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Difficulty: MediumBroker-Dealers, Investment Advisers, and Intermediaries

When a financial firm fills a customer's buy order using securities held in its own proprietary inventory, in what capacity is the firm operating, and how must its remuneration be disclosed on the trade confirmation?

  1. Operating in a principal capacity and compensated via a markup added to the priceAnswer
  2. B
    Operating in an agency capacity and compensated via a commission fee
  3. C
    Operating in an underwriting capacity and compensated via a primary market concession
  4. D
    Operating in a clearing capacity and compensated via a central depository settlement fee

Answer

Operating in a principal capacity and compensated via a markup added to the price
When a firm sells securities directly out of its own inventory to a customer, it is acting as a dealer (principal). On the trade confirmation, principal transactions must disclose the compensation earned as a markup (on purchase orders) or markdown (on sell orders).

Step-by-Step Solution

1
Identify the role of the firm based on the source of the securities.
The firm fills the trade using its own proprietary inventory, which defines a dealer (principal) role.
Broker-dealers trading for their own account act as principals.
2
Determine the appropriate compensation method for a principal trade.
Principal transactions are compensated through a markup (when selling to a client) or markdown (when buying from a client).
Commissions are reserved exclusively for agency transactions.

Key Concept

Broker-Dealer Capacities (Agent vs. Principal)
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Topics

Broker-Dealers, Investment Advisers, and Intermediaries

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