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Brokers: Roles and Responsibilities

By Frederic Ruffy, Optionetics.com | Tue July 18, 2006 5:00PM PT

The office is abuzz about a new Internet company that all of your colleagues know is a sure winner in the stock market. You've just received your bonus check and are looking for a place to invest the money. The problem is that you haven’t invested in anything since that stamp collection in the sixth grade (the same stamp collection, incidentally, that you later inadvertently used to mail love letters to your college sweetheart). So what do you do now? You’re too embarrassed to ask your cohorts at work how to buy shares.

Relax. The process is easy. The first step is to open an account with a broker. This can be done using an online broker, over the telephone, or visiting a brokerage in your area. Next comes the paperwork. The first form is called the new account agreement. This somewhat legal looking document may have you wondering if you are setting up an account or applying for a job.

Nevertheless, the new account agreement is important for two reasons. First, the form provides the brokerage firm with information about you and your financial resources, which includes assets, liabilities, income, and net worth. Second, the form spells out the terms and conditions that the broker imposes on its customers. So, while it certainly isn’t an interesting read, the new account agreement provides important information for the broker about you and details about the brokerage firm’s policy for you, the customer.

After the account form is reviewed and approved by the brokerage firm, trading can begin. Based on your experience level and financial profile, the broker may impose limits on your trading—e.g. the use of credit, limit specific option strategies, or prohibit the purchase of certain speculative investments. In most cases, however, that will not pose a problem and after the account is set up, it can then be funded and orders can be placed.

While the actual process of setting up a brokerage account is relatively easy, in the long run, finding the right broker that meets specific investment goals is sometimes more challenges. After all, there are dozens of online brokers out there these days as well as many offline brokers. Determining which one is right for you can be a long and arduous process.

One of the most important considerations when evaluating various brokers is: What type of broker is it? How does it make money? Specifically, does it specialize in one type of investment like options or does it provide a wide range of services like credit cards, loans, and other non-trading activities.  

Commissions and fees also matter. Commissions will generally be higher for brokers who offer specific advice to investors. So-called "full-service" firms have "financial consultants" or "financial advisors" who not only buy and sell shares on your behalf, but also gather information about your financial resources and make specific recommendations. Other firms, sometimes called "discount brokers" do not offer any sort of financial advice. They simply execute buy and sell orders on your behalf at the lowest cost possible. Most online brokers operate as discount brokers today.

Regardless of whether the broker charges high or low commissions, all brokers are regulated by the Securities and Exchange Commission [SEC] and are required to meet certain standards when dealing with customers. Specifically, the Securities and Exchange Act of 1934 puts forth certain provisions that all brokers must adhere to. These provisions are provided below:

Duty of Fair Dealing: This includes the duty to execute orders promptly, disclosing material information (information that a broker’s client would consider relevant as an investor), and charge prices that are in line with competitors. 

Duty of Best Execution: The broker has a responsibility to complete customer orders at the most favorable market prices possible. 

Customer Confirmation Rule: The broker must provide the investor with certain information, at or before the execution of the order (i.e. date, time, price, number of shares, commission, and other information). 

Disclosure of Credit Terms: At the time an account is opened, a broker must provide the customer with the credit terms and, in addition, provide credit customers with account statements quarterly. 

Restriction of Short Sales: This rule bars an investor from selling an exchange-listed security that they do not own (in other words, sell a stock short) unless the sale is above the price of the last trade. 

Trading During Offerings: Rule 101 prohibits the broker from buying a stock that is being offered during the "quiet period"—one to five days before and up to the offering. 

Restrictions on Insider Trading: Brokers have to establish written policies and procedures to ensure that employees do not misuse material nonpublic (or inside) information.

In conclusion, if you’re convinced that your colleagues have spotted a real winner and you are ready to invest your bonus check on a hot stock, finding a broker and opening an account is relatively straightforward. Over the long run, however, finding a broker to meet your particular investment needs is sometimes more challenging. All brokers are required to adhere to certain standards or roles and responsibilities. Most do and this is generally not an issue. If you are not sure, then ask for references or recommendations from colleagues, friends, or associates.

Also, decide how much help you need. Investors seeking frequent contact and regular investment advice are best served using the services of a full service broker. The commissions are higher, but that’s the cost of doing business with a trained professional. If you plan on doing only one or two trades and are not seeking help with respect to your overall financial plan, a discount broker who simply executes orders is probably sufficient. Or, if you plan to trade on a regular basis and make your own decisions, then online trading is probably the way to go. 


Frederic Ruffy
Optionetics.com ~ Your Options Education Site




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