The Role of the Broker/Dealer in High Finance

Broker/Dealer (B/D) firms bridge the gap between investors and institutions in the market for debt and equity financing. The Securities and Exchange Commission (SEC) regulates broker-dealers as fiduciaries to align Main Street and Wall Street interests together. Web 2.0 technologies now democratize high finance.

The Broker/Dealer

A broker is the middleman or order taker. Brokers match buyers and sellers together through auction format and earn commissions for these services. The broker does not own the asset at any time. Stockbrokers may fill orders to trade securities for clients – without offering any advice.

Dealers will purchase assets for their own account and carry inventory that is to be sold at a future date. These proprietary trades are carried out to improve bottom line profitability for the firm. Broker/Dealer firms, of course, will both fill orders for clients and trade for their own accounts.

Financial Markets

Private businesses seeking financing will “go public” at the initial public offering (IPO). Here, the corporation and investment bank sell shares of stock to investors, in exchange for cash to finance operations.

Next, shares trade on the secondary market, directly between the investors themselves. B/D firms, again, facilitate the trading activity through auction format. Orders are priced out and filled at the meeting point for the highest bidding and lowest asking prices. Brokers will pocket the spread for themselves.

The New York Stock Exchange (NYSE) and National Association of Securities Dealers Automated Quotation System (Nasdaq) are the two largest financial markets in the United States, with $250 billion in shares trading hands each day.

The Robinhood Effect

In 2005, brokers paid $3.5 million for a seat membership at the New York Stock Exchange. The following year, in 2006, the NYSE took itself public and members received 80,177 shares of the company and $300,000 in cash. Exchange memberships and floor trading are now old-time relics, with the Chicago Board of Trade permanently shutting down its own trading pits by 2021.

At the same time, discount brokerages like Scottrade and E-Trade were offering $7 trades and taking business away from traditional, white shoe institutions, like Goldman Sachs and what was left of Merrill Lynch. In 2015, it was Robinhood that changed the game, by offering up free trades. All major brokerage houses immediately followed suit, and a wave of industry consolidation ensued.

In 2016, TD Ameritrade bought Scottrade for $4 billion. Three short years later, it was Charles Schwab buying out TD Ameritrade itself for $26 billion.

Firms that failed to adapt, like UBS and Deutsche Bank, will flirt with failure. Instead of steep trading commissions, brokerage firms are now mostly asset gatherers relegated to selling customer information and collecting interest on cash balances and margin lending for generating revenue.

Financial Risks

Smaller, retail investors exacerbate stock market volatility. Wall Street Bets, a Reddit group, has repeatedly waged war against Wall Street, with diamond hands HODL [long-term buys] on AMC Entertainment and GameStop for [profit] tendies.

In 2021, the Wall Street Bets you only live once [YOLO] mentality powered both GameStop and AMC shares to the moon. That year, GameStop and AMC both peaked at $81 and $230 per share, before crashing spectacularly. Infamous Redditors now post memes of losing hundreds of thousands of dollars within a matter of days.

Talk to Onyx Investments, a registered investment adviser.