In the investment industry, broker/dealers (also known as B/Ds) perform in two ways. As a broker, they handle investment accounts and transactions for retail clients such as the typical individual investor or trader. As a dealer, they actively trade and invest in securities for their own accounts.
“Clearing” broker/dealers serve as an intermediary between a brokerage or client and an exchange. They handle order flow and trade executions from independent, corresponding B/Ds as well as safekeeping of securities, and account statement processing and reporting of activity.
All B/D firms are highly regulated and have the purpose of maintaining liquidity of shares. They are charged with making transactions as “ready” as possible in as efficient a manner as possible.
The New York Stock Exchange, as an example, serves as a public marketplace for shares of company stock to be bought and sold. Exchange members are also known as seat holders and represent buyers and sellers on the floor of the exchange in the capacity of maintaining an orderly market for securities. Clearing firms, broker/dealers and investors complete the market.
As it is a very large industry, several layers of organisation are required to make this activity available to all who wish to participate, including an individual. Members of the NYSE can also be clearing firms. There are exchanges worldwide, and some are virtual, electronic exchanges, such as the NASDAQ.
Clearing firms act on behalf of introducing B/Ds whose clients transact in publicly traded securities. They ensure that transactions are made efficiently and fairly, and transmit information to and from both sides of the purchase and sale. Clearing firms also handle the collection of payment from a buyer and payment to a seller, and expedite the settlement of trades.
In order to help maintain liquid markets, they may trade positions in shares of certain securities. For this reason, they are also known as market makers, and they stand ready to buy or sell at the best quoted market prices available to the investor.
Some clearing firms specialise in particular types of securities, such as bonds, stocks or options. A minority of firms have enough capital and technology to be able to handle all aspects of activity and reporting while maintaining regulatory compliance. These firms are not common, and usually clear transactions in issues where there is little activity and risk, such as fixed-income securities.
Most large clearing firms have a network of smaller B/D firms for which they handle these responsibilities. These smaller firms are known as “regional’ or “boutique” firms, and their association with large clearing firms provides them support, technology and credibility to offer high-quality investment service.
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