Series 7: 17.6.4.1 Principal Vs. Agency Transactions

17.6.4.1  Principal vs. Agency Transactions

Agency transactions. When a firm acts as a broker, it serves as an agent or go-between for the buyer and the seller. The broker gets paid for the service by charging a commission. Transactions where a firm is acting as a broker are called agency transactions, since the firm is acting as an agent for the buyer and seller.

In the OTC market, a firm that helps a customer execute a trade, but is not itself a market maker in the stock, would be performing in an agency capacity. In this case, the firm would earn a commission rather than a markup on the trade.

Principal transactions. When the firm acts as a dealer, it is putting its own money at risk, buying or selling securities out of its own inventory. Rather than brokering a deal for another party, the dealer is a principal to the trade, since the transaction is adding to or depleting the dealer’s own account. The dealer facilitates the trade by posting a bid-and-ask price. It profits by the spread between the bid-and-ask price plus any markup or markdown that the dealer may receive. Transactions in which a firm acts as a dealer are called principal transactions.

A markup is added to the ask/offer price when a customer purchases a security. A markdown is taken off the bid price when a customer sells a security. When a firm includes th