Broker Dealer Models
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Broker Dealer Types:
 General
Securities
 Introducing/Fully Disclosed
 Clearing
 Franchise/Independent Contractor
 Micro-cap
 Mutual Fund
 Discount
 On-line
 Bank Affiliated
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General Securities Broker Dealer
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Description
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Also known as “full service” or “wire house” B/D
Generally, “Wall Street” firms such as Merrill Lynch
and Morgan Stanley.
Agents are generally domiciled in large branch offices
where business is conducted by phone with “face to
face” supervision by branch managers.
Agents are generally considered to be “employees”
Formal employee training program
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General Securities Broker Dealer
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Normally do not allow or restrict outside business
activities
Provide all types of services
• Execution
• Clearing
• Safekeeping
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Typically offer “managed accounts” for customers
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General Securities Broker Dealer
 Advantages:
 Nationwide name recognition and advertising
campaigns
 Complete control of transaction processing
• No reliance on third party for clearing activity
 Retain all commissions
• Do not pay a clearing fee to a third party to perform “back
office” functions
 Additional revenue generated through margin debits
(excess interest charged to customers over B/D
borrowing rate) and stocks loaned (practice of lending
stock for a fee to other B/Ds)
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General Securities Broker Dealer
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Capture multiple revenue streams
Able to create, underwrite and distribute products
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General Securities Broker Dealer
 Disadvantages
 Costly initial set-up and continual operating expenses
• Requires additional “back office” personnel and procedures.
 Considerable regulatory compliance responsibilities
imposed
 Greater potential monetary and compliance liability
 Experienced personnel required
 Increased net capital requirements
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General Securities Broker Dealer
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Regulatory Issues
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Proprietary products
Supervision
Electronic records retention
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Introducing/Fully Disclosed
Broker Dealer
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Description
 The vast majority of broker dealers are this type
 Defined as a broker dealer maintaining a formal
written agreement with another broker dealer
whereby the introducing dealer does not carry
customer accounts (hold customer funds or securities
or confirm transactions).
• The agreement specifies the terms under which execution
and record keeping will be maintained.
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Introducing/Fully Disclosed
Broker Dealer
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Although introducing firms will have “back offices” and
record creation and retention requirements, they enter
into these agreements to reduce operating expenses.
Required to promptly transmit money and securities.
The phrases “account carried by” or “account
courtesy of” will be on firm’s documents.
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Introducing/Fully Disclosed
Broker Dealer
 Advantages
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Significantly less initial start-up and operating
costs than general and self-clearing brokerdealers
Less administrative and compliance
responsibilities
Lower net capital requirement
Reduced back office expenses
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Introducing/Fully Disclosed
Broker Dealer
 Disadvantages
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Total reliance upon clearing firm for settling
transactions, loss of “back office” control
Sizeable portion of revenues may be paid in
clearing costs (i.e., clearing deposit,
compliance reports, etc.)
Must share participation in margin debits and
stock loans with clearing firm
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Clearing Broker Dealer
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Description
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Enters into agreements with introducing broker
dealer to “carry” or “clear” accounts
A substantial number of clearing firms are affiliated
with or are divisions of a General Securities
Broker Dealer
Handles trade executions and transfers
Provides safekeeping (of customer
funds/securities) services
Most states require registration of these types of
firms as they hold customer funds and securities
for customers of your state.
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Clearing Broker Dealer
 Advantages:
 Complete control of transaction processing
• No reliance on third party.
 Additional revenue generated through margin
debits (excess interest charged to customers over
B/D borrowing rate) and stock loaned (practice of
lending stock for a fee to other B/Ds)
 No retail sales force means less compliance
issues.
 Able to maximize use of technology to automate
processes and reduce expenses.
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Clearing Broker Dealer
 Disadvantages
 Total reliance upon introducing dealers to acquire
customers.
 Costly initial set-up and continual operating expenses.
• Requires additional “back office” personnel and procedures.
 Greater potential monetary liability.
 Experienced operational personnel required.
 Increased net capital requirements.
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Franchise/Independent
Contractor Broker Dealer
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Description
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Business model under which the firm operates
pursuant to a network of franchise offices and agents
that are independent contractors for tax purposes.
