A customer's trade confirmation states that the firm acted as principal, and the same customer's mortgage statement shows an outstanding principal balance. He asks whether the firm therefore has money at stake in his bonds in the way he has money at stake in his house. How should the two uses of the word be distinguished?

The confirmation names the firm's capacity as a party to the trade; the statement names a sum of money, the word carrying a different referent in each

Both name a sum at risk: the firm's position in the bonds in the one case, and the customer's debt on the house in the other, measured the same way

Both name a party: the firm in the confirmation, and the lender to whom the balance on the house is owed in the statement, each document naming a participant

The confirmation uses the word as the statement does, naming the amount of its own capital the firm committed to the trade and still has at risk in it

A client approaching retirement tells her adviser that preservation of principal is her overriding investment objective. What does adopting that objective commit her to?

Holding every position she buys to maturity, on the footing that selling earlier would turn a paper movement into a loss of capital

Accepting returns below what riskier assets offer, since the instruments that hold their capital value steady pay less

Accepting a lower income in the near term in exchange for growth in the capital value of the portfolio over her retirement

Matching the return of a conservative benchmark while tolerating falls in capital value that the benchmark itself experiences

Principal risk, also called capital risk, is one dimension of investment risk. Which exposure does it describe?

That the income the investment produces will vary from one period to the next, whatever happens to the sum committed

That the investment's value will move up and down during the holding period before the whole of the sum committed is recovered

That the investor will receive back less than the sum originally committed, losing some or all of that capital

That the return earned will fall short of what comparable investments returned over the same period, though the capital is intact

What does the principal in a principal-agent relationship owe the agent?

Loyalty in dealings with third parties, and disclosure of any material information that bears on the agency

Supervision of the agent's conduct, and correction of any decision the agent takes beyond the authority granted

A share of the profit the agency produces, and reimbursement of the overheads the agent carries to do the work

Compensation as agreed, and indemnity for liabilities the agent reasonably incurs in performing the agency

An adviser manages one client's account with full discretion and another client's account on a basis that requires the client's approval of each transaction. How does the agency capacity of the parties differ between the two relationships?

It does not differ: in each the client is the party on whose behalf the adviser acts, and only the authority granted changes

In the non-discretionary account the client acts as his own agent, the adviser serving only as the party that carries his instructions into the market

Neither is an agency relationship until the adviser actually places an order, the capacity arising transaction by transaction as each instruction is carried out

In the discretionary account the adviser becomes the principal, the client having given up the decision over each transaction and with it the capacity in which the account is run

A shareholder objects that the company's officers take their direction from the board rather than from the shareholders who own the company. How does the layered agency structure of a corporation answer that objection?

Shareholders are agents of the corporation alongside the officers, so neither group is entitled to direct the other in running the business

Shareholders are the ultimate principals, but they act through directors as their agents, and officers execute the plan under the board's direction

Directors are agents of the officers who appoint them, and shareholders stand outside the structure once their shares have been issued

The corporation is the principal of every participant, so directors and shareholders alike take their authority from the officers who run it

A dealer bought a corporate bond into inventory three weeks ago at a price of 95. The bond's prevailing market price is now 101, and the dealer sells the bond to a customer at 103. What markup has that customer been charged?

Eight points, the whole of the gap between the 95 the dealer paid for the bond and the 103 the customer paid for it

Six points, the rise in the bond's market price over the three weeks it sat in the dealer's inventory before the sale

Two points, the gap between what the customer paid and what the bond was worth in the market when the trade was done

None, the dealer having sold at its own quoted offering price rather than adding a separate charge to a market price

FINRA's five percent policy is applied to a customer transaction on which the firm has taken a markup and has also charged the customer a commission. What figure does the policy weigh against the transaction price?

The markup alone, a commission charged on the same transaction being weighed against the separate standard that governs agency business

Whichever charge is the larger of them, the policy addressing the dominant element of what the customer was asked to pay

The markup together with the cost of carrying the position in inventory until the customer bought it, that cost forming part of the charge

The combined total of the markup and the commission, the policy addressing what the customer is charged altogether

When an advisory client opened her account she signed a provision in the advisory agreement authorising the adviser to act as principal in transactions with her. The adviser now proposes to sell her a bond out of its own inventory. What does Section 206(3) of the Investment Advisers Act require?

