Agent vs Principal, Commissions vs Markups, and How One Firm Acts in Both Capacities

A broker buys and sells securities on behalf of customers and is paid a commission, while a dealer buys and sells securities for its own account and earns a markup or markdown. The broker acts as an agent, standing between the customer and the market, and the dealer acts as a principal, taking the other side of the customer’s trade.

Most firms do both, which is why the industry uses the combined term broker-dealer. The firm is the same, but in each individual trade it must act in one capacity or the other, and that choice determines how it is paid, what it must disclose and which conflicts it faces.

This guide covers the legal definitions, how each capacity is paid, how a single firm switches between them, the disclosure and fair pricing rules, how state law treats broker-dealers, worked examples, the exam traps and five practice questions. For a look at the people who work inside these firms, FRC’s guide to what a stockbroker does explains the day-to-day role.

Why the Distinction Exists

The difference between acting as agent and acting as principal goes to the heart of the customer relationship. An agent works for the customer and is paid to find the best available trade, while a principal is the customer’s counterparty and profits from the price it charges.

Both models are legitimate and both are essential to how markets work. Customers need agents to reach the market, and they need dealers who are willing to buy and sell from their own inventory when no other buyer or seller is immediately available.

Because the incentives are different, the rules are different. Regulators require firms to tell customers which capacity they acted in, and they limit how much a firm can charge in either role.

Where This Topic Appears on the Exams

Broker and dealer capacity appears on the Series 65, the Series 7 and the SIE. Questions test the definitions, how each is paid, what must appear on a trade confirmation and how state law defines a broker-dealer.

FRC’s Series 65 Exam Preparation course covers broker-dealer definitions and registration under the Uniform Securities Act, and the exam requires no sponsor. The Series 7 Exam Preparation course covers agency and principal trading, markups and confirmations in depth, and the SIE Examination Preparation course introduces the market participants behind every trade.

Every FRC course can be spread across interest-free monthly payments, so cost is no reason to delay. The agent and principal split comes up again and again across these exams, so learning it once pays off several times.

The Legal Definitions

The Securities Exchange Act of 1934 defines a broker as any person engaged in the business of effecting transactions in securities for the account of others. The key words are for the account of others, because the broker never owns the securities it is trading.

A dealer is defined as any person engaged in the business of buying and selling securities for its own account. The key words here are for its own account, because the dealer owns the securities, even if only for a moment.

The definition of dealer has an important exclusion for traders. A person who buys and sells securities for their own account, but not as part of a regular business of dealing with customers, is generally not a dealer, which is why an individual investor managing a personal portfolio does not need to register.

How a Broker Is Paid

A broker is paid a commission for executing a trade. The commission is a separate charge, shown on the customer’s confirmation, for the service of finding and completing the trade.

Because the broker does not own the securities, it has no direct stake in the price. Its job is to get the customer the best price reasonably available, which is the duty of best execution.

Many firms now charge zero commissions on online stock trades. That does not change the broker’s role, and firms may still earn revenue in other ways, such as payment for order flow or interest on customer cash, which must be disclosed.

How a Dealer Is Paid

A dealer is paid through the price itself. When it sells a security to a customer, it charges a markup above the prevailing market price, and when it buys a security from a customer, it pays a markdown below that price.

The markup or markdown is built into the price rather than charged separately. That is why principal trades can be harder for customers to evaluate, and why regulators pay close attention to them.

Dealers that stand ready to buy and sell a security continuously, quoting both a bid and an ask, are known as market makers. They earn the bid-ask spread and provide the liquidity that lets investors trade quickly.

One Firm, Two Capacities

A broker-dealer can act as a broker in one trade and a dealer in the next. What it cannot do is act as both in the same trade, charging a commission and a markup on the same transaction.

The capacity often depends on the security. Exchange-listed stocks are commonly traded on an agency basis, while bonds, which trade over the counter with no central exchange, are often sold to customers from the firm’s own inventory on a principal basis.

