Companies that engage in buying and selling new securities are primarily known as investment banks. These institutions often operate as broker-dealers when facilitating the issuance and initial sale of these securities in the primary market.
Understanding Broker-Dealers in the Securities Market
At its core, a broker-dealer is a firm or person in the business of buying and selling securities for its own account or on behalf of its customers. This designation is commonly used in U.S. securities regulation to describe stock brokerages, as most function both as agents (brokers) and principals (dealers).
- Broker: When acting as a broker, the firm executes trades on behalf of its clients, earning commissions for facilitating the transaction without taking ownership of the securities. They act as an intermediary.
- Dealer: When acting as a dealer, the firm buys and sells securities for its own account, holding them in inventory and profiting from the spread between the buying and selling price. They act as a principal in the transaction.
How Broker-Dealers Engage with New Securities (Primary Market)
While broker-dealers are prominently involved in the secondary market (where existing securities are traded among investors), their role extends significantly to the primary market where new securities are initially offered to the public. In this context, they typically operate as part of larger financial institutions known as investment banks during the underwriting process.
The underwriting process involves:
- Advising the Issuer: Investment banks advise companies, governments, or other entities on the best way to raise capital through the issuance of new stocks or bonds.
- Structuring the Offering: They help determine the terms, pricing, and timing of the new security offering.
- Underwriting the Securities: This is where the broker-dealer function becomes critical:
- Firm Commitment Underwriting: The investment bank (acting as a dealer) buys the entire new issue from the issuer and then resells it to investors. The bank assumes the risk of not being able to sell all the securities.
- Best Efforts Underwriting: The investment bank (acting as a broker) agrees to sell as much of the issue as possible on behalf of the issuer but does not guarantee the sale of the entire issue.
- Distribution and Sales: After underwriting, the investment bank, leveraging its broker-dealer capabilities, distributes the new securities to a broad network of institutional and retail investors. This often involves forming a syndicate of other broker-dealers to help sell the issue.
Key Roles and Activities in New Securities Offerings
Firms involved in the initial sale of new securities perform several critical functions:
| Role | Description | Primary Market Involvement |
|---|---|---|
| Broker | Executes orders for clients; acts as an agent. | Sells new securities to clients on behalf of the issuer or underwriter. |
| Dealer | Trades securities for its own account; acts as a principal. | Buys new issues from an issuer (underwriting) and resells them. |
| Underwriter | A specialized function within an investment bank that manages the issuance and distribution of new securities. | Central to bringing new securities to market (e.g., IPOs, bond offerings). |
Examples of New Securities Offerings:
- Initial Public Offerings (IPOs): When a private company first sells shares to the public.
- Follow-on Offerings: Subsequent sales of shares by a public company.
- Debt Offerings: Issuance of new bonds by corporations or governments.
In summary, while the specific activity of facilitating the initial sale of new securities is called underwriting and is primarily conducted by investment banks, these banks operate as broker-dealers to carry out the buying and selling aspects of these transactions, acting as both agents and principals.