The provision does not satisfy the section, which looks for disclosure and consent on this transaction itself

Nothing further, the section reaching only an adviser that is also registered with the Commission as a broker-dealer

Nothing further, provided the adviser records the price obtained and reviews it against the market after the trade has settled

The provision must be renewed in writing each year, a standing authorisation being treated as good for twelve months

An investment adviser wishes to buy a block of bonds from an advisory client into the adviser's own inventory, rather than to sell bonds to that client. Does the Investment Advisers Act requirement governing principal transactions reach a purchase of this kind?

No, the requirement addresses sales to clients, where the adviser determines what the client ends up holding in the account it manages

Yes, the adviser is the party on the other side of the client's trade either way, which is what makes it a principal transaction

No, a purchase relieves the client of a holding rather than placing one with him, so the adviser takes nothing from the client in the trade

Yes, but only where the adviser resells the bonds at a profit rather than holding them in its inventory for its own longer-term purposes

An advisory firm weighs the disclosure and consent obligations that attach to dealing as principal with its advisory clients. What course do many advisers take instead, and what does it achieve?

They restrict principal dealing to clients whose accounts exceed a stated size, confining the procedures to a small number of substantial relationships

They take no markup or markdown on such trades, which removes the financial interest in the price that creates the difficulty for the firm

They decline to deal as principal with advisory clients at all, which removes the conflict as well as the procedures it would require

They describe the practice in the firm's disclosure brochure and then deal freely, that description answering for the firm and all of its clients

An institution places two orders on the same morning. The listed equity order is matched against another investor's order on an exchange, while the corporate bond order is filled by a dealer selling the bonds out of its own position. What accounts for the way the bond order was filled?

The bond order was too large to be matched, orders above a stated size being filled out of inventory in either market

Bond orders must be executed against a dealer's inventory, execution on an exchange being confined by rule to equity securities

The dealer held those bonds as agent for another customer and passed them on, the sale from its position being a bookkeeping step

Corporate bonds trade over the counter with no central order book, so a dealer standing as counterparty is how the order is filled

A customer asks his firm to buy shares for him on an exchange, and the firm acts as his agent in doing so. The next day the same firm sells him a bond from its inventory, and the confirmation says it acted as principal. Who is the principal in each of the two trades?

The firm in both, since a firm that executes a trade for a customer is the principal to it whether it is acting on the customer's behalf or for itself

The customer in the first, as the party on whose behalf the firm acts, and the firm itself in the second, as the dealer trading for its own account

The customer in both, since every trade is carried out on behalf of the customer who places the order, whatever capacity the firm's confirmation names

The exchange in the first, as the venue whose system matches the order, and the firm itself in the second, as the dealer selling the bond from its own inventory

A widow living on the income from her savings tells her adviser that preserving the capital she has is her overriding objective. Toward which holdings should that objective shape her allocation?

Toward long-dated zero-coupon Treasury bonds, which carry no default risk and so cannot lose any of the capital invested in them

Toward dividend-paying blue-chip shares, whose steady dividends protect the capital however far the share prices themselves fall

Toward short-duration bonds, certificates of deposit and money market funds, the capital-stable instruments the objective calls for

Toward high-yield corporate bonds, whose large coupons make good any loss of capital that a default among the issuers might cause

Which of these outcomes is a realisation of principal risk, as opposed to some other dimension of investment risk?

An investor sells her bond fund holding for eight thousand dollars, having put ten thousand into it, and so recovers less than she committed

An investor's certificate of deposit renews at a lower rate, so the interest it pays her falls although the deposit itself remains intact

An investor's shares fall by a fifth during the year and then recover fully, and she sells them at exactly the price she originally paid

An investor's balanced fund returns three percent while comparable funds return six, although she has lost none of the capital she put in

A dealer sells a customer a security from its inventory at a markup of two and a half percent of the transaction price, and it also charges a commission of three percent of that price. How does FINRA's five percent policy treat the charge to the customer?

As two separate charges that each fall below five percent, so the policy raises no question about the transaction however they add up

As one combined charge of five and a half percent, which is above the five percent general benchmark for what the customer pays

As a charge of three percent, the policy weighing only the larger of the two charges against the transaction price in each case

As a charge of two and a half percent, the commission being left to the separate standard that governs agency business instead

An investor pays nine hundred and fifty dollars for a bond with a face amount of one thousand dollars and a coupon rate of six percent. What annual coupon interest does she receive?

