What is a Broker?

A broker is a person who acts as an intermediary between a person who wants to invest funds and a securities exchange that sells stocks. The reason investors need a broker is that securities exchanges will only accept an order from a company or individual who has a membership with an exchange. Brokers step in to fill that need. They receive compensation from client fees, commissions, or direct payment from a security exchange.

Primary Functions of a Broker

The main service investors expect from their broker is for that person to initiate orders on their behalf. However, they also depend on brokers to conduct research and provide market intelligence. Some brokers sell other financial services and products offered by their firm. One example is access to private client offerings that offer customized solutions to clients with a high net worth.

Only wealthy people could afford to hire a broker to obtain access to the stock market in the past. However, the introduction of online brokerage options caused a huge spike in the demand for brokers. Financial professionals known as discount brokers soon came on the scene in response to the demand. The result was that people could start investing for a lower cost, but the trade-off was that they did not receive personalized advice.

Other Differences Between Full-Service and Discount Brokers

Full-service brokers offer a range of financial services that include retirement planning, investment advice, and market research. Investors should expect to pay higher broker fees on their trades because of this. Brokerage firms compensate full-service brokers according to how many investment products they sell and total volume of trading. Some full-service brokers offer to manage an investor’s account for an additional fee.

Discount brokers have the authority to execute multiple types of trades on an investor’s behalf. Their commission rates vary but typically do not exceed $15 per transaction. They can charge lower fees because they process higher volume and incur lower costs themselves. Most discount brokers receive a standard paycheck rather than commission. Discount brokers attract larger numbers of investors because they offer an online trading option that attracts beginning and self-directed traders.

Brokers Must Register with FINRA

Federal law requires all brokers to register with FINRA, which stands for Financial Industry Regulatory Authority. The role of FINRA is to protect investors and market integrity for the purpose of helping to create vibrant financial markets in the United States. FINRA is a non-profit government agency that oversees all American-based brokers and dealers. Registration with FINRA ensures that the broker has undergone testing and qualified for licensure.

Congress has provided authorization to FINRA to protect American investors. The organization oversees more than 624,000 brokers from across the United States and analyzes billions of market events every day to ensure fair, honest, and transparent operations. Under FINRA regulations, a broker must have a legitimate reason for recommending a specific investment or other financial product. Brokers must also demonstrate that they understand their client’s savings goals and based their recommendations on their client’s goals and not their own.

Examples of Brokers

Some of the hundreds of thousands of brokers registered with FINRA may use their designation as a broker to provide different financial services. It is a common practice for proprietary trading firms to register as brokers to allow themselves and their clients direct access to exchanges. At the same time, these brokers do not offer direct broker services to their clients. These types of brokers differ from both full-service and discount brokers.

Full-service brokers prefer to work with individuals who have a high net worth in order to offer them multiple services. Well-known examples of full-service brokers include Bank of America Merrill Lynch, Goldman Sachs, and Morgan Stanley. Companies such as these can use their status as a registered broker to initiate large block equity trades for themselves or their clients.

Some full-service brokers such as Cantor Fitzgerald, Oppenheimer, and Piper Jaffray, focus more on offering specialized services. Examples include research and trade execution. Another focus area might be personalized consultation, wealth management, and retirement planning. Firms offering these types of services include Edward Jones, LPL Financial, and Raymond James.

Discount brokers made some significant business model changes starting in 2019. The biggest difference from previous practices was that discount brokers began offering no commission trading on some or all client equity trades. Charles Schwab, E-Trade, Fidelity, Interactive Brokers, and Robinhood are all common examples.

If you have additional questions about brokers or the differences between them, please do not hesitate to contact us.

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