1 broker dealer models. 2 broker dealer types: general securities introducing/fully disclosed ...

11

Broker Dealer ModelsBroker Dealer Models

22

Broker Dealer Types:Broker Dealer Types: General SecuritiesGeneral Securities Introducing/Fully Disclosed Introducing/Fully Disclosed ClearingClearing Franchise/Independent ContractorFranchise/Independent Contractor Micro-capMicro-cap Mutual FundMutual Fund DiscountDiscount On-lineOn-line Bank AffiliatedBank Affiliated

33

General Securities Broker DealerGeneral Securities Broker Dealer

DescriptionDescription Also known as “full service” or “wire house” B/DAlso known as “full service” or “wire house” B/D Generally, “Wall Street” firms such as Merrill Lynch Generally, “Wall Street” firms such as Merrill Lynch

and Morgan Stanley.and Morgan Stanley. Agents are generally domiciled in large branch offices Agents are generally domiciled in large branch offices

where business is conducted by phone with “face to where business is conducted by phone with “face to face” supervision by branch managers.face” supervision by branch managers.

Agents are generally considered to be “employees”Agents are generally considered to be “employees” Formal employee training programFormal employee training program

44


Normally do not allow or restrict outside business Normally do not allow or restrict outside business activitiesactivities

Provide all types of servicesProvide all types of services• ExecutionExecution• ClearingClearing• SafekeepingSafekeeping

Typically offer “managed accounts” for customers Typically offer “managed accounts” for customers

55


Advantages:Advantages: Nationwide name recognition and advertising Nationwide name recognition and advertising

campaignscampaigns Complete control of transaction processingComplete control of transaction processing

• No reliance on third party for clearing activityNo reliance on third party for clearing activity Retain all commissionsRetain all commissions

• Do not pay a clearing fee to a third party to perform “back Do not pay a clearing fee to a third party to perform “back office” functionsoffice” functions

Additional revenue generated through margin debits Additional revenue generated through margin debits (excess interest charged to customers over B/D (excess interest charged to customers over B/D borrowing rate) and stocks loaned (practice of lending borrowing rate) and stocks loaned (practice of lending stock for a fee to other B/Ds)stock for a fee to other B/Ds)

66


Capture multiple revenue streamsCapture multiple revenue streams Able to create, underwrite and distribute productsAble to create, underwrite and distribute products

77


DisadvantagesDisadvantages Costly initial set-up and continual operating expensesCostly initial set-up and continual operating expenses

• Requires additional “back office” personnel and procedures.Requires additional “back office” personnel and procedures. Considerable regulatory compliance responsibilities Considerable regulatory compliance responsibilities

imposedimposed Greater potential monetary and compliance liabilityGreater potential monetary and compliance liability Experienced personnel requiredExperienced personnel required Increased net capital requirementsIncreased net capital requirements

88


Regulatory IssuesRegulatory Issues Proprietary productsProprietary products SupervisionSupervision Electronic records retentionElectronic records retention

99

Introducing/Fully Disclosed Introducing/Fully Disclosed Broker DealerBroker Dealer

DescriptionDescription The vast majority of broker dealers are this typeThe vast majority of broker dealers are this type Defined as a broker dealer maintaining a formal Defined as a broker dealer maintaining a formal

written agreement with another broker dealer whereby written agreement with another broker dealer whereby the introducing dealer does not carry customer the introducing dealer does not carry customer accounts (hold customer funds or securities or accounts (hold customer funds or securities or confirm transactions).confirm transactions).

• The agreement specifies the terms under which execution The agreement specifies the terms under which execution and record keeping will be maintained.and record keeping will be maintained.

1010


Although introducing firms will have “back offices” and Although introducing firms will have “back offices” and record creation and retention requirements, they enter record creation and retention requirements, they enter into these agreements to reduce operating expenses. into these agreements to reduce operating expenses.

Required to promptly transmit money and securities.Required to promptly transmit money and securities. The phrases “account carried by” or “account The phrases “account carried by” or “account

courtesy of” will be on firm’s documents.courtesy of” will be on firm’s documents.

