Broker Dealer Models Thursday

Introducing/Fully Disclosed Broker Dealer  The vast majority of broker dealers are this type  Defined as a broker dealer maintaining a formal written agreement with another broker deal

Broker Dealer Models

Broker Dealer Types:

General Securities Broker Dealer

 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

General Securities Broker Dealer

 Normally do not allow or restrict outside business activities

 Provide all types of services

General Securities Broker Dealer

 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

General Securities Broker Dealer

 Capture multiple revenue streams

 Able to create, underwrite and distribute products

General Securities Broker Dealer

 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

General Securities Broker Dealer

Introducing/Fully Disclosed

Broker Dealer

 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.

Introducing/Fully Disclosed

Broker Dealer

 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

responsibilities

clearing costs (i.e., clearing deposit,

compliance reports, etc.)

stock loans with clearing firm

Clearing Broker Dealer

 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

Clearing Broker Dealer

 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

Clearing Broker Dealer

 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

Franchise/Independent Contractor Broker Dealer

 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

Franchise/Independent Contractor Broker Dealer

 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

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.

Agent

Franchise

Franchise/Independent Contractor Broker Dealer

 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

Franchise/Independent Contractor Broker Dealer

 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

Franchise/Independent Contractor Broker Dealer

 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

 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

Franchise/Independent Contractor

Broker Dealer

 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

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.

Microcap/“Penny Stock” Broker

Dealer

 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.

Microcap/“Penny Stock” Broker

Dealer

raising money for small or start up businesses

 Required limited start up capital

a short period of time

Microcap/“Penny Stock” Broker

Dealer

product line

recognition

Microcap/“Penny Stock” Broker

Limited Product Broker Dealer

 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)

Limited Product Broker Dealer

 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

Limited Product Broker Dealer

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

Limited Product Broker Dealer

Discount Broker Dealer

with agents and few services offered.

of service.

 Agents generally receive “unsolicited” calls via

“800” numbers rather than solicit customers.

Discount Broker Dealer

and choose their own securities

Discount Broker Dealer

brokers believe their market knowledge is

sufficient to perform their own research and make trade decisions.

Discount Broker Dealer

Online Broker Dealer

Online Broker Dealer

crisis without advice

Bank Affiliated Broker Dealer

to the broker dealer

Bank Affiliated Broker Dealer

bank funds to invest (CDs maturing)

customers’ trust of the bank

Bank Affiliated Broker Dealer

blurred

(circuit riders)

Bank Affiliated Broker Dealer