registered clearing agency to take action to "close-out" failure-to-deliver positions "open fails" in threshold securities that have persisted for 13 consecutive settlement days. Closing out requires the broker or dealer to purchase securities of like kind and quantity.
Until the position is closed out, the broker or dealer and any broker or dealer for which it clears transactions for example, an introducing broker may not effect further short sales in that threshold security without borrowing or entering into a bona fide agreement to borrow the security known as the "pre-borrowing" requirement. Creating uniform order marking requirements for sales of all equity securities.
This means that a broker-dealer must mark orders as "long" or "short. Regulation M is designed to protect the integrity of the securities trading market as an independent pricing mechanism by governing the activities of underwriters, issuers, selling security holders, and other participants in connection with a securities offering.
These rules are aimed at preventing persons having an interest in an offering from influencing the market price for the offered security in order to facilitate a distribution. The adopting release for Regulation M is available at http: Rule of Regulation M generally prohibits underwriters, broker-dealers and other distribution participants from bidding for, purchasing, or attempting to induce any person to bid for or purchase, any security which is the subject of a distribution until the applicable restricted period has ended.
An offering's "restricted period" begins either one or five business days depending on the trading volume value of the offered security and the public float value of the issuer before the day of the offering's pricing and ends upon completion of the distribution.
Rule contains various exceptions that are designed to permit an orderly distribution of securities and limit disruption in the market for the securities being distributed. In addition, the following activities, among others, may be excepted from Rule , if they meet specified conditions:.
Rule of Regulation M prohibits issuers, selling security holders, and their affiliated purchasers from bidding for, purchasing, or attempting to induce any person to bid for or purchase, any security which is the subject of a distribution until after the applicable restricted period.
Rule of Regulation M governs passive market making by broker-dealers participating in an offering of a Nasdaq security. Rule of Regulation M governs stabilization transactions, syndicate short covering activity, and penalty bids. Rule of Regulation M prevents manipulative short sales prior to pricing an offering by prohibiting the purchase of offering securities if a person sold short the security that is the subject of the offering during the Rule restricted period.
The rule contains exceptions for bona fide purchases, separate accounts, and investment companies. The SEC and the courts interpret Section 10 b and Rule 10b-5 under the Act to bar the use by any person of material non-public information in the purchase or sale of securities, whenever that use violates a duty of trust and confidence owed to a third party. Section 15 f of the Act specifically requires broker-dealers to have and enforce written policies and procedures reasonably designed to prevent their employees from misusing material non-public information.
Because employees in the investment banking operations of broker-dealers frequently have access to material non-public information, firms need to create procedures designed to limit the flow of this information so that their employees cannot use the information in the trading of securities.
Broker-dealers can use these information barriers as a defense to a claim of insider trading. Such procedures typically include:. NASD Rule provides that "no person associated with a member shall participate in any manner in a private securities transaction" except in accordance with the provisions of the rule. To the extent that any such transactions are permitted under the rule, prior to participating in any private securities transaction, the associated person must provide written notice to the member firm as described in the rule.
If compensation is involved, the member firm must approve or disapprove the proposed transaction, record it in its books and records, and supervise the transaction as if it were executed on behalf of the member firm. Other conditions may also apply. In addition, private securities transactions of an associated person may be subject to an analysis under Exchange Act Section 10 b and Rule 10b-5, as well as the broker-dealer supervisory provisions of Section 15 f described in Part V.
Regulation AC or Regulation Analyst Certification requires brokers, dealers, and persons associated with brokers or dealers that publish, distribute, or circulate research reports to include in those reports a certification that the views expressed in the report accurately reflect the analyst's personal views. The report must also disclose whether the analyst received compensation for the views expressed in the report. If the analyst has received related compensation, the broker, dealer, or associated person must disclose its amount, source, and purpose.
Regulation AC applies to all brokers and dealers, as well as to those persons associated with a broker or dealer that fall within the definition of "covered person. The SRO rules impose restrictions on analyst compensation, personal trading activities, and involvement in investment banking activities. The SRO rules also include disclosure requirements for research reports and public appearances. In addition, staff responses to frequently asked questions are available at http: Broker-dealers that are members of national securities exchanges are subject to additional regulations regarding transactions they effect on exchanges.