1111


AdvantagesAdvantages Significantly less initial start-up and operating Significantly less initial start-up and operating

costs than general and self-clearing broker-costs than general and self-clearing broker-dealersdealers

Less administrative and compliance Less administrative and compliance responsibilitiesresponsibilities

Lower net capital requirementLower net capital requirement Reduced back office expensesReduced back office expenses

1212


DisadvantagesDisadvantages Total reliance upon clearing firm for settling Total reliance upon clearing firm for settling

transactions, loss of “back office” controltransactions, loss of “back office” control Sizeable portion of revenues may be paid in Sizeable portion of revenues may be paid in

clearing costs (i.e., clearing deposit, clearing costs (i.e., clearing deposit, compliance reports, etc.)compliance reports, etc.)

Must share participation in margin debits and Must share participation in margin debits and stock loans with clearing firmstock loans with clearing firm

1313

Clearing Broker DealerClearing Broker Dealer

DescriptionDescription Enters into agreements with introducing broker Enters into agreements with introducing broker

dealer to “carry” or “clear” accountsdealer to “carry” or “clear” accounts A substantial number of clearing firms are affiliated A substantial number of clearing firms are affiliated

with or are divisions of a General Securities Broker with or are divisions of a General Securities Broker DealerDealer

Handles trade executions and transfersHandles trade executions and transfers Provides safekeeping (of customer Provides safekeeping (of customer

funds/securities) servicesfunds/securities) services Most states require registration of these types of Most states require registration of these types of

firms as they hold customer funds and securities firms as they hold customer funds and securities for customers of your state.for customers of your state.

1414


Advantages:Advantages: Complete control of transaction processingComplete control of transaction processing

• No reliance on third party.No reliance on third party. Additional revenue generated through margin Additional revenue generated through margin

debits (excess interest charged to customers over debits (excess interest charged to customers over B/D borrowing rate) and stock loaned (practice of B/D borrowing rate) and stock loaned (practice of lending stock for a fee to other B/Ds)lending stock for a fee to other B/Ds)

No retail sales force means less compliance No retail sales force means less compliance issues.issues.

Able to maximize use of technology to automate Able to maximize use of technology to automate processes and reduce expenses.processes and reduce expenses.

1515


DisadvantagesDisadvantages Total reliance upon introducing dealers to acquire Total reliance upon introducing dealers to acquire

customers.customers. Costly initial set-up and continual operating expenses.Costly initial set-up and continual operating expenses.

• Requires additional “back office” personnel and procedures.Requires additional “back office” personnel and procedures. Greater potential monetary liability.Greater potential monetary liability. Experienced operational personnel required.Experienced operational personnel required. Increased net capital requirements.Increased net capital requirements.

1616

Franchise/Independent Franchise/Independent Contractor Broker DealerContractor Broker Dealer

DescriptionDescription Business model under which the firm operates Business model under which the firm operates

pursuant to a network of franchise offices and agents pursuant to a network of franchise offices and agents that are independent contractors for tax purposes.that are independent contractors for tax purposes.

The firm may have started out as a small operation The firm may have started out as a small operation but has grown to have a large number of branch but has grown to have a large number of branch offices that are geographically disbursed and operate offices that are geographically disbursed and operate with one or two persons in each office.with one or two persons in each office.

Many outside business activitiesMany outside business activities Limited or no on-site supervisionLimited or no on-site supervision

1717


Each office may operate under a name other than Each office may operate under a name other than that of the registered broker dealer.that of the registered broker dealer.

The terms by which the location operates in The terms by which the location operates in conjunction with the dealer are defined in the conjunction with the dealer are defined in the franchise agreement.franchise agreement.

The agreement sets forth the terms by which The agreement sets forth the terms by which areas such as trading, record keeping, supervision areas such as trading, record keeping, supervision and expenses are handled.and expenses are handled.

Franchises bear most of their own expenses (rent, Franchises bear most of their own expenses (rent, insurance, staff salaries). In return, they receive insurance, staff salaries). In return, they receive commission payouts of up to 90-95%.commission payouts of up to 90-95%.

Compliance resources in the dealer’s home officeCompliance resources in the dealer’s home office

1818


William F. Reilly, Jr.

REILLY FINANCIAL, INC.123 Main Street

Miami, FL 33131Phone (305) 123-4567

Securities offered through XYZ SecuritiesMember FINRA and SIPC

William F. Reilly, Jr.