Fifty-seven dollars, the coupon being calculated as a percentage of the nine hundred and fifty dollars she actually paid for the bond

Sixty-three dollars, the coupon rising so as to compensate her for the discount below face at which she bought the bond

Sixty dollars, the coupon being calculated as a percentage of the bond's one thousand dollar face amount, not of what she paid

Thirty dollars, the six percent rate being applied to the face amount only for the half of the year after her purchase

What is one of the central challenges that the layered agency relationships of corporate governance create?

Managing the conflicts of interest that arise when agents' personal interests diverge from those of the principals they serve

Deciding which level of the structure owns the corporation's assets, since each level holds a share of the legal title to them

Keeping the structure to two levels, since agency duties cannot pass through more than one intermediate party in a chain

Preventing any level from owing fiduciary duties, which would leave the levels below it without the authority to act at all

A business owner authorises her office manager to order supplies up to a stated limit. The manager places an order within that limit, and the owner later decides she would rather not have bought the goods. Where does she stand?

She may cancel, since an agent's order binds the principal only once the principal has confirmed it in writing

She is bound, the manager's order within the authority granted binding her as if she had placed it herself

She is bound only if the supplier knew of the limit, the authority otherwise being the manager's alone to answer for

She may refuse the goods, leaving the manager personally liable for an order that she as principal has not adopted

An adviser holds discretionary authority over a client's account under an advisory agreement and an investment policy statement that excludes commodities. Without consulting her, it buys a commodity fund for the account. How does the purchase stand?

Within the authority granted, since discretion allows the adviser to decide what to buy for the account without asking the client first

Within the authority granted as long as the fund performs well, a good result showing that the decision served the client's interests

Outside the authority granted, since the agreement and the policy statement set the limits within which the adviser's decisions are made

Outside the authority only because the adviser did not ask her first, the policy statement's exclusions binding a non-discretionary adviser

A dealer buys a corporate bond from a customer at 97 when the bond's prevailing market price is 99, and resells it to another investor a week later at 100. What markdown was the selling customer charged?

Three points, the profit the dealer made between buying from the customer and reselling a week later

One point, the gap between the prevailing market price and the price at which the dealer later resold it

Half a point, the dealer's share of the spread being split between the seller and the later buyer

Two points, the gap between the prevailing market price and the price the customer received for the bond

A dealer sells a customer a thinly traded bond at a markup of four percent of the price, charging no commission. Does staying under FINRA's five percent policy settle that the charge is fair?

No, the five percent figure being guidance rather than an absolute rule, the appropriate charge depending on the transaction

Yes, the five percent figure being a safe harbour, so that any charge falling below it is treated as fair whatever the trade

Yes, the policy reaching only charges that combine a markup with a commission, so a markup charged alone falls outside it

No, the five percent figure applying to listed shares, while bonds are held to a separate ceiling of three percent instead

An investment adviser sells a bond from its own inventory to an advisory client. The next day it sends her written disclosure that it acted as principal and obtains her written consent. Has Section 206(3) been satisfied?

Yes, the written disclosure and consent having been obtained within the settlement period of the trade itself

No, the written disclosure and the client's consent having to come before or at the time of the transaction

Yes, provided the price she paid was close to the prevailing market price, a fair price curing the late consent

No, the section prohibiting an adviser from ever acting as principal with an advisory client in any circumstances

Before selling a client a bond from its own inventory, an adviser explains on the telephone that it would be acting as principal, and the client agrees on the call. Nothing is put in writing. Has Section 206(3) been satisfied?

Yes, since the disclosure and the client's agreement to it both came before the transaction was carried out

Yes, provided the adviser keeps a recording of the call, a recorded conversation counting as a written record of it

No, since the disclosure of the principal nature of the transaction must be given to the client in writing

No, since the consent must be given by the client's lawyer or by another representative acting independently on her behalf

Last month an advisory client received written disclosure and gave her consent when her adviser sold her a bond as principal. The adviser now proposes to sell her a second bond from its inventory on similar terms. What does Section 206(3) require?

Nothing further, the earlier consent extending to later sales of the same kind of security on similar terms to the first

Disclosure alone, the client's consent to the practice having already been given and needing no repetition for the sale

Fresh consent only if the second bond is priced above the first, a sale on the same or better terms being covered already

Fresh disclosure and consent for the second sale, the earlier consent having covered only the transaction it was given for

Why does a principal transaction between an investment adviser and its own advisory client create a direct conflict of interest?

