WEBVTT 00:00:00.000 --> 00:00:01.760 Welcome back to the Deep Dive. It's great to 00:00:01.760 --> 00:00:04.519 be here. So the source material you brought in 00:00:04.519 --> 00:00:08.279 today, it really gets to the absolute heart of 00:00:08.279 --> 00:00:10.240 the financial system, doesn't it? It really does. 00:00:10.339 --> 00:00:12.000 We're not talking about something on the fringes. 00:00:12.000 --> 00:00:13.839 We're talking about the fundamental plumbing, 00:00:14.060 --> 00:00:17.859 the gears that allow trillions of dollars of 00:00:17.859 --> 00:00:20.660 assets to move around the globe. Every single 00:00:20.660 --> 00:00:25.160 day. And we're tackling this foundational entity 00:00:25.160 --> 00:00:26.859 that I think a lot of people have heard of, but 00:00:26.859 --> 00:00:29.379 maybe don't. fully grasped, we're talking about 00:00:29.379 --> 00:00:32.399 the broker -dealer. They are the central nervous 00:00:32.399 --> 00:00:34.399 system. I mean, you could call them the power 00:00:34.399 --> 00:00:37.619 grid of trading. If markets need liquidity and 00:00:37.619 --> 00:00:40.140 turnover to function, well, the broker -dealer 00:00:40.140 --> 00:00:42.219 is the indispensable infrastructure that makes 00:00:42.219 --> 00:00:44.500 it all happen. It's where capital, risk, and 00:00:44.500 --> 00:00:47.060 regulation all collide. Exactly. It's a convergence 00:00:47.060 --> 00:00:49.359 point. Right. And the sources you've shared, 00:00:49.439 --> 00:00:52.119 they made a picture of an entity with just enormous 00:00:52.119 --> 00:00:55.579 influence, but also this inherent internal conflict. 00:00:55.659 --> 00:00:58.149 The split personality, really. A split personality. 00:00:58.390 --> 00:01:01.770 I like that. So our mission today for you is 00:01:01.770 --> 00:01:04.209 to unpack that conflict. We want to help you 00:01:04.209 --> 00:01:06.890 gain a really comprehensive understanding of 00:01:06.890 --> 00:01:09.849 this critical financial player. We'll look at 00:01:09.849 --> 00:01:12.450 its two distinct roles, how it supports the entire 00:01:12.450 --> 00:01:15.250 market, functions like market making, and then 00:01:15.250 --> 00:01:18.129 maybe most importantly, how this intricate global 00:01:18.129 --> 00:01:21.260 regulatory net. tries to govern it. And that 00:01:21.260 --> 00:01:24.000 net stretches from the US to the UK to Japan, 00:01:24.140 --> 00:01:26.299 all with their own flavor. Absolutely. So let's 00:01:26.299 --> 00:01:28.579 start with the most basic definition, because 00:01:28.579 --> 00:01:31.090 that hyphenated name. says it all. It really 00:01:31.090 --> 00:01:34.950 does. At its core, a broker dealer is a person, 00:01:35.109 --> 00:01:37.629 a company, or an organization that's in the business 00:01:37.629 --> 00:01:40.590 of trading securities. Okay. But the reason we 00:01:40.590 --> 00:01:42.709 use that term broker dealer is because of its 00:01:42.709 --> 00:01:45.430 dual purpose. They trade securities either for 00:01:45.430 --> 00:01:47.650 their own account or on behalf of their customers. 00:01:47.930 --> 00:01:50.930 And that tiny little word or, that's not just 00:01:50.930 --> 00:01:53.489 a technicality, is it? Not at all. It is the 00:01:53.489 --> 00:01:56.049 legal and operational foundation for this entire 00:01:56.049 --> 00:01:58.569 deep dive. It changes everything about a transaction. 00:01:59.200 --> 00:02:01.340 Okay, so let's unpack that dual identity right 00:02:01.340 --> 00:02:05.459 away. This split personality seems like it would 00:02:05.459 --> 00:02:08.360 be a regulator's nightmare. Why is it even allowed 00:02:08.360 --> 00:02:10.819 to exist in one company? That is a fundamental 00:02:10.819 --> 00:02:13.819 question. Why not just force firms to be, I don't 00:02:13.819 --> 00:02:15.560 know, a broker corporation or dealer corporation? 00:02:15.879 --> 00:02:18.419 Keep them separate. And the simple answer is 00:02:18.419 --> 00:02:21.520 efficiency. I mean, yes, the duality creates 00:02:21.520 --> 00:02:23.780 massive potential for conflicts of interest, 00:02:23.879 --> 00:02:26.599 which we'll get into. Of course. But having a 00:02:26.599 --> 00:02:29.710 combined broker -dealer is just, exponentially 00:02:29.710 --> 00:02:32.110 more efficient for the market. It allows for 00:02:32.110 --> 00:02:34.349 a speed and a depth of service that would be, 00:02:34.370 --> 00:02:37.150 well, impossible if the entity constantly had 00:02:37.150 --> 00:02:39.949 to pass transactions back and forth to a totally 00:02:39.949 --> 00:02:42.349 separate, unrelated firm. So it's a trade off. 00:02:42.469 --> 00:02:45.150 We get market efficiency, but it comes at a cost. 00:02:45.289 --> 00:02:47.810 And that cost is the need for constant heavy 00:02:47.810 --> 00:02:50.530 handed regulation, which is why we're here. So 00:02:50.530 --> 00:02:53.069 when we hear broker dealer, we are really talking 00:02:53.069 --> 00:02:55.310 about two completely different legal relationships 00:02:55.310 --> 00:02:57.699 all wrapped up in one institution. That's the 00:02:57.699 --> 00:02:59.620 perfect way to put it. And the role they're playing 00:02:59.620 --> 00:03:03.000 in any given microsecond determines their obligations 00:03:03.000 --> 00:03:05.439 either to their client or, well, to themselves. 