REILLY FINANCIAL, INC.123 Main Street

Miami, FL 33131Phone (305) 123-4567

Securities offered through XYZ SecuritiesMember FINRA and SIPC

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

Registered

Dealer

1919


Independent contractorsIndependent contractors The term is not discussed in any securities rule The term is not discussed in any securities rule

or or regulation but is used for tax purposes.regulation but is used for tax purposes. A Broker Dealer has supervisory responsibility A Broker Dealer has supervisory responsibility

over its independent contractors.over its independent contractors. Broker Dealer and agent relationships may be Broker Dealer and agent relationships may be

spelled out pursuant to independent contractor spelled out pursuant to independent contractor agreements.agreements.

The agent may enter into this agreement with the The agent may enter into this agreement with the broker dealer or the franchise branch office.broker dealer or the franchise branch office.

2020


AdvantagesAdvantages Franchise operator maintains name recognition.Franchise operator maintains name recognition. Example: Potential customers may not know the Example: Potential customers may not know the

name of the broker dealer but, the name of the name of the broker dealer but, the name of the franchise may be well known.franchise may be well known.

Profits of the branch are maintained by the franchise Profits of the branch are maintained by the franchise owner rather than the registered firm.owner rather than the registered firm.

Generally neither the firm nor the franchise owners Generally neither the firm nor the franchise owners pay benefits (i.e., medical insurance) to independent pay benefits (i.e., medical insurance) to independent contractors.contractors.

Broker dealer can expand rapidly with little increase in Broker dealer can expand rapidly with little increase in costs because substantially all operating expenses costs because substantially all operating expenses are paid by the agent.are paid by the agent.

2121


DisadvantagesDisadvantages Occasionally, individuals who are statutorily Occasionally, individuals who are statutorily

disqualified or have extensive disciplinary problems disqualified or have extensive disciplinary problems associate themselves with or own franchise branch associate themselves with or own franchise branch offices.offices.

Franchise branch offices may be operating more like Franchise branch offices may be operating more like an independent broker dealer than a branch.an independent broker dealer than a branch.

Supervision is a problem. Harder to detect serious Supervision is a problem. Harder to detect serious violations such as theft or selling away.violations such as theft or selling away.

2222

Franchise/Independent Contractor Franchise/Independent Contractor Broker DealerBroker Dealer

DisadvantagesDisadvantages Franchise branch offices and independent contractors Franchise branch offices and independent contractors

tend to have problems caused by selling away and/or tend to have problems caused by selling away and/or unauthorized outside business activities.unauthorized outside business activities.

Agents may be geographically dispersedAgents may be geographically dispersed Lack of close, onsite supervision may result in Lack of close, onsite supervision may result in

regulatory issuesregulatory issues Agent may have little or no loyalty to dealer’s image Agent may have little or no loyalty to dealer’s image

or brand nameor brand name Some agents work part-timeSome agents work part-time

2323

Franchise/Independent Contractor Franchise/Independent Contractor Broker DealerBroker Dealer

Regulatory IssuesRegulatory Issues Agents see themselves as “entrepreneurs.”Agents see themselves as “entrepreneurs.” Client may not understand which entity is registered.Client may not understand which entity is registered. Advertising and public communication issuesAdvertising and public communication issues Inadequate branch office audits or follow up to red Inadequate branch office audits or follow up to red

flags.flags. Compliance staffing may not be able to keep pace Compliance staffing may not be able to keep pace

with the expansion of business products and with the expansion of business products and increased numbers of agents and branch offices. increased numbers of agents and branch offices.

2424

Microcap/“Penny Stock” Broker Microcap/“Penny Stock” Broker DealerDealer

DescriptionDescription Sometimes referred to as “boiler rooms” dealing in Sometimes referred to as “boiler rooms” dealing in

high-risk securitieshigh-risk securities Characterized by high pressure sales tactics.Characterized by high pressure sales tactics. May employ agents with extensive disciplinary history.May employ agents with extensive disciplinary history. Stocks they sell:Stocks they sell:

• Have generally little or no operating history.Have generally little or no operating history.• Are thinly capitalized and traded.Are thinly capitalized and traded.• May or may not be SEC reporting companies and therefore May or may not be SEC reporting companies and therefore

lack transparency.lack transparency.• Are often listed on the FINRA Over the Counter Bulletin Are often listed on the FINRA Over the Counter Bulletin

Board (OTCBB) or in the Pink Sheets.Board (OTCBB) or in the Pink Sheets.