Because the adviser represents the client's interest as her fiduciary while holding its own financial interest in the price as the other party

Because the adviser earns a commission on the trade as well as its advisory fee, so that the client ends up paying twice for one service

Because the client cannot check the price, advisory trades being reported to the market only after a delay that brokerage trades avoid

Because the trade takes the client's securities out of custody, leaving them with the adviser instead of with a qualified custodian

What does the Municipal Securities Rulemaking Board require a dealer to disclose to a customer about its role in a municipal securities transaction?

Whether it holds other bonds of the same issuer in its inventory, which tells the customer how far the dealer is exposed to that issuer

Whether it is dealing with the customer for its own account, which tells the customer the nature of the trade and their economic relationship

Whether another dealer bid for the bonds before the trade, which tells the customer how much competition there was for the bonds

Whether it has held the bonds for more than a month, which tells the customer how long the dealer has carried the inventory risk

The MSRB's fair pricing rules govern the total price of a municipal securities transaction in which the dealer trades with the customer from its own position. What do they protect the customer against?

Being sold bonds whose credit rating has fallen since the dealer first bought them into its own inventory

Being exposed to the issuer's default, the dealer having to stand behind the bonds it sells from its position

Being charged an excessive spread in a trade where the dealer itself stands as the customer's direct counterparty

Being charged for research on the issuer that the dealer prepared for the use of its own trading desk

Equity orders are often executed as agent through exchange order matching. Why is principal market-making instead the dominant execution model across most fixed income markets, municipal bonds included?

Because municipal and corporate issuers require their bonds to be bought and sold through the dealer that underwrote each issue for its whole life

Because bond interest accrues daily, and only a dealer holding the bonds in its own inventory can calculate the accrued amount owed by a buyer

Because bond buyers are mostly institutions, which may not by law place their bond orders through a broker that would act as their agent

Because most fixed income markets are over the counter, so dealers buying from sellers and selling to buyers from inventory make the market

What Is Principal in Finance? 3 Meanings and Exam Tips

What Is Principal in Finance?

The term principal carries several distinct meanings in the financial services and investment context, each referring to a different but related concept that investment professionals must clearly distinguish based on the context in which the term appears. The three primary meanings are the original sum of money invested or borrowed, the party on whose behalf an agent acts in a principal-agent relationship, and the party acting as dealer on their own account rather than as broker or agent in a securities transaction. Each of these meanings is tested in securities industry examinations and appears regularly in investment practice, regulatory documentation, and client communications, making precision in the use of this term an important competency for any investment professional.

The multiplicity of meanings attached to a single common term like principal is not unique to financial services but is particularly consequential in this context because the distinctions among the different meanings have significant legal, regulatory, and practical implications. An investment professional who conflates the principal as the original amount of a loan with the principal as a party acting as dealer in a securities transaction, or who confuses the principal in a principal-agent relationship with the principal in a fixed income context, risks misunderstanding the fundamental nature of a transaction, mischaracterising the obligations of the parties involved, or miscommunicating with clients about the terms and economics of their investments.

Principal as the Original Sum of Money

In the context of lending and investment, principal refers to the original sum of money that has been borrowed, invested, or placed at risk, as distinguished from the interest, dividends, fees, or other returns generated by that original sum. The principal is the face value or notional amount of the investment or obligation, representing the baseline capital that must be preserved and ultimately returned to the investor or repaid by the borrower before any discussion of profit or return is meaningful.

In fixed income investing, the principal is the face value or par value of a bond, the amount that the issuer promises to repay to the bondholder at the maturity of the instrument. As described in the Debt Security article in Section D, the standard par value for most US bonds is one thousand dollars, and the periodic coupon interest payments are calculated as a percentage of this principal amount. The return of principal at maturity represents the recovery of the investor's original capital investment, with the coupon income received during the life of the bond representing the return on that principal.

In lending, the principal is the original amount borrowed that the borrower is obligated to repay over the life of the loan, distinct from the interest that accrues on the outstanding principal balance. Mortgage amortisation schedules illustrate the distinction clearly, with each monthly payment divided between an interest component calculated on the outstanding principal balance and a principal component that reduces the outstanding loan balance. In the early years of a mortgage, the interest component dominates and relatively little of each payment reduces the principal balance. As the loan matures and the principal balance declines, the interest component shrinks and an increasing proportion of each payment goes toward principal reduction.

