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Difficulty: Very hardBroker-Dealers, Investment Advisers, and Intermediaries

A wealth management firm holds dual registration as both an Investment Adviser (IA) and a Broker-Dealer (BD). A retail advisory client submits an order to purchase corporate bonds. To execute the order, the firm sells the bonds directly to the client from its own proprietary trading account. Under securities regulations, in what capacity is the firm operating for this transaction, and what compensation structure applies to the trade confirmation?

  1. The firm acts in a principal capacity as a dealer and receives compensation through a mark-up.Answer
  2. B
    The firm acts in an agency capacity as a broker and receives compensation through a commission.
  3. C
    The firm acts exclusively in an advisory capacity and is prohibited from receiving any transaction-based remuneration beyond its asset-based fee.
  4. D
    The firm acts as an underwriter in the primary market and receives compensation through an underwriting spread paid by the issuing corporation.

Answer

The firm acts in a principal capacity as a dealer and receives compensation through a mark-up.
When a broker-dealer sells securities directly from its proprietary inventory to a client, it is acting in a principal (dealer) capacity. In principal transactions, the firm's compensation is built into the trade price as a mark-up (when selling) or mark-down (when buying), which must be disclosed on the trade confirmation.

Step-by-Step Solution

1
Analyze the trade execution method described in the scenario.
The firm is selling bonds to the client directly from its own proprietary account (inventory).
Selling from inventory defines a principal transaction rather than an agency transaction.
2
Determine the firm's capacity and corresponding compensation structure.
When trading as a principal/dealer, the firm adjusts the price by adding a mark-up (for sales) or deducting a mark-down (for purchases).
Brokers acting as agents earn commissions, whereas dealers acting as principals earn mark-ups or mark-downs.
3
Verify regulatory confirmation disclosure rules for dual-registered firms.
The confirmation must accurately disclose that the firm acted as a principal and state the mark-up charged.
Securities regulations require clear disclosure of capacity and transaction compensation on client confirmations.

Key Concept

Broker vs. Dealer Capacity and Markup/Commission Rules
Estimated Time:1m 30s
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Topics

Broker-Dealers, Investment Advisers, and Intermediaries

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