2525


Agents:Agents: Are often young professionals with little or no securities Are often young professionals with little or no securities

experience.experience. Make their living by making “cold calls.”Make their living by making “cold calls.” Generally use scripts containing price guarantees, Generally use scripts containing price guarantees,

misleading information, spamming, or unsupported misleading information, spamming, or unsupported statements about the company.statements about the company.

Generally sell “Blue Chip” stocks to “hook” customers then Generally sell “Blue Chip” stocks to “hook” customers then move them to low-priced/high risk stocks. move them to low-priced/high risk stocks.

May receive undisclosed compensation or higher payout for May receive undisclosed compensation or higher payout for selling low-priced/high risk stocks.selling low-priced/high risk stocks.

2626


AdvantagesAdvantages Specialized firm serving a legitimate niche by Specialized firm serving a legitimate niche by

raising money for small or start up businessesraising money for small or start up businesses Required limited start up capitalRequired limited start up capital Agents can make large amounts of money in Agents can make large amounts of money in

a short period of timea short period of time

2727


DisadvantagesDisadvantages Pressure by management to sell a limited Pressure by management to sell a limited

product lineproduct line Poor customer retentionPoor customer retention High rate of employee turnoverHigh rate of employee turnover Firm may not have widespread name Firm may not have widespread name

recognitionrecognition

2828


Regulatory IssuesRegulatory Issues FraudFraud Culture of greedCulture of greed Self-funding private placementsSelf-funding private placements Boiler–room tacticsBoiler–room tactics Hidden control or ownershipHidden control or ownership

2929

Limited Product Broker DealerLimited Product Broker Dealer DescriptionDescription

Generally serves as a “salesperson” offering various Generally serves as a “salesperson” offering various limited products (i.e., mutual funds, variable annuities, limited products (i.e., mutual funds, variable annuities, direct participation programs, etc.).direct participation programs, etc.).

Orders are transmitted to the mutual fund sponsor on Orders are transmitted to the mutual fund sponsor on either an “application” basis (customers’ monies and a either an “application” basis (customers’ monies and a subscription application are sent to the mutual fund subscription application are sent to the mutual fund sponsor) or on a “wire order” basis (mutual fund sponsor) or on a “wire order” basis (mutual fund orders are transmitted by phone or wire to the orders are transmitted by phone or wire to the sponsor without an application)sponsor without an application)

3030

Limited Product Broker DealerLimited Product Broker Dealer AdvantageAdvantage

Specialized firm requiring little capital expenditure or Specialized firm requiring little capital expenditure or operational expenses beyond commissions to its operational expenses beyond commissions to its salespersons and general office expenses.salespersons and general office expenses.

Agents only need to pass Series 6 exam.Agents only need to pass Series 6 exam. Limited products allow for a less sophisticated Limited products allow for a less sophisticated

supervisory system and agent training.supervisory system and agent training. Products are well designed and marketed by the Products are well designed and marketed by the

issuers.issuers. Sales support from third-party wholesalers.Sales support from third-party wholesalers. Less start-up investment needed.Less start-up investment needed.

3131

Limited Product Broker DealerLimited Product Broker Dealer

DisadvantageDisadvantage Offers a limited product line to customersOffers a limited product line to customers Investor funds are “locked up” for extended Investor funds are “locked up” for extended

period of timeperiod of time Limited incentive for agents to provide Limited incentive for agents to provide

ongoing review of customer accountsongoing review of customer accounts Supervision relies heavily on electronic Supervision relies heavily on electronic

reports, self-reporting and internal auditsreports, self-reporting and internal audits

3232

Limited Product Broker DealerLimited Product Broker Dealer

Regulatory IssuesRegulatory Issues Variable annuity suitabilityVariable annuity suitability Switching or 1035 exchangesSwitching or 1035 exchanges SupervisionSupervision Mutual fund breakpointsMutual fund breakpoints Revenue sharingRevenue sharing

3333

Discount Broker DealerDiscount Broker Dealer

DescriptionDescription Characterized by minimal customer contact Characterized by minimal customer contact

with agents and few services offered.with agents and few services offered. Customers may pay extra for additional levels Customers may pay extra for additional levels

of service.of service. Agents generally receive “unsolicited” calls via Agents generally receive “unsolicited” calls via

“800” numbers rather than solicit customers.“800” numbers rather than solicit customers. Relies on advertising to draw customers.Relies on advertising to draw customers.