There is also a hybrid known as a riskless principal trade. The firm receives a customer order, buys the security in the market for its own account and immediately sells it to the customer, taking almost no market risk, and the trade is treated as principal for disclosure and pricing purposes.

Disclosure on the Confirmation

Every trade generates a confirmation, and under SEC rules the confirmation must disclose whether the firm acted as agent or principal. This lets the customer understand how the firm was paid.

For agency trades, the confirmation shows the commission. For many principal trades in corporate and municipal bonds with retail customers, FINRA and MSRB rules require the markup or markdown to be disclosed as well, which is covered in FINRA Rule 2232.

The disclosure requirement exists because the customer cannot otherwise see the dealer’s profit. Making it visible allows customers to compare costs and holds firms accountable for what they charge.

Fair Prices and Commissions

Whatever the capacity, a firm’s charges must be fair. FINRA Rule 2121 requires that commissions, markups and markdowns be fair, taking into account factors such as market conditions, the cost of executing the trade and the value of the service provided.

FINRA’s long-standing guidance, often called the 5% policy, treats a 5% markup as a reference point rather than a hard limit. Some trades can justify more and many should be much less, depending on the security, the size of the trade and the effort involved.

The same fairness standard applies to riskless principal trades, where the markup is generally expected to be modest because the firm takes little risk. Regulators can and do act against firms whose charges are excessive.

Which Capacity Is Better for the Customer?

Neither capacity is automatically better. An agency trade gives the customer a visible, separate commission and a broker focused on finding the best price, which suits liquid, exchange-listed securities.

A principal trade can be the only practical way to buy or sell a less liquid security, such as a particular corporate or municipal bond. The dealer’s willingness to commit its own capital means the customer can trade immediately, even when no other buyer or seller is available at that moment.

What protects the customer in both cases is the same set of rules: fair charges, clear disclosure and recommendations that serve the customer’s interests. A well-informed customer looks at the total cost of a trade, not just whether a commission appears on the confirmation.

The Conflicts in Each Capacity

Acting as agent creates its own conflict. A broker paid per trade has an incentive to encourage more trading than a customer needs, which is why excessive trading, known as churning, is prohibited.

Acting as principal creates a different conflict. A dealer selling from its own inventory has an incentive to recommend securities it wants to sell, or to charge the highest price the customer will accept.

FINRA’s suitability rule, FINRA Rule 2111, and Regulation Best Interest require recommendations to serve the customer regardless of capacity. Firms also need supervisory systems under FINRA Rule 3110 to catch trades that cross the line.

How Broker-Dealers Are Regulated

Broker-dealers register with the SEC on Form BD and, with limited exceptions, must become members of FINRA. Most must also be members of the Securities Investor Protection Corporation.

Dealers carry more financial risk, because they hold inventory. The SEC’s net capital rule, Rule 15c3-1, requires firms to keep enough liquid capital to meet their obligations, and FRC’s guide to what net capital a broker-dealer must maintain explains how it works.

The customer protection rule, Rule 15c3-3, requires firms holding customer assets to keep them separate from the firm’s own. That protection is most important when a firm acts as a dealer, because it ensures the firm’s trading risks do not spill over onto customer property.

How State Law Treats Broker-Dealers

The Uniform Securities Act uses the single term broker-dealer, defined as any person engaged in the business of effecting transactions in securities for the account of others or for its own account. It covers both capacities in one definition.

Several persons are excluded from the definition. These include agents, who are individuals acting for a broker-dealer, issuers selling their own securities, banks and savings institutions, and broker-dealers with no place of business in the state that deal only with issuers, other broker-dealers and institutional investors.

A broker-dealer that does not fall within an exclusion must register in each state where it does business. Its individual representatives register separately as agents, and the firm is responsible for supervising them.