For example, except under certain conditions, they generally cannot effect transactions on exchanges for their own accounts, the accounts of their associated persons, or accounts that they or their associated persons manage. Exceptions from this general rule include transactions by market makers, transactions routed through other members, and transactions that yield to other orders. Exchange members may wish to seek guidance from their exchange regarding these provisions.
Section 11 d 1 of the Act generally prohibits a broker-dealer that participates in the distribution of a new issue of securities from extending credit to customers in connection with the new issue during the distribution period and for 30 days thereafter. Sales by a broker-dealer of mutual fund shares and variable insurance product units are deemed to constitute participation in the distribution of a new issue.
Therefore, purchase of mutual fund shares or variable product units using credit extended or arranged by the broker-dealer during the distribution period is a violation of Section 11 d 1. However, Exchange Act Rule 11d permits a broker-dealer to extend credit to a customer on newly sold mutual fund shares and variable insurance product units after the customer has owned the shares or units for 30 days. Section 11 d 2 of the Act requires a broker-dealer to disclose in writing, at or before the completion of each transaction with a customer, whether the broker-dealer is acting in the capacity of broker or dealer with regard to the transaction.
Regulation NMS addresses four interrelated topics that are designed to modernize the regulatory structure of the U. Regulation NMS also updates and streamlines the existing Exchange Act rules governing the national market system previously adopted under Section 11A of the Exchange Act, and consolidates them into a single regulation. For additional details regarding Regulation NMS, see http: Broker-dealers that are exchange specialists or Nasdaq market makers must comply with particular rules regarding publishing quotes and handling customer orders.
These two types of broker-dealers have special functions in the securities markets, particularly because they trade for their own accounts while also handling orders for customers. These rules, which include the "Quote Rule" and the "Limit Order Display Rule," increase the information that is publicly available concerning the prices at which investors may buy and sell exchange-listed and Nasdaq National Market System securities.
The Quote Rule requires specialists and market makers to provide quotation information to their self-regulatory organization for dissemination to the public. The quote information that the specialist or market maker provides must reflect the best prices at which he is willing to trade the lowest price the dealer will accept from a customer to sell the securities and the highest price the dealer will pay a customer to purchase the securities.
A specialist or market maker may still trade at better prices in certain private trading systems, called electronic communications networks, or "ECNs," without publishing an improved quote.
This is true only when the ECN itself publishes the improved prices and makes those prices available to the investing public.
Thus, the Quote Rule ensures that the public has access to the best prices at which specialists and market makers are willing to trade even if those prices are in private trading systems. Limit orders are orders to buy or sell securities at a specified price. The Limit Order Display Rule requires that specialists and market makers publicly display certain limit orders they receive from customers.
If the limit order is for a price that is better than the specialist's or market maker's quote, the specialist or market maker must publicly display it.
The rule benefits investors because the publication of trading interest at prices that improve specialists' and market makers' quotes present investors with improved pricing opportunities. For purposes of the regulation, an alternative trading system or ATS is any organization, association, person, group of persons, or system that constitutes, maintains, or provides a marketplace or facilities for bringing together purchasers and sellers of securities or for otherwise performing with respect to securities the functions commonly performed by a stock exchange as defined in Rule 3b under the Exchange Act.
Further, for purposes of the regulation, an ATS may not set rules governing the conduct of subscribers other than with respect to the use of the particular trading system , or discipline subscribers other than by exclusion from trading. To the extent that an ATS or the sponsoring broker-dealer seeks to establish conduct or disciplinary rules, the entity may be required to register as a national securities exchange or obtain a Commission exemption from exchange registration based on limited trading volume.
In order to acquire the status of an ATS, a firm must first be registered as a broker-dealer, and it must file an initial operation report with respect to the trading system on Form ATS at least 20 days before commencing operation. The initial operation report must be accurate and kept current. The Commission does not issue approval orders for Form ATS filings; however, the Form ATS is not considered filed unless it complies with all applicable requirements under the Regulation. Regulation ATS contains provisions concerning the system's operations, including: An ATS must also comply with any applicable SRO rules and with state laws relating to alternative trading systems and relating to the offer or sale of securities or the registration or regulation of persons or entities effecting securities transactions.