00:03:06.080 --> 00:03:08.259 Let's define the broker role first. That one 00:03:08.259 --> 00:03:11.039 feels more intuitive. It is. So the broker role. 00:03:12.060 --> 00:03:14.599 When an institution is executing trade orders 00:03:14.599 --> 00:03:17.460 on behalf of a customer, it's acting as a broker. 00:03:17.639 --> 00:03:20.659 An agent. Exactly. The core function is agency. 00:03:21.289 --> 00:03:23.610 They're a middleman facilitating a transaction 00:03:23.610 --> 00:03:26.270 for a client. They're not taking on the primary 00:03:26.270 --> 00:03:28.370 risk of the trade itself. They're just earning 00:03:28.370 --> 00:03:30.389 a commission or a fee for doing what the client 00:03:30.389 --> 00:03:32.770 asked them to do. Precisely. Their job is to 00:03:32.770 --> 00:03:34.750 go into the market and find the other side of 00:03:34.750 --> 00:03:36.949 that trade for their customer. It's that traditional 00:03:36.949 --> 00:03:40.090 facilitator role. So the relationship is one 00:03:40.090 --> 00:03:43.750 of agency and the broker's duty is first and 00:03:43.750 --> 00:03:47.370 foremost to the client. Yes. To act in the best 00:03:47.370 --> 00:03:49.289 interest of the person who hired them. Okay. 00:03:49.330 --> 00:03:52.039 So now let's flip that coin. The other side of 00:03:52.039 --> 00:03:54.960 the personality. The dealer role. Right. And 00:03:54.960 --> 00:03:57.080 this is where the risk, the capital, and the 00:03:57.080 --> 00:03:59.340 conflict really come in. When the institution 00:03:59.340 --> 00:04:02.219 executes trades for its own account, it's acting 00:04:02.219 --> 00:04:04.960 as a dealer. So they're a principal in the transaction. 00:04:05.340 --> 00:04:07.879 Exactly. They are not an agent for a client anymore. 00:04:08.039 --> 00:04:10.219 They are taking on market risk for themselves, 00:04:10.479 --> 00:04:12.979 using their own capital for their own book. So 00:04:12.979 --> 00:04:16.160 in this role, they might be, say... buying securities 00:04:16.160 --> 00:04:18.220 from one client and selling them to another. 00:04:18.399 --> 00:04:21.339 Correct. Acting as a dealer on both sides. Or 00:04:21.339 --> 00:04:23.060 they could just be adding those securities to 00:04:23.060 --> 00:04:26.040 their own inventory, their own holdings. That's 00:04:26.040 --> 00:04:28.699 the critical distinction. When a firm acts as 00:04:28.699 --> 00:04:31.060 a dealer, they're staking their own balance sheet 00:04:31.060 --> 00:04:34.639 on that trade. If they buy 10 ,000 shares of 00:04:34.639 --> 00:04:37.600 some stock, they now own 10 ,000 shares of that 00:04:37.600 --> 00:04:40.800 stock. So if a broker executes my order, they 00:04:40.800 --> 00:04:42.759 find someone else out in the market for me. A 00:04:42.759 --> 00:04:45.319 third party, yes. But if a dealer executes my 00:04:45.319 --> 00:04:47.699 order, they're often the counterparty themselves. 00:04:48.180 --> 00:04:50.800 They are. They're selling directly to you from 00:04:50.800 --> 00:04:53.420 their inventory or buying directly from you for 00:04:53.420 --> 00:04:56.279 their inventory. In that instant, they're not 00:04:56.279 --> 00:04:58.759 serving you as an agent. They're trading against 00:04:58.759 --> 00:05:00.800 you as a principal. And that's the conflict we 00:05:00.800 --> 00:05:03.399 talked about. If I want to buy a security and 00:05:03.399 --> 00:05:06.019 the firm acts as a dealer, selling it to me from 00:05:06.019 --> 00:05:08.439 its own holdings. The firm wants the highest 00:05:08.439 --> 00:05:11.509 price possible. But if they were my broker. they'd 00:05:11.509 --> 00:05:13.910 be obligated to get the best price possible for 00:05:13.910 --> 00:05:17.550 you. How do regulators even begin to manage that 00:05:17.550 --> 00:05:20.889 instantaneous shift in motivation? It happens 00:05:20.889 --> 00:05:23.110 in a microsecond. It's the central tension, especially 00:05:23.110 --> 00:05:26.110 in the U .S. system. And the legal framework 00:05:26.110 --> 00:05:28.889 tries to manage it by imposing these really strict 00:05:28.889 --> 00:05:31.740 behavioral rules. Things like... The duty of 00:05:31.740 --> 00:05:34.379 best execution, which we'll get to. It's all 00:05:34.379 --> 00:05:37.120 about trying to minimize the potential harm from 00:05:37.120 --> 00:05:39.500 that conflict. And the source material is clear 00:05:39.500 --> 00:05:41.819 that this structure isn't just for small independent 00:05:41.819 --> 00:05:44.920 shops. This is the model for the giants. Oh, 00:05:45.000 --> 00:05:47.420 absolutely. The broker dealer is often the crucial 00:05:47.420 --> 00:05:51.019 business unit or subsidiary inside the huge financial 00:05:51.019 --> 00:05:53.180 conglomerates. We're talking commercial banks, 00:05:53.420 --> 00:05:55.579 investment banks. So when I trade through a J 00:05:55.579 --> 00:05:57.800 .P. Morgan or a Goldman Sachs. You're dealing 00:05:57.800 --> 00:06:00.389 with their specific. registered broker dealer 00:06:00.389 --> 