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Difficulty: HardMarket Participants and Investor Classifications

Apex Securities, a registered broker-dealer, receives two customer trade orders during the trading day. For Order 1, Apex fills a customer's buy order directly using shares held in its own proprietary trading inventory, charging the client a mark-up. For Order 2, Apex acts on behalf of another customer by routing their sell order to an external exchange to find a counterparty, charging a commission upon execution. Under securities industry regulations, which of the following statements correctly identifies the capacity in which Apex Securities acted for each transaction?

  1. Apex acted as a dealer (principal) in Order 1 and as a broker (agent) in Order 2.Answer
  2. B
    Apex acted as a broker (agent) in Order 1 and as a dealer (principal) in Order 2.
  3. C
    Apex acted as a National Securities Clearing Corporation (NSCC) clearing agency in Order 1 and as a Depository Trust Company (DTC) custodian in Order 2.
  4. D
    Apex acted as a self-regulatory organization (SRO) in Order 1 and as a Qualified Institutional Buyer (QIB) in Order 2.

Answer

Apex Securities acted as a dealer (principal) in Order 1 and as a broker (agent) in Order 2.
A broker-dealer acts in a dealer (principal) capacity when it buys or sells securities for its own account/inventory, earning a mark-up or mark-down. It acts in a broker (agent) capacity when it represents a customer by finding a counterparty in the market, earning a commission.

Step-by-Step Solution

1
Analyze the firm's action for Order 1.
Apex filled the order out of its own inventory and charged a mark-up.
When a firm trades for its own account as a counterparty to a trade, it acts as a principal/dealer.
2
Analyze the firm's action for Order 2.
Apex routed the order to an external exchange to match the customer with a third-party buyer and charged a commission.
When a firm acts as an intermediary facilitating a trade between two parties without taking a proprietary position, it acts as an agent/broker.
3
Match the analyzed roles to the correct capacity classification.
Order 1 is dealer (principal); Order 2 is broker (agent).
Broker-dealers cannot act in both capacities (broker and dealer) in the exact same trade, but routinely switch capacities across different client orders depending on execution method.

Key Concept

Broker vs. Dealer Capacity and Compensation
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Topics

Market Participants and Investor Classifications

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