Finally, an ATS may not use in its name the word "exchange," or terms similar to the word "exchange," such as the term "stock market. For further information on the operation and regulation of alternative trading systems, see the adopting release for Regulation ATS at http: Most broker-dealers that effect transactions in "penny stocks" have certain enhanced suitability and disclosure obligations to their customers. Penny stocks include the equity securities of private companies with no active trading market if they do not qualify for one of the exclusions from the definition of penny stock.
Before a broker-dealer that does not qualify for an exemption 9 may effect a solicited transaction in a penny stock for or with the account of a customer it must: The broker-dealer also must wait at least two business days after sending the customer the risk disclosure document and the suitability statement before effecting the transaction.
In addition, Exchange Act Rules 15g-3 through 15g-6 generally require a broker-dealer to give each penny stock customer:. Broker-dealers, including foreign broker-dealers registered with the Commission and unregistered broker-dealers in the United States, must comply with Regulation S-P, See 17 CFR Part even if their consumers are non-U.
These notices must be clear and conspicuous, and must accurately reflect the broker-dealer's policies and practices. Before disclosing nonpublic personal information about a consumer to a nonaffiliated third party, a broker-dealer must first give a consumer an opt-out notice and a reasonable opportunity to opt out of the disclosure.
There are exceptions from these notice and opt-out requirements for disclosures to other financial institutions under joint marketing agreements and to certain service providers. There also are exceptions for disclosures made for purposes such as maintaining or servicing accounts, and disclosures made with the consent or at the direction of a consumer, or for purposes such as protecting against fraud, reporting to consumer reporting agencies, and providing information to law enforcement agencies.
In addition, it includes a safeguards rule that requires a broker-dealer to adopt written policies and procedures for administrative, technical, and physical safeguards to protect customer records and information. Further, it includes a disposal rule that requires a broker-dealer other than a broker-dealer registered by notice with the Commission to engage solely in transactions in securities futures that maintains or possesses consumer report information for a business purpose to take reasonable measures to protect against unauthorized access to or use of the information in connection with its disposal.
Recently proposed amendments which would further strengthen the privacy protections under Regulation S-P are available at http: Broker-dealers offering certain types of accounts and services may also be subject to regulation under the Investment Advisers Act. See Section a 11 of the Investment Advisers Act. In general, a broker-dealer whose performance of advisory services is "solely incidental" to the conduct of its business as a broker-dealer and that receives no "special compensation" is excepted from the definition of investment adviser.
Thus, for example, a broker-dealer that provides advice and offers fee-based accounts i. Finally, under the same proposed rule, a broker-dealer that is registered under the Exchange Act and registered under the Investment Advisers Act would be an investment adviser solely with respect to those accounts for which it provides services that subject the broker-dealer to the Investment Advisers Act.
Pursuant to the rules of self-regulatory organizations, broker-dealers are required to arbitrate disputes with their customers, if the customer chooses to arbitrate. The purpose of this rule is to require a broker-dealer to have at all times enough liquid assets to promptly satisfy the claims of customers if the broker-dealer goes out of business.
Under this rule, broker-dealers must maintain minimum net capital levels based upon the type of securities activities they conduct and based on certain financial ratios. Broker-dealers that do not clear and carry customer accounts can operate with lower levels of net capital. This rule protects customer funds and securities held by broker-dealers. Under the rule, a broker-dealer must have possession or control of all fully-paid or excess margin securities held for the account of customers, and determine daily that it is in compliance with this requirement.
The broker-dealer must also make periodic computations to determine how much money it is holding that is either customer money or obtained from the use of customer securities.
If this amount exceeds the amount that it is owed by customers or by other broker-dealers relating to customer transactions, the broker-dealer must deposit the excess into a special reserve bank account for the exclusive benefit of customers. This rule thus prevents a broker-dealer from using customer funds to finance its business.