00:06:02.709 subsidiary. Internally, there's a separation 00:06:02.709 --> 00:06:04.930 of duties for compliance reasons, but from the 00:06:04.930 --> 00:06:08.009 outside, it just looks like one massive fluid 00:06:08.009 --> 00:06:11.310 institution. And that fluidity is the secret 00:06:11.310 --> 00:06:15.079 sauce. The ability to switch hats from agent 00:06:15.079 --> 00:06:18.180 to principal in a split second. It provides unparalleled 00:06:18.180 --> 00:06:21.420 speed and liquidity to the market, but it necessitates 00:06:21.420 --> 00:06:24.540 this enormous regulatory apparatus to police 00:06:24.540 --> 00:06:27.220 that line. OK, so let's move beyond just the 00:06:27.220 --> 00:06:29.459 execution of single trades. You mentioned that 00:06:29.459 --> 00:06:32.199 the dealer side is where the real systemic importance 00:06:32.199 --> 00:06:34.480 comes in. Yes. They aren't just order takers. 00:06:34.480 --> 00:06:36.980 They are, and this is not an exaggeration, the 00:06:36.980 --> 00:06:39.600 architects of market stability. Through their 00:06:39.600 --> 00:06:41.720 commitment to providing liquidity. That's the 00:06:41.720 --> 00:06:44.160 key. The dealer is responsible for organizing 00:06:44.160 --> 00:06:47.019 and supporting turnover in the market. It's a 00:06:47.019 --> 00:06:50.060 function known everywhere as market making. Market 00:06:50.060 --> 00:06:51.839 making. It's a term we hear all the time. It 00:06:51.839 --> 00:06:54.160 sounds passive, like they're just... It's anything 00:06:54.160 --> 00:06:56.660 but passive. It's a constant, real -time commitment 00:06:56.660 --> 00:06:59.279 to being willing to transact. It's what ensures 00:06:59.279 --> 00:07:01.620 that you can buy or sell a security pretty much 00:07:01.620 --> 00:07:03.720 anytime you want during market hours. And without 00:07:03.720 --> 00:07:06.740 them. Without market makers, trading slows to 00:07:06.740 --> 00:07:09.699 a crawl. Prices get erratic, bid -ask spreads 00:07:09.699 --> 00:07:11.939 blow out, and the whole system can just seize 00:07:11.939 --> 00:07:14.180 up. So it's more than just providing a quote. 00:07:15.040 --> 00:07:17.519 The source material you gave us is really specific 00:07:17.519 --> 00:07:20.420 about this. It's not just a role. It involves 00:07:20.420 --> 00:07:23.759 a clear, mandatory set of duties. Four of them, 00:07:23.800 --> 00:07:26.839 in fact. Yes, and it's a very high -stakes, capital 00:07:26.839 --> 00:07:29.699 -intensive job. The first duty is the most obvious 00:07:29.699 --> 00:07:33.170 one. The dealer has to announce the price. Meaning 00:07:33.170 --> 00:07:36.529 a bid and an ask. A bid, the price they commit 00:07:36.529 --> 00:07:38.790 to buying at, and an ask, the price they commit 00:07:38.790 --> 00:07:42.269 to selling at. That two -sided quote establishes 00:07:42.269 --> 00:07:44.529 the spread and gives the whole market a reference 00:07:44.529 --> 00:07:47.310 point. Okay, but if that's all they did, a hedge 00:07:47.310 --> 00:07:49.269 fund could come in with a massive order and just 00:07:49.269 --> 00:07:52.250 wipe them out instantly. Precisely. Which brings 00:07:52.250 --> 00:07:54.550 us to the second duty. They have to announce 00:07:54.550 --> 00:07:56.589 the other essential conditions, specifically 00:07:56.589 --> 00:07:59.170 the minimum and maximum number of securities 00:07:59.170 --> 00:08:01.470 they're willing to trade at that announced price. 00:08:01.790 --> 00:08:03.269 So they're not just posting a price, they're 00:08:03.269 --> 00:08:05.810 posting a price for a certain size. Right. It 00:08:05.810 --> 00:08:07.790 tells the market about the depth of the liquidity 00:08:07.790 --> 00:08:10.589 they're offering. They might quote a price for, 00:08:10.730 --> 00:08:13.910 say, 10 ,000 shares. If you want to trade more 00:08:13.910 --> 00:08:16.449 than that, the price might change. It's how they 00:08:16.449 --> 00:08:18.930 manage their inventory and capital exposure. 00:08:19.290 --> 00:08:22.029 So the market knows the price and the volume 00:08:22.029 --> 00:08:25.329 available. But modern trading is incredibly fast. 00:08:25.610 --> 00:08:27.509 They can't just offer a price and then pull it 00:08:27.509 --> 00:08:30.250 back a millisecond later, can they? They can't. 00:08:30.250 --> 00:08:32.769 And that's the third duty. They have to implement 00:08:32.769 --> 00:08:35.750 and announce the time periods when those prices 00:08:35.750 --> 00:08:38.450 are available. It's a validity term. Ah, so the 00:08:38.450 --> 00:08:41.529 quote is firm for a certain window of time. It 00:08:41.529 --> 00:08:43.490 might be seconds, it might be less, but it has 00:08:43.490 --> 00:08:47.029 to be a real executable commitment. It prevents 00:08:47.029 --> 00:08:50.169 bad faith quoting and allows other market participants 00:08:50.169 --> 00:08:52.610 to actually rely on those prices to make decisions. 