Broker

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A broker (also known as a stockbroker) is a regulated professional individual, usually associated with a brokerage firm or broker-dealer, who buys and sells exchange-traded funds (ETFs), stocks and other securities for both retail and institutional clients, through a stock exchange or over the counter, in return for a fee or commission. Stockbrokers are known by numerous professional designations, depending on the license they hold, the type of securities they sell, or the services they provide.

Licensing requirements

In the United States, a stockbroker must pass both the Series 7[1] and either the Series 63[2] or the Series 66[3] exams in order to be properly licensed.

Broker types

In the United States two types of brokerage companies predominate: full service brokerages and discount brokerages. The main differences between these financial institutions are the levels of service offered, and the cost of services. Both brokerages offer cash accounts and margin accounts.

Full service broker

A full service broker provides clients an all-inclusive selection of services such as advice on security selection and financial planning.[4] A full service broker establishes a one on one relationship with the client and according to what is determined suitable for the client's needs and risk profile,[5] offers advice on the purchase of securities.

Full service brokers normally receive commissions for security transactions, and since recommendations employ the investment firm's research reports, the commissions on stock sales are higher than those charged by discount brokerages. Commissioned sales compensation introduces a potential conflict of interest in that the broker may sell products for the commission income rather than lower cost products that may be more in line with the investor's best interest. Full service brokers primarily sell load mutual funds charging front-end or redemption sales loads, in combination with 12b-1 marketing fees. Other common products include commission-fee unit investment trusts; and such instruments as illiquid private real estate investment trusts (REITs).

If the full service broker has passed the requisite series 6 exams, the broker may also sell commissioned insurance based products such as variable annuities and equity-indexed annuities.

A client may open two types of brokerage accounts, distinguished by the amount of authority granted the broker.[6]

  • Advisory account: A brokerage account in which a broker can only make limited investment decisions without consulting the investor. Such decisions must be made in accordance with the customer's stated investment goals.[7]
  • Discretionary account: A discretionary account is an account that allows a broker to buy and sell securities without the client's consent. The client must sign a discretionary disclosure with the broker as documentation of the clients consent.[8]

Wrap accounts

Full service brokerages offer an alternate pricing model through various wrap programs. Instead of charging sales commissions, the brokerage charges a set fee, known as a wrap fee. A wrap fee is a comprehensive charge levied by an investment manager or investment advisor to a client for providing a bundle of services, such as investment advice, investment research and brokerage services.[9] A wrap account might hold individual stocks or exchange traded funds. A mutual fund wrap account holds mutual funds. The wrap fee most often ranges from 0.50% to 2.00% of assets under management.[10] Keep in mind that the wrap fee is a separate fee and that the investor is also bearing the underlying expense ratio for the mutual fund or exchange-traded fund investments.

Discount broker

A discount broker is a brokerage house featuring relatively low commission rates in comparison to a full-service broker.[11] The first U.S. discount brokerage firms were established soon after May 1, 1975, when brokerages changed from a fixed commission for securities transactions to a negotiated one.[12] The expansion of the internet between 1990 - 2000 triggered the development of on-line trading, so that many discount brokers are predominately on-line brokers.

Discount brokerage eliminates the costs of personalized advice as do-it-yourself investors directly purchase stocks, mutual funds, or exchange-traded funds. For the index fund investor, most discount brokers offer no-trade fee index funds, a specified number of commission-free trades, or a select list of no-commission fee exchange-traded funds.

Broker malfeasance

I fear that in the financial sector fraud has become a feature and not a bug.

— Luigi Zingales, Does Finance Benefit Society?, prepared remarks in his 2015 American Finance Association presidential address[13]

Research by Egan, Matvos, and Seru (2016) indicates that broker misconduct is a significant risk facing investors. More than 12% of financial advisers have a disclosure on their record, and approximately 7% have been disciplined for misconduct and/or fraud. Prior offenders are five times as likely to engage in new misconduct as the average financial adviser. Firms discipline misconduct: approximately half of financial advisers lose their job after misconduct. The labor market partially undoes firm-level discipline: of these advisers, 44% are reemployed in the financial services industry within a year.[14]

The Financial Industry Regulatory Authority (FINRA) provides FINRA BrokerCheck, a free tool to help investors check the professional background of current and former FINRA-registered securities firms and brokers.[note 1] It should be the first resource investors turn to when choosing whether to do business with a particular broker or brokerage firm. Note that financial advisers can also be registered brokers.[15]

Notes

  1. FINRA’s BrokerCheck Program provides the following information on brokerage firms:
    • A summary report that provides an overview of the firm
    • A profile of the firm’s ownership
    • A firm history, including any mergers, acquisitions or name changes
    • A description of the firm’s operations, listing its active licenses and registrations, the types of businesses it conducts and other details
    • Arbitration awards and any regulatory or disciplinary events on the firm’s records
    BrokerCheck provides the following information on individual brokers:
    • A summary report that provides an overview of the broker and his or her credentials
    • A listing of the broker’s qualifications, including current registrations or licenses and industry exams that the broker has passed
    • Previous employment data for the past 10 years, both in and outside the securities industry, as reported by the broker
    • Any customer disputes or regulatory and disciplinary events on the broker’s record.

See also

References

  1. SEC.gov | Series 7 Examination, viewed February 28, 2016.
  2. Series 63 - Uniform Securities Agent State Law Examination | FINRA.org, viewed February 28, 2016.
  3. Series 66 - Uniform Combined State Law Examination | FINRA.org, viewed February 28, 2016.
  4. Full service broker:Financial Glossary. 2011. Campbell R. Harvey, Retrieved 10 March 2016
  5. Suitability, SEC. Retrieved 11 March 2016
  6. Accounts – Opening A Brokerage Account, SEC, Retrieved 10 March 2016
  7. Definition, Farlex Financial Dictionary, Retrieved 10 March 2016
  8. Definition, Investopedia, Retrieved 10 March 2016
  9. Wrap Fee Definition, Investopedia, Retrieved 12 March 2016
  10. Mutual fund wrap account, Investopedia, Retrieved 12 March 2016.
  11. Discount broker:Financial Glossary. 2011. Campbell R. Harvey, Reviewed 10 March 2016
  12. May Day Definition, Retrieved 12 March 2016.
  13. American Finance Association presidential address, Retrieved 13 March 2016
  14. Egan, Mark; Matvos, Gregor; Seru, Amit (March 1, 2016). The Market for Financial Adviser Misconduct. SSRN. http://ssrn.com/abstract=2739170.
  15. FINRA BrokerCheck

External links