The Brokerage Business



Every investor who wishes to transact business in the securities market will need the services of a brokerage firm unless such an investor is a member of an organized exchange or a registered dealer in securities.


Brokerage firms and dealers insecurities can be classified according to the three broad functions they perform. They function as:

Investment Bankers

Brokerage firms act as investment bankers because they sell securities to the public  without using  the  facilities of  an  exchange. Investment  bankers normally buy new issue from the issuer at an agreed price and hope to resell it at a higher price to the general public. In this capacity, investment bankers are said to underwrite an issue. Sales through an investment banker can take the  form of  best-efforts  or agency  agreement.  In this  case,  the investment banker  does  not underwrite  the  issue but  use  his  best  effort to  sell  it. Any unsold  securities  will be  returned  to the  issuer.  This best-efforts  activity  will normally be  used  in  the  sale of  new  and small companies‟ shares  that  are thought to be highly risky.

As Buyers And Sellers Of Securities On Behalf Of Customers

A brokerage firm functions as a buyer and seller of securities for customers. It is this function that most  brokerage firms  are  known  by  the  investing  public and the function with which the individual investor comes in contact with the broker. A broker trading in listed securities is acting as an agent on behalf of a client. Compensation  for  this  service  is  in  the  form  of commission.  It is important  that  the  brokerage  firm  exercises  care  and  demonstrate  a reasonable amount of skill in filling customers orders. The brokerage firm may be  liable  for  any  losses  that  result  from  its  mistake.  

The  care with which brokerage firm issues orders is determined by what is reasonable practice in the  brokerage business.  The  exercise of  broker’s  skill requires  that instructions  are followed  and  the order  placed  in the  market  where the securities  are  traded fastest  possible  time. The  broker  is required  to  refrain from making  secret  profits or  crossing  orders in  its  office by  acting  as both dealers and brokers in the same transaction. The brokerage firm cannot act as  dealer  and broker  in  the same  transaction  because there could  be  a conflict of  interest and  this could  result  in the  client  paying double commission. All  Securities listed on an exchange must be traded on the floor of that exchange. They cannot be executed off the floor by the broker except in certain circumstances.

As Principal-Making Markets in Securities

The  broker functions  as  a principal  and  makes markets  in  securities. The broker’s main principal activity is to bring sellers and buyers together. Thus, the  brokerage  firm is  a  middleman. As  a  true  intermediary, brokers  bring sellers  and buyers  together,  thus creating  a  market. This  is  generally done through over-the-counter issue, but can also take place in listed securities. If the securities to be traded are not listed on an exchange but traded in over the-counter market, the broker might own the shares himself.He/she will be acting  as  a principal  or  dealer in  the  transaction. Many  brokerage  firms specialize  in making  a  market in  a  certain securities.  In  this case  the brokerage firm will sell the security to the customer at the asking price and will not  charge a  commission  for handling  the  transaction. The  brokerage  firm makes its fee from the difference between the price it pays for the securities for its own account and the price it sells them to the investor. The difference between  the asked  and  the bid  price  is called  the  spread and  is  the compensation for making a market in that security.

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