00:08:52.909 --> 00:08:54.809 And that leads to the fourth duty, which feels 00:08:54.809 --> 00:08:57.070 like the most critical one, the one that requires 00:08:57.070 --> 00:08:59.549 all the capital. It is. This is the moment of 00:08:59.549 --> 00:09:02.409 truth. The final duty is maintaining the duty 00:09:02.409 --> 00:09:05.129 to sell and buy the security at the announced 00:09:05.129 --> 00:09:07.950 price during that validity term. No matter what 00:09:07.950 --> 00:09:09.750 happens in the broader market in that little 00:09:09.750 --> 00:09:12.490 window. Absolutely. If a dealer commits to buying 00:09:12.490 --> 00:09:15.710 a bond at a price of $99 and a second later some 00:09:15.710 --> 00:09:17.649 shock hits the market and the price drops to 00:09:17.649 --> 00:09:21.009 $97, they still have to honor that $99 price 00:09:21.009 --> 00:09:24.210 for the committed volume. Wow. That's taking 00:09:24.210 --> 00:09:27.360 a lot of risk. That obligation is exactly why 00:09:27.360 --> 00:09:30.740 broker dealers need access to massive pools of 00:09:30.740 --> 00:09:34.360 capital. And it's why that 2004 leverage rule 00:09:34.360 --> 00:09:37.500 change we'll discuss was so important. They are, 00:09:37.519 --> 00:09:40.500 in effect, the market's shock absorbers. And 00:09:40.500 --> 00:09:43.059 they get paid for that risk through the bid ask 00:09:43.059 --> 00:09:45.919 spread. That's their compensation for taking 00:09:45.919 --> 00:09:49.000 on that instantaneous existential risk. But if 00:09:49.000 --> 00:09:52.320 they mismanage it, their capital is gone. So 00:09:52.320 --> 00:09:55.080 these dealers are the front line dealing with 00:09:55.080 --> 00:09:57.019 end users like pension funds and hedge funds. 00:09:57.159 --> 00:09:59.679 They're constantly taking on and shedding inventory. 00:09:59.919 --> 00:10:02.299 How do they manage all that risk they're accumulating? 00:10:02.379 --> 00:10:04.820 Right. If they're constantly buying from clients, 00:10:04.980 --> 00:10:07.200 they can end up with too much of one asset. They 00:10:07.200 --> 00:10:09.360 need a way to hedge that to offload some of that 00:10:09.360 --> 00:10:11.460 risk quickly, but without disrupting the very 00:10:11.460 --> 00:10:13.259 market they're supposed to be stabilizing. And 00:10:13.259 --> 00:10:15.340 that happens somewhere else in a more exclusive 00:10:15.340 --> 00:10:17.799 market. Yes. The source explains this really 00:10:17.799 --> 00:10:20.159 well. They hedge their risk by participating 00:10:20.159 --> 00:10:22.600 in the interdealer market. The interdealer market. 00:10:22.720 --> 00:10:26.600 Think of the dealers as the retail storefronts 00:10:26.600 --> 00:10:30.139 of finance. They deal with the public. The interdealer 00:10:30.139 --> 00:10:33.519 market is the secret wholesale warehouse where 00:10:33.519 --> 00:10:35.740 only the dealers are allowed to trade with each 00:10:35.740 --> 00:10:37.860 other. Okay, so give me an example. Let's say 00:10:37.860 --> 00:10:41.740 Deutsche Bank, acting as a dealer, buys a massive 00:10:41.740 --> 00:10:44.580 block of corporate bonds from a client. Now they're 00:10:44.580 --> 00:10:47.730 overexposed. Right. They're too long. that particular 00:10:47.730 --> 00:10:50.509 bond, they need to sell some of it. But if they 00:10:50.509 --> 00:10:52.690 dump it on the open market, the price will crater. 00:10:52.830 --> 00:10:54.950 Which hurts their own position and the client 00:10:54.950 --> 00:10:57.169 they just bought from. Exactly. So instead, they 00:10:57.169 --> 00:10:59.590 go into the interdealer market and discreetly 00:10:59.590 --> 00:11:02.649 sell a chunk of that position to, say, JP Morgan 00:11:02.649 --> 00:11:05.429 or Barclays. And this is facilitated by specialized 00:11:05.429 --> 00:11:08.190 firms. Yes, interdealer brokers. They facilitate 00:11:08.190 --> 00:11:10.409 the price discovery and execution between the 00:11:10.409 --> 00:11:12.649 primary dealers. It's a way for the giants to 00:11:12.649 --> 00:11:14.909 balance their books among themselves, keeping 00:11:14.909 --> 00:11:16.590 the risk from spilling over into the. retail 00:11:16.590 --> 00:11:19.509 market. It's an internal shock absorber for the 00:11:19.509 --> 00:11:21.929 shock absorbers. It's an incredible layer cake 00:11:21.929 --> 00:11:24.730 of risk management. The end user market is stabilized 00:11:24.730 --> 00:11:27.250 by the dealers who are in turn stabilized by 00:11:27.250 --> 00:11:29.809 the inter dealer market. And it all rests on 00:11:29.809 --> 00:11:32.429 the broker dealers commitment to managing capital 00:11:32.429 --> 00:11:35.070 and inventory. We shouldn't forget the other 00:11:35.070 --> 00:11:37.490 services, though, particularly on the broker 00:11:37.490 --> 00:11:40.259 side. Not at all. I mean, broker -dealers still 00:11:40.259 --> 00:11:42.759 perform all the traditional functions of a stockbroker. 00:11:42.860 --> 00:11:45.659 That includes offering financial consulting services. 00:11:46.000 --> 00:11:48.019 Which, as we said, sits right on that tricky 00:11:48.019 --> 00:11:51.799 regulatory line. Is it advice or is it a sales 00:11:51.799 --> 00:11:54.720 pitch? That's the billion -dollar question. And 00:11:54.720 --> 00:11:57.519 another huge piece of their business is distributing 00:11:57.519 --> 00:12:00.500 packaged products. They are the main sellers 00:12:00.500 --> 00:12:02.879 and distributors of things like mutual fund shares. 