Series 65: 7.1.3 Principal Vs. Agency Transactions

7.1.3  Principal vs. Agency Transactions

Secondary market transactions are conducted primarily by brokers and dealers. A firm may act as one or the other, but not both on any particular transaction. When a firm acts as a broker, the firm serves as an agent, or matchmaker, for the buyer and the seller. The broker gets paid for the service by charging a commission. Transactions where a firm is acting as a broker are called agency transactions, since the firm is acting as an agent for the buyer and seller. In the OTC market, a firm that helps a client execute a trade but is not itself a market maker in the stock is performing in an agency capacity. In this case, the firm earns a commission rather than a markup on the trade.

When the firm acts as a dealer, in contrast, it is putting its own money at risk, buying or selling securities out of its own inventory. Rather than brokering a deal for another party, the dealer is a principal to the trade, since the transaction is adding to or depleting the dealer’s own account. For this reason, dealer transactions are often referred to as principal transactions.

The dealer facilitates the trade by posting a bid-and-ask price, and it profits on the spread between the two and any markup or markdown that it may receive. Transactions in which a firm acts as a dealer are called principal transactions. In this type of transaction, a dealer will often add a markup to the quoted price of the security. When a firm includes the markup in th