The firm may have started out as a small operation
but has grown to have a large number of branch
offices that are geographically disbursed and operate
with one or two persons in each office.
Many outside business activities
Limited or no on-site supervision
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Franchise/Independent
Contractor Broker Dealer
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Each office may operate under a name other than
that of the registered broker dealer.
The terms by which the location operates in
conjunction with the dealer are defined in the
franchise agreement.
The agreement sets forth the terms by which
areas such as trading, record keeping, supervision
and expenses are handled.
Franchises bear most of their own expenses (rent,
insurance, staff salaries). In return, they receive
commission payouts of up to 90-95%.
Compliance resources in the dealer’s home office
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Franchise/Independent
Contractor Broker Dealer
Business cards and correspondence used by a franchise, such as
Reilly Financial, Inc., must disclose the name of the dealer with
whom the franchise is affiliated and that the registered dealer, rather
than the franchise company, is a member of the FINRA and SIPC.
William F. Reilly, Jr.
Agent
Franchise
REILLY FINANCIAL, INC.
123 Main Street
Miami, FL 33131
Phone (305) 123-4567
Registered
Dealer
Securities offered through XYZ Securities
Member FINRA and SIPC
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Franchise/Independent
Contractor Broker Dealer
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Independent contractors
The term is not discussed in any securities rule or
regulation but is used for tax purposes.
 A Broker Dealer has supervisory responsibility over
its independent contractors.
 Broker Dealer and agent relationships may be
spelled out pursuant to independent contractor
agreements.
 The agent may enter into this agreement with the
broker dealer or the franchise branch office.
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Franchise/Independent
Contractor Broker Dealer
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Advantages
 Franchise operator maintains name recognition.
 Example: Potential customers may not know the
name of the broker dealer but, the name of the
franchise may be well known.
 Profits of the branch are maintained by the franchise
owner rather than the registered firm.
 Generally neither the firm nor the franchise owners
pay benefits (i.e., medical insurance) to independent
contractors.
 Broker dealer can expand rapidly with little increase in
costs because substantially all operating expenses
are paid by the agent.
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Franchise/Independent
Contractor Broker Dealer
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Disadvantages
 Occasionally, individuals who are statutorily
disqualified or have extensive disciplinary problems
associate themselves with or own franchise branch
offices.
 Franchise branch offices may be operating more like
an independent broker dealer than a branch.
 Supervision is a problem. Harder to detect serious
violations such as theft or selling away.
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Franchise/Independent Contractor
Broker Dealer
 Disadvantages
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Franchise branch offices and independent contractors
tend to have problems caused by selling away and/or
unauthorized outside business activities.
Agents may be geographically dispersed
Lack of close, onsite supervision may result in
regulatory issues
Agent may have little or no loyalty to dealer’s image
or brand name
Some agents work part-time
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Franchise/Independent Contractor
Broker Dealer
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Regulatory Issues
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Agents see themselves as “entrepreneurs.”
Client may not understand which entity is registered.
Advertising and public communication issues
Inadequate branch office audits or follow up to red
flags.
Compliance staffing may not be able to keep pace
with the expansion of business products and
increased numbers of agents and branch offices.
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Microcap/“Penny Stock” Broker
Dealer
 Description
 Sometimes referred to as “boiler rooms” dealing in
high-risk securities
 Characterized by high pressure sales tactics.
 May employ agents with extensive disciplinary history.
 Stocks they sell:
• Have generally little or no operating history.
• Are thinly capitalized and traded.
• May or may not be SEC reporting companies and therefore
lack transparency.
• Are often listed on the FINRA Over the Counter Bulletin
Board (OTCBB) or in the Pink Sheets.
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Microcap/“Penny Stock” Broker
Dealer
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Agents:
 Are often young professionals with little or no securities
experience.
 Make their living by making “cold calls.”
 Generally use scripts containing price guarantees,
misleading information, spamming, or unsupported
statements about the company.
 Generally sell “Blue Chip” stocks to “hook” customers then
move them to low-priced/high risk stocks.
 May receive undisclosed compensation or higher payout for
selling low-priced/high risk stocks.