00:12:03.259 --> 00:12:05.120 So if you invested in mutual fund, chances are 00:12:05.120 --> 00:12:07.159 it was a broker -dealer that facilitated that 00:12:07.159 --> 00:12:09.929 transaction. Overwhelmingly so. It's a massive 00:12:09.929 --> 00:12:12.190 business area for them, handling the sales, the 00:12:12.190 --> 00:12:14.330 paperwork, the compliance. It's a core function. 00:12:14.590 --> 00:12:17.250 OK, so this scale, this dual role of proprietary 00:12:17.250 --> 00:12:20.789 risk taking, it all screams for heavy regulation. 00:12:21.289 --> 00:12:23.769 It seems totally logical that they would be among 00:12:23.769 --> 00:12:26.370 the most intensely regulated players in the entire 00:12:26.370 --> 00:12:28.830 financial world. They have to be. The integrity 00:12:28.830 --> 00:12:31.090 of the entire market rests on their stability 00:12:31.090 --> 00:12:33.350 and their adherence to the rules. Let's break 00:12:33.350 --> 00:12:35.409 down how the major global markets handle this. 00:12:35.769 --> 00:12:37.809 Let's start with the United States, which has 00:12:37.809 --> 00:12:41.250 a very complex and historically layered system. 00:12:41.429 --> 00:12:43.350 That's a good way to put it. The U .S. framework 00:12:43.350 --> 00:12:46.610 is a direct reaction to the failures of the 1920s 00:12:46.610 --> 00:12:48.470 and the Great Depression. It was all designed 00:12:48.470 --> 00:12:51.289 to restore and maintain public trust. And the 00:12:51.289 --> 00:12:53.289 cornerstone of that is? The Securities Exchange 00:12:53.289 --> 00:12:56.809 Act of 1934. That's the foundational law. It 00:12:56.809 --> 00:12:58.889 created the main regulator, the Securities and 00:12:58.889 --> 00:13:01.789 Exchange Commission, the SEC. And it's the act 00:13:01.789 --> 00:13:04.090 that broker dealers are fundamentally governed 00:13:04.090 --> 00:13:06.580 by. For someone trying to understand this, the 00:13:06.580 --> 00:13:08.899 legal definition of who has to register as a 00:13:08.899 --> 00:13:11.879 broker dealer is everything. That's the trigger 00:13:11.879 --> 00:13:14.539 for the entire regulatory burden. It is. The 00:13:14.539 --> 00:13:17.559 law is very specific. A broker is defined as 00:13:17.559 --> 00:13:19.860 any person engaged in the business of affecting 00:13:19.860 --> 00:13:22.519 transactions and securities for the account of 00:13:22.519 --> 00:13:24.840 others. Okay. Engaged in the business of. And 00:13:24.840 --> 00:13:27.080 a dealer is any person engaged in the business 00:13:27.080 --> 00:13:29.019 of buying and selling securities for his own 00:13:29.019 --> 00:13:32.000 account. There it is again. The key phrase that 00:13:32.000 --> 00:13:35.379 separates a professional firm from, say, an active 00:13:35.379 --> 00:13:38.740 individual investor is engaged in the business. 00:13:39.320 --> 00:13:41.440 What does that business test actually mean in 00:13:41.440 --> 00:13:43.879 practice? It's the single most important legal 00:13:43.879 --> 00:13:46.419 distinction. I mean, if you're just trading frequently 00:13:46.419 --> 00:13:48.340 for your own personal account, even with high 00:13:48.340 --> 00:13:50.620 volume, but you're using your own capital and 00:13:50.620 --> 00:13:52.840 you're not offering your services to the public. 00:13:53.059 --> 00:13:54.860 You're just a trader. You're considered a trader. 00:13:55.220 --> 00:13:57.799 And as a trader, you're subject to things like 00:13:57.799 --> 00:14:01.440 capital gains tax, but not the incredibly onerous 00:14:01.440 --> 00:14:04.059 registration, compliance and capital requirements 00:14:04.059 --> 00:14:07.009 of a full blown broker dealer. So the minute 00:14:07.009 --> 00:14:09.429 you start taking commissions for executing trades 00:14:09.429 --> 00:14:11.570 for other people or you hold yourself out to 00:14:11.570 --> 00:14:13.350 the public as a market maker. You've crossed 00:14:13.350 --> 00:14:15.809 the line. You've triggered the need to register. 00:14:16.029 --> 00:14:18.470 And that brings you under the oversight of multiple 00:14:18.470 --> 00:14:21.509 powerful authorities. OK, so once you're registered, 00:14:21.690 --> 00:14:23.929 who are you answering to? A few different layers. 00:14:24.090 --> 00:14:27.250 First, most of them must be members of the Securities 00:14:27.250 --> 00:14:30.970 Investor Protection Corporation or SIPC. SIPC. 00:14:31.049 --> 00:14:33.460 That's like the FDIC for. Brokerage accounts, 00:14:33.659 --> 00:14:36.100 right? It protects customer assets if a firm 00:14:36.100 --> 00:14:38.419 fails. Exactly. It's customer insurance. But 00:14:38.419 --> 00:14:40.679 the day -to -day regulatory authority isn't just 00:14:40.679 --> 00:14:43.879 with the SEC. The SEC delegates a huge amount 00:14:43.879 --> 00:14:46.820 of power. To who? To the Financial Industry Regulatory 00:14:46.820 --> 00:14:49.820 Authority, or FINRA. FINRA is the largest and 00:14:49.820 --> 00:14:52.460 most influential self -regulatory organization, 00:14:52.919 --> 00:14:55.980 an SRO, in the U .S. A self -regulatory organization. 