Broker-dealers must make and keep current books and records detailing, among other things, securities transactions, money balances, and securities positions. They also must keep records for required periods and furnish copies of those records to the SEC on request. These records include e-mail. Broker-dealers also must file with the SEC periodic reports, including quarterly and annual financial statements. The annual statements generally must be certified by an independent public accountant.
In addition, broker-dealers must notify the SEC and the appropriate SRO 12 regarding net capital, recordkeeping, and other operational problems, and in some cases file reports regarding those problems, within certain time periods. This gives us and the SROs early warning of these problems. Certain broker-dealers must maintain and preserve certain information regarding those affiliates, subsidiaries and holding companies whose business activities are reasonably likely to have a material impact on their own financial and operating condition including the broker-dealer's net capital, liquidity, or ability to conduct or finance operations.
Broker-dealers must also file a quarterly summary of this information. This information is designed to permit the SEC to assess the impact these entities may have on the broker-dealer. In addition to the provisions discussed above, broker-dealers must comply with other requirements.
The appropriate SRO generally inspects newly-registered broker-dealers for compliance with applicable financial responsibility rules within six months of registration, and for compliance with all other regulatory requirements within twelve months of registration. A broker-dealer must permit the SEC to inspect its books and records at any reasonable time. In general, all broker-dealers must register in the lost and stolen securities program. The limited exceptions include broker-dealers that effect securities transactions exclusively on the floor of a national securities exchange solely for other exchange members and do not receive or hold customer securities, and broker-dealers whose business does not involve handling securities certificates.
Broker-dealers must report losses, thefts, and instances of counterfeiting of securities certificates on Form XF-1A, and, in some cases, broker-dealers must make inquiries regarding securities certificates coming into their possession. A registration form can be obtained from Securities Information Center, P. Box , Boston, MA For registration and additional information, see the SIC's website at https: Generally, every partner, officer, director, or employee of a broker-dealer must be fingerprinted and submit his or her fingerprints to the U.
This requirement does not apply, however, to broker-dealers that sell only certain securities that are not ordinarily evidenced by certificates such as mutual funds and variable annuities or to persons who do not sell securities, have access to securities, money or original books and records, and do not supervise persons engaged in such activities.
A broker-dealer claiming an exemption must comply with the notice requirements of Rule 17f Broker-dealers have broad obligations under the Bank Secrecy Act "BSA" 13 to guard against money laundering and terrorist financing through their firms. The BSA, its implementing regulations, and Rule 17a-8 under the Exchange Act require broker-dealers to file reports or retain records relating to suspicious transactions, customer identity, large cash transactions, cross-border currency movement, foreign bank accounts and wire transfers, among other things.
Firms must develop and implement a written anti-money laundering compliance program, approved in writing by a member of senior management, which is reasonably designed to achieve and monitor the member's ongoing compliance with the requirements of the BSA and its implementing regulations.
Under this obligation, firms must:. For a compilation of key anti-money laundering laws, rules and guidance applicable to broker-dealers, see Anti-Money Laundering Source Tool http: OFAC administers and enforces economic and trade sanctions based on US foreign policy and national security goals against targeted foreign countries, terrorists, international narcotics traffickers, and those engaged in activities related to the proliferation of weapons of mass destruction.
OFAC's sanctions programs are separate and distinct from, and in addition to, the anti-money laundering requirements imposed under the BSA on broker-dealers. OFAC programs are also strict liability programs — there are no safe harbors and no de minimis standards, although having a comprehensive compliance program in place could act as a mitigating factor in any enforcement action. OFAC publishes regulations implementing each of its programs, which include trade restrictions and asset blockings against particular countries and parties tied to terrorism, narcotics trafficking, proliferation of weapons of mass destruction, as well as a number of programs targeting members of certain foreign jurisdictions.
As part of its efforts to implement these programs, OFAC publishes a list of Specially Designated Nationals, which is frequently updated on an as-needed basis.
This screening should include originators or recipients of wire and securities transfers. The Commission, Federal Reserve Board, and Comptroller of the Currency published an interagency White Paper emphasizing the importance of core clearing and settlement organizations and establishing guidelines for their capacity and ability to restore operations within a short time of a wide-scale disruption.