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Microcap/“Penny Stock” Broker
Dealer
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Advantages
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Specialized firm serving a legitimate niche by
raising money for small or start up businesses
Required limited start up capital
Agents can make large amounts of money in
a short period of time
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Microcap/“Penny Stock” Broker
Dealer
 Disadvantages
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Pressure by management to sell a limited
product line
Poor customer retention
High rate of employee turnover
Firm may not have widespread name
recognition
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Microcap/“Penny Stock” Broker
Dealer
 Regulatory
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Issues
Fraud
Culture of greed
Self-funding private placements
Boiler–room tactics
Hidden control or ownership
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Limited Product Broker Dealer
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Description
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Generally serves as a “salesperson” offering various
limited products (i.e., mutual funds, variable annuities,
direct participation programs, etc.).
Orders are transmitted to the mutual fund sponsor on
either an “application” basis (customers’ monies and a
subscription application are sent to the mutual fund
sponsor) or on a “wire order” basis (mutual fund
orders are transmitted by phone or wire to the
sponsor without an application)
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Limited Product Broker Dealer
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Advantage
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Specialized firm requiring little capital expenditure or
operational expenses beyond commissions to its
salespersons and general office expenses.
Agents only need to pass Series 6 exam.
Limited products allow for a less sophisticated
supervisory system and agent training.
Products are well designed and marketed by the
issuers.
Sales support from third-party wholesalers.
Less start-up investment needed.
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Limited Product Broker Dealer
 Disadvantage
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Offers a limited product line to customers
Investor funds are “locked up” for extended
period of time
Limited incentive for agents to provide
ongoing review of customer accounts
Supervision relies heavily on electronic
reports, self-reporting and internal audits
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Limited Product Broker Dealer
 Regulatory
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Issues
Variable annuity suitability
Switching or 1035 exchanges
Supervision
Mutual fund breakpoints
Revenue sharing
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Discount Broker Dealer
 Description
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Characterized by minimal customer contact
with agents and few services offered.
Customers may pay extra for additional levels
of service.
Agents generally receive “unsolicited” calls via
“800” numbers rather than solicit customers.
Relies on advertising to draw customers.
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Discount Broker Dealer
 Advantages
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Low transaction costs
Ease of execution
Most investors conduct their own research
and choose their own securities
Limited number of employees
Agent’s advice is limited and many trades are
unsolicited
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Discount Broker Dealer
 Disadvantages
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Provide minimal, if any, advice to customers
Most investors using the services of discount
brokers believe their market knowledge is
sufficient to perform their own research and
make trade decisions.
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Discount Broker Dealer
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Regulatory Issues
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Customers’ ability to navigate a market crisis
without advice
Customer service
Advertising
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Online Broker
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Description
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Trades are placed with the firm via personal
computers.
Execution of trades occurs generally without any
personal contact.
Online firms offer help desk services.
Custodian for small IA clients.
Highly dependent on technology
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Online Broker Dealer
 Advantages
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Low transaction costs
Ease of execution
Investors perform their own research
 Disadvantages
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Hackers/Intruded accounts
Requires enhanced anti-money laundering
(AML) procedures
Investors perform their own research
Server/Systems Interruption
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Online Broker Dealer
 Regulatory
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Issues
Customers’ ability to navigate a market
crisis without advice
Customer service
Advertising
Hackers
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Bank Affiliated Broker Dealer
 Characteristics
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3rd party dealer under contract with bank
Broker dealer may operate using a DBA
Customers tend to be conservative
Face to face contact in the bank
Bank employees may help steer business
to the broker dealer
Compliance resources at home office
Agents may be “circuit riders”
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Bank Affiliated Broker Dealer
 Advantages
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Captive audience
Real time ability to know when clients have
bank funds to invest (CDs maturing)
Partner with bank – ability to piggyback on
customers’ trust of the bank
Bank employees are a referral network
Synergy with bank marketing efforts
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Bank Affiliated Broker Dealer
 Disadvantages
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Clients are generally less sophisticated
Need to spend time educating clients
Line between bank and broker dealer can be
blurred
Agents assigned to multiple office locations
(circuit riders)
Bank employees may be protective of bank
customers and work against the agent
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Bank Affiliated Broker Dealer
 Regulatory
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•
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Issues
Compliance with NASD Conduct Rule
2350
Suitability
Supervision
Networking Arrangements
Incentive Program
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