00:14:56.100 --> 00:14:58.960 So the industry polices itself to some extent. 00:14:59.059 --> 00:15:01.759 To a large extent. FINRA writes the rules of 00:15:01.759 --> 00:15:04.129 conduct. They conduct examinations of firms. 00:15:04.269 --> 00:15:06.370 They license individuals. You have to pass their 00:15:06.370 --> 00:15:09.049 exams. And they enforce discipline. They really 00:15:09.049 --> 00:15:11.470 are the frontline police force of the brokerage 00:15:11.470 --> 00:15:13.289 industry. And the source mentioned a third layer, 00:15:13.370 --> 00:15:16.730 too. The states. The so -called blue sky laws. 00:15:17.029 --> 00:15:19.190 Right. It's a great name. These are separate 00:15:19.190 --> 00:15:21.750 state -level securities laws that regulate the 00:15:21.750 --> 00:15:24.169 offer and sale of securities within that specific 00:15:24.169 --> 00:15:27.370 state's borders. Why blue sky? The term supposedly 00:15:27.370 --> 00:15:30.169 came about in the early 20th century. A judge 00:15:30.169 --> 00:15:32.129 said that some of these speculative investment 00:15:32.129 --> 00:15:34.730 schemes had nothing backing them but the blue 00:15:34.730 --> 00:15:38.009 sky. So the laws were designed to protect investors 00:15:38.009 --> 00:15:40.789 from those kinds of fraudulent promotions. So 00:15:40.789 --> 00:15:43.590 you have the SEC at the federal level, FENOR 00:15:43.590 --> 00:15:48.250 as the industry SRO, and then 50 different state 00:15:48.250 --> 00:15:50.769 laws. It's a complex web. It's a very complex 00:15:50.769 --> 00:15:52.809 compliance environment. OK, let's go back to 00:15:52.809 --> 00:15:55.210 the broker role for a second. The agent acting 00:15:55.210 --> 00:15:58.220 for a customer. If I hire a firm to be my broker, 00:15:58.360 --> 00:16:01.480 what is the single most important non -negotiable 00:16:01.480 --> 00:16:03.799 duty they owe me? It is the best execution duty. 00:16:04.000 --> 00:16:06.379 This is a powerful legal mandate. Best execution. 00:16:06.500 --> 00:16:08.039 It sounds simple, like just getting the best 00:16:08.039 --> 00:16:09.960 price. It's more than that. It's not just about 00:16:09.960 --> 00:16:12.379 getting the lowest possible dollar price on a 00:16:12.379 --> 00:16:16.059 purchase. It requires a holistic consideration 00:16:16.059 --> 00:16:18.100 of all the factors. What other factors could 00:16:18.100 --> 00:16:20.879 there be besides price? Well, the duty is to 00:16:20.879 --> 00:16:23.120 get the best economic result for the client under 00:16:23.120 --> 00:16:25.919 the circumstances. That includes the speed of 00:16:25.919 --> 00:16:28.559 the execution, the likelihood of the trade actually 00:16:28.559 --> 00:16:31.220 getting completed, the total transaction cost, 00:16:31.419 --> 00:16:33.019 which includes... includes commissions and fees 00:16:33.019 --> 00:16:36.139 and the size of the order. So a good broker might 00:16:36.139 --> 00:16:38.980 prioritize speed and certainty over a fractionally 00:16:38.980 --> 00:16:41.480 better price if the market is moving really fast. 00:16:41.779 --> 00:16:44.639 Exactly. It's a judgment call, but the legal 00:16:44.639 --> 00:16:46.799 standard is that they must always prioritize 00:16:46.799 --> 00:16:49.620 the customer's overall financial interest. Okay, 00:16:49.659 --> 00:16:51.940 let's pivot to that regulatory gray area we touched 00:16:51.940 --> 00:16:56.240 on. Investment advice. Broker -dealers give advice 00:16:56.240 --> 00:16:59.340 all the time. But the source material says they 00:16:59.340 --> 00:17:01.860 are often exempt from registering as full investment 00:17:01.860 --> 00:17:04.339 advisors. This is the crux of one of the biggest 00:17:04.339 --> 00:17:06.940 debates in retail finance. It all stems from 00:17:06.940 --> 00:17:09.180 a different law, the Investment Advisors Act 00:17:09.180 --> 00:17:12.440 of 1940. And that act holds registered advisors 00:17:12.440 --> 00:17:15.339 to a full fiduciary standard, right? A full fiduciary 00:17:15.339 --> 00:17:17.500 standard. But broker -dealers can often escape 00:17:17.500 --> 00:17:19.619 those stringent requirements, provided they meet 00:17:19.619 --> 00:17:21.740 two very specific conditions for an exemption. 00:17:22.059 --> 00:17:24.440 What are those two magic conditions? First, the 00:17:24.440 --> 00:17:27.420 investment advice they provide has to be... solely 00:17:27.420 --> 00:17:30.220 incidental to their brokerage activities. Solely 00:17:30.220 --> 00:17:33.059 incidental, meaning the advice is secondary to 00:17:33.059 --> 00:17:35.039 the main business of executing a trade. Right. 00:17:35.119 --> 00:17:38.220 You come in to buy a stock, and the broker advises 00:17:38.220 --> 00:17:40.359 you on which one to buy as part of that process. 00:17:40.660 --> 00:17:44.400 The advice can't be the primary standalone service. 00:17:44.539 --> 00:17:46.519 And the second condition. It has to do with how 00:17:46.519 --> 00:17:49.200 they get paid, I imagine. It does. The broker 00:17:49.200 --> 00:17:51.440 -dealer must receive no special compensation 00:17:51.440 --> 00:17:54.660 for giving that specific advice. So they can't 00:17:54.660 --> 00:17:56.400 charge a separate fee for the advice itself? 