The concept of principal preservation is central to the investment objectives of many conservative investors, particularly those in or approaching retirement who need their portfolio to maintain its value while generating income. An investment objective of principal preservation means that the investor prioritises avoiding losses of the original capital above all other considerations, accepting lower returns in exchange for the highest possible probability of recovering the full amount initially invested. This objective shapes the asset allocation toward capital-stable instruments including short-duration bonds, certificates of deposit, and money market funds that minimise the risk of loss of the original principal.

Principal risk, also called capital risk, is the risk that an investor will receive back less than their original investment, losing some or all of the principal they committed. Principal risk is the most fundamental dimension of investment risk for conservative investors and is the primary reason that higher-risk investments must offer higher expected returns to attract capital from investors who could alternatively choose the relative safety of principal-preserving instruments.

Principal in the Principal-Agent Relationship

In the legal and regulatory context of agency relationships, a principal is the party on whose behalf an agent acts, making decisions and taking actions that bind the principal in the same manner as if the principal had acted personally. The principal-agent relationship is one of the most fundamental legal relationships in business and finance, arising whenever one party, the principal, delegates authority to another party, the agent, to act on the principal's behalf in dealings with third parties.

The principal-agent relationship creates a set of legal obligations on both parties that govern the conduct of the agency. The agent owes fiduciary duties to the principal including the duty of loyalty requiring the agent to act in the principal's interest rather than their own, the duty of care requiring the agent to act with appropriate skill and diligence, and the duty of disclosure requiring the agent to share material information with the principal. The principal in turn has obligations to the agent including the obligation to compensate the agent as agreed and to indemnify the agent for liabilities reasonably incurred in the performance of their duties.

In the investment advisory context, the investment adviser acts as an agent for the client who is the principal, making investment decisions on the client's behalf within the authority granted through the advisory agreement and the investment policy statement. The agent's authority may be discretionary, allowing the adviser to make investment decisions without prior client approval, or non-discretionary, requiring client approval before each transaction as described in the Discretionary Account article in Section D. In both cases the client remains the principal whose interests the adviser is obligated to serve as a fiduciary.

The power of attorney relationship discussed in the preceding article is a specific form of the principal-agent relationship in which the principal expressly documents and formalises the authority granted to the agent through the power of attorney document. The agent under a power of attorney is sometimes called the attorney-in-fact, but their legal role is that of agent acting on behalf of the principal who granted the power.

Corporate governance is structured around a layered principal-agent relationship in which shareholders are the ultimate principals who own the corporation, directors are agents of the shareholders who oversee the company's management, and officers and employees are agents of the corporation who execute the business plan under the direction of the board. This layered structure creates multiple levels of agency relationship each with its own set of fiduciary duties and accountability mechanisms, and the management of conflicts of interest that arise when the agents' personal interests diverge from the interests of the principals they serve is one of the central challenges of corporate governance.

Principal as Dealer in Securities Transactions

In the context of securities transactions, a principal is a party that buys or sells securities for its own account, acting as dealer rather than as broker or agent for another party. When a broker-dealer acts as principal in a transaction, it buys securities from its own inventory to sell to a customer, or sells securities from its inventory to a customer, earning the profit on the spread between the price at which it acquired the securities and the price at which it sells them rather than earning a commission for facilitating a transaction between third parties.

The distinction between principal and agency transactions is one of the most fundamental in the regulation of broker-dealer activity, with significant implications for the pricing transparency, conflict of interest management, and disclosure obligations applicable to each type of transaction.

In a principal transaction, the broker-dealer is the counterparty to the customer's trade, selling securities from its own inventory to the customer at a markup above the price at which it acquired the securities, or buying securities from the customer at a markdown below the price at which it will subsequently sell them. The broker-dealer profits from this markup or markdown, which represents the economic equivalent of the commission earned in an agency transaction but is embedded in the price of the securities rather than charged as a separate explicit fee. Because the markup or markdown in a principal transaction is not separately disclosed as a commission, it can be less transparent to customers than the explicit commission charged in an agency transaction.

In an agency transaction, the broker-dealer acts as an intermediary that facilitates a transaction between the customer and another party in the market, neither buying nor selling securities for its own account. The broker-dealer earns a commission for this intermediation service, which is disclosed explicitly to the customer as a separate charge rather than being embedded in the price of the securities.

