Did the firm match you with someone, or sell you its own inventory? The confirmation tells you, and so does the exam.
Two ways a firm can fill the same order
When a firm acts as agent it arranges the trade and stands aside from it. The customer’s money goes to whoever sold the security and the firm takes a commission for the service. The firm never owns the security, never has capital at risk in it, and earns the same fee whether the price rises or falls the following morning. This is the broker half of broker-dealer.
Keep reading: 3 more paragraphs (about 1 min)
When a firm acts as principal it is the other side of the trade. It sells the customer a security out of its own inventory, or buys the customer’s security into that inventory. It earns the difference between what the security cost it and what it charged, which is a markup on a sale to a customer and a markdown on a purchase from one. This is the dealer half.
The market context is the quote. A dealer publishes a bid, the price at which it will buy, and an ask or offer, the price at which it will sell. The gap between them is the spread, and it is the dealer’s compensation for holding inventory and being willing to trade when nobody else is. A markup is measured from the prevailing market price rather than from whatever the dealer happens to have paid. FINRA’s markup policy treats 5% as a guide, not a rule. A markup of 5% or even less can still be unfair. The policy does not apply to securities sold at a fixed public offering price with a prospectus.
The two capacities cannot be mixed on the same side of the same trade: a firm is either arranging it or taking the other side of it. The customer confirmation must disclose which capacity was used, and a commission and a markup are shown differently, which is why an exam question can hand you a confirmation and expect you to name the capacity from it.
Exam terms (6)
- Agency trade
- The firm arranges a trade for a customer with someone else and charges a commission.
- Principal trade
- The firm takes the other side from its own inventory.
- Commission
- The fee an agent charges for arranging a trade.
- Markup
- The amount added when a dealer sells to a customer from inventory.
- Markdown
- The amount deducted when a dealer buys a security from a customer.
- Bid and ask
- The prices at which a dealer will buy and sell; the gap is the spread.
Agent or principal
| Agency | Principal | |
|---|---|---|
| Firm owns the security | No | Yes, in inventory |
| Firm is paid by | A commission | A markup or markdown |
| Other side of the trade | Another investor or dealer | The firm itself |
| Firm’s capital at risk | None in the security | Inventory risk |
| Shown on the confirmation as | Commission, stated separately | The price, reflecting the markup |
Try it: Sketch two confirmations for the same purchase of 200 shares. On the first, write a price and a separately stated commission; on the second, write a single price with no commission line. Then say which capacity each represents and where the firm’s pay is hidden in the second one.
Check yourself
Try a question, then read the explanation to review the rule.
Opening your study record…
Worked example
A customer wants 500 shares of a security quoted 24.10 bid, 24.40 ask, and two firms fill the order in different capacities.
- The first firm has none of the stock. It goes to the market, buys 500 shares at the offer of $24.40 for the customer’s account and charges a commission of $50.
- The confirmation shows a price of $24.40 and a commission of $50 stated separately. The firm acted as agent and never owned the shares.
- The second firm holds the stock in inventory. It sells 500 shares to the customer at $24.50, which is the prevailing market offer of $24.40 plus a markup of ten cents a share.
- That confirmation shows a price of $24.50 and no commission line, because the firm’s pay of $50 is inside the price. It acted as principal.
- The customer paid the same amount both times, and the two trades are still different in law. The capacity determines what must be disclosed and how the charge is measured.
Same rule, new context
Opening your study record…
The closest contrast
Agency: commission.
Principal: markup.
This decides what a confirmation is telling you. A separately stated commission means the firm arranged the trade; a price with no commission line usually means the firm was the other side and has been paid inside the price.
Summary
- An agent arranges the trade, owns nothing and charges a commission.
- A principal takes the other side from inventory and earns a markup or markdown.
- The bid is where a dealer buys, the ask is where it sells, and the spread is its compensation.
- The capacity must be disclosed on the customer confirmation.
Related practice
- Long vs short positions and capacityPractice this
Sources
- SIE Examination Content Outline (2025) · FINRA · checked 2026-10-12
- FINRA Rule 2232 — Customer Confirmations · FINRA · checked 2026-09-04
- Bid Price/Ask Price (SEC Office of Investor Education and Advocacy glossary) · Investor.gov · checked 2026-09-04
- FINRA Rule 2121, Supplementary Material .01 and .02 — the 5% Policy and prevailing market price · FINRA · checked 2026-10-09