00:17:56.859 --> 00:17:59.440 Precisely. If they start charging an asset under 00:17:59.440 --> 00:18:01.859 management fee or a separate consulting fee just 00:18:01.859 --> 00:18:04.319 for advice, they lose the exemption and they 00:18:04.319 --> 00:18:06.920 have to register as an investment advisor. As 00:18:06.920 --> 00:18:08.440 long as they're only paid through the transaction 00:18:08.440 --> 00:18:10.799 commission, they generally stay exempt. It's 00:18:10.799 --> 00:18:13.319 a line that has been fought over in court and 00:18:13.319 --> 00:18:17.000 by regulators for decades. It's a loophole that 00:18:17.000 --> 00:18:19.720 lets salesmanship look like advice without the 00:18:19.720 --> 00:18:22.380 full legal consequence of being a fiduciary. 00:18:22.519 --> 00:18:24.319 That's a very good way to describe the controversy. 00:18:24.940 --> 00:18:27.480 Okay, let's talk about their role as mutual fund 00:18:27.480 --> 00:18:29.839 distributors. The source says this is a huge 00:18:29.839 --> 00:18:32.339 business. How does the money flow there? How 00:18:32.339 --> 00:18:35.180 do they get paid? There are two primary channels. 00:18:35.440 --> 00:18:38.890 First is the traditional way. Through sales loads 00:18:38.890 --> 00:18:42.369 paid by investors. That's an upfront or deferred 00:18:42.369 --> 00:18:44.670 commission charged directly to the person buying 00:18:44.670 --> 00:18:47.069 the fund shares. Okay, a direct fee. The second 00:18:47.069 --> 00:18:49.569 way is a bit more indirect. They can be paid 00:18:49.569 --> 00:18:53.529 via Rule 12b -1 fees or servicing fees that are 00:18:53.529 --> 00:18:55.710 paid by the mutual funds themselves. So the fee 00:18:55.710 --> 00:18:58.450 comes out of the fund's assets. Yes. The fund 00:18:58.450 --> 00:19:00.609 pays the broker -dealer for marketing and distribution 00:19:00.609 --> 00:19:03.690 services. So the cost is borne by all the shareholders 00:19:03.690 --> 00:19:06.269 in the fund rather than just the new investor. 00:19:07.230 --> 00:19:09.369 But either way, the broker -dealer is the crucial 00:19:09.369 --> 00:19:12.210 intermediary collecting that income. This all 00:19:12.210 --> 00:19:14.269 brings us to what might be the biggest structural 00:19:14.269 --> 00:19:16.990 change in modern memory, something that redefined 00:19:16.990 --> 00:19:19.670 the risk profile of these global giants, that 00:19:19.670 --> 00:19:23.009 2004 modification to the net capital rule. This 00:19:23.009 --> 00:19:25.369 is a critical piece of context. It really explains 00:19:25.369 --> 00:19:27.490 why the largest firms operate at the scale they 00:19:27.490 --> 00:19:31.559 do today. On April 28, 2004, the SEC voted to 00:19:31.559 --> 00:19:34.519 alter the net capital rule. And this rule dictates 00:19:34.519 --> 00:19:37.079 how much liquid capital a firm has to keep on 00:19:37.079 --> 00:19:39.779 hand relative to its risk. Correct. It's a safety 00:19:39.779 --> 00:19:42.200 buffer. And this change wasn't for everyone. 00:19:42.380 --> 00:19:44.940 It was specifically designed for the handful 00:19:44.940 --> 00:19:48.799 of massive U .S.-based... global financial firms. 00:19:49.000 --> 00:19:51.960 Why just them? So they could compete on the world 00:19:51.960 --> 00:19:55.079 stage against huge European universal banks like 00:19:55.079 --> 00:19:58.079 Deutsche Bank or UBS, which operated under a 00:19:58.079 --> 00:20:00.619 different set of rules. The change allowed U 00:20:00.619 --> 00:20:03.319 .S. broker dealers with tentative net capital 00:20:03.319 --> 00:20:06.299 of more than $5 billion to dramatically increase 00:20:06.299 --> 00:20:09.079 their leverage. Let's define tentative net capital. 00:20:09.220 --> 00:20:11.700 It sounds very technical. It's basically a firm's 00:20:11.700 --> 00:20:14.279 net worth assets minus liabilities before you 00:20:14.279 --> 00:20:16.640 take any haircuts or deductions for market risk. 00:20:16.809 --> 00:20:18.609 It's the raw capital they have to work with. 00:20:18.710 --> 00:20:21.069 So if a firm had over $5 billion of this raw 00:20:21.069 --> 00:20:24.630 capital. The 2004 rule let them use a new, more 00:20:24.630 --> 00:20:27.349 advanced, and often internal risk model to calculate 00:20:27.349 --> 00:20:29.190 their capital requirements. And what was the 00:20:29.190 --> 00:20:31.650 result of letting them use their own more aggressive 00:20:31.650 --> 00:20:34.309 risk models? The result was that it freed up 00:20:34.309 --> 00:20:36.809 billions and billions of dollars in capital that 00:20:36.809 --> 00:20:39.609 previously had to be held in reserve. They could 00:20:39.609 --> 00:20:42.109 now leverage their balance sheets much more aggressively. 