Worked Example: An Agency Stock Trade

A customer asks a broker-dealer to buy 200 shares of a listed company. The firm routes the order to the market and buys the shares at $50 from another market participant.

The customer pays $10,000 for the shares plus a $15 commission. The confirmation shows the firm acted as agent and lists the commission separately.

The firm never owned the shares. Its duty was to find the best available price, and its payment was the commission.

Worked Example: A Principal Bond Trade

A retail customer buys $20,000 face value of a corporate bond. The firm sells the bonds from its own inventory at a price of 101, when the prevailing market price is 100.

The difference of one point, or $200, is the markup. The confirmation shows the firm acted as principal and, because this is a retail corporate bond trade, discloses the markup.

There is no separate commission. The firm’s payment is built into the price it charged.

Worked Example: Riskless Principal

A customer places an order to buy 1,000 shares of a stock traded over the counter. The firm buys the shares in the market at $20.00 for its own account and immediately sells them to the customer at $20.10.

This is a riskless principal trade. The firm held the shares only momentarily, so its 10-cent markup, or $100 in total, must be fair in light of the minimal risk involved.

The confirmation shows principal capacity. The firm could not also charge a commission on the same trade.

The Exam Traps

The first trap is mixing up the roles. A broker acts as agent for the customer’s account, and a dealer acts as principal for its own account.

The second trap is mixing up the payment. A broker earns a commission, and a dealer earns a markup or markdown, never both on the same trade.

The third trap is treating the 5% policy as a hard rule, when it is only a guideline and charges must be fair in all the circumstances. The fourth trap is forgetting that the Uniform Securities Act excludes agents, issuers and banks from the definition of broker-dealer.

FRC’s guide to Series 65 ethics and laws questions and exam traps covers more traps in this area. For the full list, see FRC’s guide to Series 65 exam traps and common mistakes.

A Memory Aid

Remember “agent and commission, principal and markup.” The broker is the agent paid a commission, and the dealer is the principal paid a markup or markdown.

For the definitions, remember “broker for others, dealer for itself.” That captures the legal test in four words each.

Practice Questions

Question one: a firm buys securities for a customer from another market participant and charges a commission. In what capacity did it act? As a broker, or agent.

Question two: a firm sells bonds to a customer from its own inventory. How is it paid? Through a markup built into the price.

Question three: can a firm charge both a commission and a markup on the same trade? No, it must act in one capacity per trade.

Question four: is FINRA’s 5% markup policy a strict maximum? No, it is a guideline, and all charges must be fair in the circumstances.

Question five: under the Uniform Securities Act, is an individual who sells securities for a broker-dealer a broker-dealer? No, they are an agent, which is excluded from the definition.

Related Questions

The difference between agent and principal is also central to the duties firms owe their customers. FRC’s guide to the fiduciary standard vs the suitability standard explains how broker-dealers and investment advisers are held to different standards.

Get Exam-Ready

Broker and dealer questions reward candidates who can tell agent from principal at a glance. Once the definitions, the payment methods and the disclosure rules are clear, these become some of the most dependable marks on the exam.

The FRC dictionary is more than a dictionary. It is a library of explainer videos, written explanations and on-page quizzes covering the FINRA and SEC rules you are tested on, so you can open any term and go deeper whenever a question catches you out.

Study With FRC

FRC’s programs and memberships are open to everyone. Whether you are preparing for the Series 65, the Series 7, the SIE or a combination, structured exam preparation turns topics like broker-dealer capacity into marks you can rely on.

FRC’s Professional Membership adds verified progress and a Digital Profile, so when you apply for roles, employers can see your exam progress and the knowledge you are building, not just read about it on a resume.

Your Next Step

A broker acts as agent for its customers and earns a commission, while a dealer acts as principal for its own account and earns a markup or markdown. A broker-dealer can do both, but only one per trade, and every charge must be fair and disclosed on the confirmation.

Remember “broker for others, dealer for itself,” and you will be ready for every version of this question the exam can ask.