FINRA's five percent policy provides general guidance that the combined total of markups, markdowns, and commissions charged by broker-dealers in customer transactions should not exceed five percent of the transaction price, though this is a guideline rather than an absolute rule and the appropriate charge depends on the specific characteristics of each transaction. In principal transactions the markup or markdown must be calculated from the prevailing market price of the security rather than from the broker-dealer's acquisition cost, ensuring that the customer pays a price related to the current market value of the securities rather than to the historical cost of the broker-dealer's inventory.

Principal Transactions and Investment Adviser Conflicts of Interest

The intersection of the principal transaction concept with the investment adviser fiduciary obligation creates one of the most significant conflict of interest scenarios in the investment advisory industry, requiring specific disclosure and consent procedures that are directly tested on securities examinations.

As described in the Discretionary Account article in Section D, Section 206(3) of the Investment Advisers Act prohibits a registered investment adviser from acting as principal in any transaction with a client without providing written disclosure of the principal nature of the transaction and obtaining the client's consent before or at the time of the transaction. This prohibition reflects the recognition that a principal transaction between an investment adviser and a client creates a direct conflict of interest, as the adviser simultaneously represents the client's interest as their fiduciary and has a personal financial interest in the price of the transaction as the other party to the trade.

The Section 206(3) disclosure and consent requirement cannot be waived in advance by a blanket provision in the investment advisory agreement, meaning that each individual principal transaction requires contemporaneous or prior written disclosure and consent rather than relying on general pre-authorisation. This transaction-by-transaction consent requirement ensures that clients are specifically aware of each instance in which their adviser is acting as counterparty rather than as pure fiduciary, allowing them to make informed decisions about whether to proceed with each specific transaction on the disclosed terms.

The practical implications of Section 206(3) mean that investment advisers who wish to sell securities from their own inventory to advisory clients, or to purchase securities from advisory clients into their own inventory, must implement specific compliance procedures including the preparation and delivery of principal transaction disclosure documents for each such transaction and the collection and documentation of client consent. Many investment advisers choose to avoid principal transactions with advisory clients entirely rather than implementing the required disclosure and consent procedures, simplifying their compliance obligations and eliminating the associated conflict of interest.

Principal in Fixed Income Pricing

In fixed income markets, the principal-agent distinction takes on an additional practical dimension related to the pricing conventions used in different market segments.

The municipal securities market, the corporate bond market, and most other fixed income markets trade primarily on a principal basis, with broker-dealers acting as market makers who buy bonds from sellers and sell bonds to buyers from their own inventory, earning the spread between their purchase and sale prices as compensation for providing market-making services and bearing the inventory risk associated with holding bond positions. Unlike equity markets where agency execution through exchange order matching is more common, the over-the-counter nature of most fixed income markets makes principal market-making the dominant execution model.

The Municipal Securities Rulemaking Board requires dealers to disclose when they are acting as principal in municipal securities transactions with customers, providing customers with information about the nature of the transaction and the economic relationship between the dealer and the customer. The MSRB's fair pricing rules require that the total transaction price in a principal municipal securities transaction reflect a fair and reasonable markup or markdown from the prevailing market price, protecting customers from being charged excessive spreads in transactions where the dealer is acting as the direct counterparty.

Examination Relevance and Key Takeaways

Principal is tested on the SIE, Series 7, and Series 65 examinations across multiple contexts that reflect its different meanings in different financial settings. Candidates must understand the three primary meanings of the term including the original sum of money invested or borrowed, the party on whose behalf an agent acts in a principal-agent relationship, and the party acting as dealer on its own account in a securities transaction, and must be able to apply the correct meaning based on the context in which the term appears.

The core points to retain are these: in lending and investment principal refers to the original amount of money invested or borrowed as distinguished from the interest or returns generated on that amount; in agency law principal refers to the party who delegates authority to an agent to act on their behalf with the agent owing fiduciary duties to the principal including loyalty, care, and disclosure; in securities transactions principal refers to a dealer acting for its own account rather than as broker for a third party earning the spread between purchase and sale prices rather than a separate commission; Section 206(3) of the Investment Advisers Act prohibits registered investment advisers from acting as principal in transactions with advisory clients without written disclosure of the principal nature of the transaction and specific client consent before or at the time of each transaction; this disclosure and consent requirement cannot be waived in advance and applies to each individual principal transaction; the FINRA five percent policy provides guidance that markups markdowns and commissions in customer transactions should not exceed five percent of the transaction price as a general benchmark; and fixed income markets trade primarily on a principal basis with broker-dealer market makers earning the spread between bid and ask prices rather than charging explicit commissions as in most equity market transactions.