3434


AdvantagesAdvantages Low transaction costsLow transaction costs Ease of executionEase of execution Most investors conduct their own research Most investors conduct their own research

and choose their own securitiesand choose their own securities Limited number of employeesLimited number of employees Agent’s advice is limited and many trades are Agent’s advice is limited and many trades are

unsolicitedunsolicited

3535


DisadvantagesDisadvantages Provide minimal, if any, advice to customersProvide minimal, if any, advice to customers Most investors using the services of discount Most investors using the services of discount

brokers believe their market knowledge is brokers believe their market knowledge is sufficient to perform their own research and sufficient to perform their own research and make trade decisions.make trade decisions.

3636


Regulatory IssuesRegulatory Issues Customers’ ability to navigate a market crisis Customers’ ability to navigate a market crisis

without advicewithout advice Customer serviceCustomer service AdvertisingAdvertising

3737

Online BrokerOnline Broker

DescriptionDescription Trades are placed with the firm via personal Trades are placed with the firm via personal

computers.computers. Execution of trades occurs generally without any Execution of trades occurs generally without any

personal contact.personal contact. Online firms offer help desk services.Online firms offer help desk services. Custodian for small IA clients.Custodian for small IA clients. Highly dependent on technology Highly dependent on technology

3838

Online Broker DealerOnline Broker Dealer

AdvantagesAdvantages Low transaction costsLow transaction costs Ease of executionEase of execution Investors perform their own researchInvestors perform their own research

DisadvantagesDisadvantages Hackers/Intruded accountsHackers/Intruded accounts Requires enhanced anti-money laundering Requires enhanced anti-money laundering

(AML) procedures(AML) procedures Investors perform their own researchInvestors perform their own research Server/Systems InterruptionServer/Systems Interruption

3939

Online Broker DealerOnline Broker Dealer

Regulatory IssuesRegulatory Issues Customers’ ability to navigate a market Customers’ ability to navigate a market

crisis without advicecrisis without advice Customer service Customer service AdvertisingAdvertising HackersHackers

4040

Bank Affiliated Broker DealerBank Affiliated Broker Dealer

CharacteristicsCharacteristics 3rd party dealer under contract with bank 3rd party dealer under contract with bank Broker dealer may operate using a DBA Broker dealer may operate using a DBA Customers tend to be conservativeCustomers tend to be conservative Face to face contact in the bank Face to face contact in the bank Bank employees may help steer business Bank employees may help steer business

to the broker dealerto the broker dealer Compliance resources at home officeCompliance resources at home office Agents may be “circuit riders”Agents may be “circuit riders”

4141


AdvantagesAdvantages Captive audienceCaptive audience Real time ability to know when clients have Real time ability to know when clients have

bank funds to invest (CDs maturing)bank funds to invest (CDs maturing) Partner with bank – ability to piggyback on Partner with bank – ability to piggyback on

customers’ trust of the bankcustomers’ trust of the bank Bank employees are a referral networkBank employees are a referral network Synergy with bank marketing effortsSynergy with bank marketing efforts

4242


DisadvantagesDisadvantages Clients are generally less sophisticatedClients are generally less sophisticated Need to spend time educating clientsNeed to spend time educating clients Line between bank and broker dealer can be Line between bank and broker dealer can be

blurredblurred Agents assigned to multiple office locations Agents assigned to multiple office locations

(circuit riders)(circuit riders) Bank employees may be protective of bank Bank employees may be protective of bank

customers and work against the agentcustomers and work against the agent

4343


Regulatory IssuesRegulatory Issues Compliance with NASD Conduct Rule 2350Compliance with NASD Conduct Rule 2350 Suitability Suitability SupervisionSupervision• Networking ArrangementsNetworking Arrangements• Incentive ProgramIncentive Program

1 broker dealer models. 2 broker dealer types: general securities introducing/fully disclosed ...

Documents

broker dealer types

broker dealer models

bds slide

clearing fee

office personnel

face supervision

bds additional revenue

branch managers