Securities Brokers and Dealers

Securities brokers and dealers conduct trading in secondary markets. Brokers act as agents for investors in the purchase or sale of securities. Their function is to match buyers with sellers, a function for which they are paid brokerage commissions. In contrast to brokers, dealers link buyers and sellers by standing ready to buy and sell securities at given prices. Therefore, dealers hold inventories of securities and make their living by selling these securities for a slightly higher price than they paid for them—that is, on the "spread" between the asked price and the bid price. This can be a high-risk business because dealers hold securities that can rise or fall in price; in recent years, several firms specializing in bonds have collapsed. Brokers, by contrast, are not as exposed to risk because they do not own the securities involved in their business dealings.

Brokerage firms engage in all three securities market activities, acting as brokers, dealers, and investment bankers. The largest in the United States is Merrill Lynch; other well-known ones are UBS PaineWebber, Morgan Stanley Dean Witter, and Salomon Smith Barney. The SEC not only regulates the investment banking operation of the firms but also restricts brokers and dealers from misrepresenting securities and from trading on insider information, nonpublic information known only to the management of a corporation.

The forces of competition led to an important development: Brokerage firms started to engage in activities traditionally conducted by commercial banks. In 1977, Merrill Lynch developed the cash management account (CMA), which provides a package of financial services that includes credit cards, immediate loans, check-writing privileges, automatic investment of proceeds from the sale of securities into a money market mutual fund, and unified record keeping. CMAs were adopted by other brokerage firms and spread rapidly. The result is that the distinction between banking activities and the activities of nonbank financial institutions has become blurred. Another development is the growing importance of the Internet in securities markets (see the E-Finance box).

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