Market Participants and Their Roles

The securities industry is a crowded stage, and the exam expects you to know who is standing where. The cast sorts into a few groups: the investors who put up the money, the intermediaries who connect them to the markets, the underwriters who bring new securities to life, and the back-office machinery that settles the trades. This chapter walks through each. Most questions here are simple matching, so the goal is to pin each player to its job and its risks.

Start with the people whose money moves the markets. Investors sort into a few buckets the exam likes to keep separate.

Retail and accredited investors

Retail investors are ordinary individuals investing their own, non-professional money. Some clear a higher bar and become accredited investors, individuals or entities meeting set wealth or income thresholds (broadly, $200,000 in annual income, $300,000 jointly with a spouse, or $1 million in net worth excluding the primary residence). Crossing that line matters, because accredited investors may buy into private placements that ordinary retail investors cannot.

Institutional investors

Institutional investors are the giants, organizations that trade in huge volume and play by somewhat different rules. The main types:

• Pension funds manage retirement money for employees and owe a fiduciary duty to their beneficiaries under ERISA. They are among the largest investors anywhere.
• Insurance companies invest premium income to cover future claims, and tend to favor fixed income to match those obligations.
• Mutual fund companies pool retail money and invest it toward a stated objective.
• Endowments and foundations manage money for universities, hospitals, and charities, usually over very long horizons.
• Sovereign wealth funds are state-owned investment pools, like Norway's Government Pension Fund, and they are enormous.

FINRA draws a formal line here. Under Rule 4512, an "institutional account" includes banks, insurance companies, registered investment companies, government entities, FINRA member firms, and any entity with at least $50 million in total assets. That $50 million figure is the one to remember.

Between the investors and the markets sits a layer of professionals and firms, each with a specialized job:

• Investment advisers give investment advice for compensation and owe a fiduciary duty to their clients, meaning they must put the client's interest first.
• Municipal advisors advise state and local governments on issuing municipal securities and related financial products.
• Market makers stand ready to buy and sell a security continuously, quoting both a bid and an ask. They supply liquidity and earn the bid-ask spread for it.
• Transfer agents keep the records of who owns a security, process ownership transfers, and handle dividend and interest payments.
• Custodians and trustees hold and safeguard assets on behalf of clients.

When a company wants to sell new securities to the public, it hires investment banks to act as underwriters and shepherd the deal to market. On a typical deal the work splits across three tiers, and the exam wants you to know who does what and, above all, who takes the risk.

Who plays what role

• The lead (or managing) underwriter runs the whole show: due diligence, filing the registration statement, setting the offering price, and allocating the shares.
• Syndicate members are other investment banks that join the lead to share the underwriting risk and help place shares.
• The selling group is made up of broker-dealers that help sell shares but take on no underwriting risk. Because they carry no risk, they earn only a selling concession, which the exam tests directly.

The four commitment types

• Firm commitment: the underwriter buys the entire issue from the issuer and resells it to the public, taking on all the risk of any shares that do not sell. This is the standard for large IPOs, and it is why the underwriter, not the issuer, absorbs the loss on unsold shares.
• Best efforts: the underwriter acts only as an agent, promising to sell as many shares as it can but guaranteeing nothing. Whatever does not sell simply returns to the issuer.
• All-or-none: a stricter best-efforts deal where either the whole issue sells or the offering is canceled and every investor gets their money back.
• Mini-max: a best-efforts deal with a floor and a ceiling, a minimum that must sell for the deal to close and a maximum it cannot exceed.

Underwriters get paid through the underwriting spread, the gap between what the public pays for a new issue and what the issuer actually pockets. That spread is carved into three pieces, and who collects which piece depends on the role they played:

The distinction the exam loves: a selling group member earns only the selling concession, because it took no underwriting risk and did no managing. A syndicate member can collect all three pieces on the shares it sells, and only the lead takes the management fee.

Worked example: if the public offering price is $20 and the issuer receives $18.50, the spread is $1.50. It might break down as $0.25 management, $0.50 underwriting, and $0.75 selling concession, with the selling concession typically the biggest slice.

Not every broker-dealer does the same job. The exam draws a sharp line between firms based on whether they actually hold your money and settle your trades:

• An introducing broker-dealer takes your order but does not hold your cash or securities. It hands the trade off to another firm to clear and settle. Think of it as the storefront.
• A clearing broker-dealer (also called a carrying firm) is the one that actually holds customer assets, settles the trades, and runs the back office. When a question asks which firm holds customer funds and securities and handles settlement, this is the answer.
• A prime broker provides a bundle of specialized services to hedge funds and other large traders, including custody, securities lending, and trade execution across multiple firms.

Once a trade is agreed, an invisible layer of infrastructure makes sure the right securities and cash actually change hands. A few names sit at the center of it:

• DTCC, the Depository Trust and Clearing Corporation, is the parent company that oversees most U.S. clearing and settlement.
• DTC, the Depository Trust Company, holds securities electronically in book-entry form. Almost all securities today live at DTC as electronic records rather than paper certificates.
• NSCC, the National Securities Clearing Corporation, handles clearing, settlement, and risk management, and acts as the central counterparty to every trade. If one side defaults, the NSCC steps in so the other side is still made whole.

Street name versus direct registration

How your securities are held is its own small exam topic. In street name, your shares are registered in the broker-dealer's name (the "street") but held for your benefit. This is the default for most brokerage accounts because it makes trading fast and easy. Under direct registration (DRS), the shares are recorded directly in your own name on the issuer's books, with no certificate and a statement coming from the transfer agent instead.