00:20:42.450 --> 00:20:44.750 Which allowed them to do what? It allowed them 00:20:44.750 --> 00:20:47.289 to hold far larger inventories of securities, 00:20:47.829 --> 00:20:51.529 manage huge derivatives books and become much, 00:20:51.589 --> 00:20:53.650 much bigger and more aggressive market makers 00:20:53.650 --> 00:20:56.170 on the global stage. It was a massive engine 00:20:56.170 --> 00:20:59.829 for growth and yes, for risk. So the U .S. regulators 00:20:59.829 --> 00:21:02.190 basically created a special, more lightly capitalized 00:21:02.190 --> 00:21:04.730 class for their biggest firms to make sure they 00:21:04.730 --> 00:21:07.009 could compete globally. And the source confirms 00:21:07.009 --> 00:21:10.019 that rule modification is still in effect. It 00:21:10.019 --> 00:21:12.859 is. OK, let's step across the Atlantic to the 00:21:12.859 --> 00:21:15.579 UK, another huge global financial center. How 00:21:15.579 --> 00:21:18.059 does their system compare? Do they even use the 00:21:18.059 --> 00:21:20.519 term broker -dealer? They generally don't. UK 00:21:20.519 --> 00:21:23.480 securities law prefers the term intermediary. 00:21:23.980 --> 00:21:26.339 Intermediary. That's an interesting choice. It 00:21:26.339 --> 00:21:28.660 seems to emphasize the agency role. I think that's 00:21:28.660 --> 00:21:31.440 the idea. It frames the entity as someone facilitating 00:21:31.440 --> 00:21:34.299 a transaction between two other parties. The 00:21:34.299 --> 00:21:37.160 primary regulatory body in the UK is the Financial 00:21:37.160 --> 00:21:41.740 Conduct Authority, or the FCA. Yes. The FCA authorizes, 00:21:41.819 --> 00:21:44.819 regulates, and supervises these businesses. Unlike 00:21:44.819 --> 00:21:46.880 the sort of layered system in the U .S., the 00:21:46.880 --> 00:21:50.359 FCA is the central powerful authority for conduct 00:21:50.359 --> 00:21:52.500 regulation. And the legal framework that gives 00:21:52.500 --> 00:21:54.700 the FCA its power. That would be the Financial 00:21:54.700 --> 00:21:57.420 Services and Markets Act 2000. It's often called 00:21:57.420 --> 00:22:00.579 FSMA. It's the blueprint for nearly all U .K. 00:22:00.660 --> 00:22:03.339 financial regulation. It defines what a regulated 00:22:03.339 --> 00:22:05.819 activity is, sets the rules for authorization, 00:22:06.220 --> 00:22:09.180 and gives the FCA its enforcement powers. But 00:22:09.180 --> 00:22:11.579 does the U .K. system still have that same inherent 00:22:11.579 --> 00:22:14.420 conflict between the firm acting for a client 00:22:14.420 --> 00:22:16.880 versus acting for itself? Oh, absolutely. That 00:22:16.880 --> 00:22:20.039 conflict exists anywhere trading happens. The 00:22:20.039 --> 00:22:22.920 FCA's approach, however, tends to be very prescriptive 00:22:22.920 --> 00:22:24.980 about managing those conflicts of interest. In 00:22:24.980 --> 00:22:27.579 what way? The UK has very robust rules requiring 00:22:27.579 --> 00:22:29.660 things like the segregation of client assets 00:22:29.660 --> 00:22:32.779 and strict organizational systems to ensure the 00:22:32.779 --> 00:22:35.500 firm prioritizes the client's interests, especially 00:22:35.500 --> 00:22:38.119 when acting as an agent. The framework is heavily 00:22:38.119 --> 00:22:40.420 focused on making sure the firm's internal governance 00:22:40.420 --> 00:22:42.539 prevents the conflict from actually harming the 00:22:42.539 --> 00:22:45.079 client. So different names, different structures, 00:22:45.160 --> 00:22:48.690 but the same core regulatory goal. Police the 00:22:48.690 --> 00:22:51.250 dual role to maintain market confidence. Exactly. 00:22:51.509 --> 00:22:54.990 OK, let's head to Asia. Japan is a critical financial 00:22:54.990 --> 00:22:58.250 hub. What's the terminology there and what are 00:22:58.250 --> 00:23:01.150 the specific rules for these firms? In Japan, 00:23:01.289 --> 00:23:05.069 the common term is securities company or Shukken 00:23:05.069 --> 00:23:07.509 Geisha. They're regulated by the financial services 00:23:07.509 --> 00:23:10.130 agency, the FSA, which is Japan's equivalent 00:23:10.130 --> 00:23:12.740 of the SEC. And their main law. It's called the 00:23:12.740 --> 00:23:15.160 Financial Instruments and Exchange Law. In the 00:23:15.160 --> 00:23:17.339 Japanese regulatory environment, it places a 00:23:17.339 --> 00:23:20.119 really strong emphasis on institutional stability 00:23:20.119 --> 00:23:22.960 and corporate transparency right from the start. 00:23:23.099 --> 00:23:24.680 You can see that in their structural requirements, 00:23:24.839 --> 00:23:26.960 right? You can. The source material points out 00:23:26.960 --> 00:23:29.740 some very specific rules. For one, securities 00:23:29.740 --> 00:23:32.980 companies must be organized as a kabushiki kaisha. 00:23:33.180 --> 00:23:35.440 Which is a specific type of stock company in 00:23:35.440 --> 00:23:38.880 Japan. Right. And crucially, that corporate form 00:23:38.880 --> 00:23:41.880 requires them to have either a stack. statutory 00:23:41.880 --> 00:23:44.859 auditor or a full auditing committee. It's a 00:23:44.859 --> 00:23:47.240 mandate designed to ensure rigorous internal 00:23:47.240 --> 00:23:49.619 governance and independent financial oversight 00:23:49.619 --> 00:23:52.099 are baked into the company's structure. That 00:23:52.099 --> 00:23:54.680 feels very proactive, building the oversight 00:23:54.680 --> 00:23:57.430 in from day one. It is. And there's also a clear 00:23:57.430 --> 00:23:59.730 capital requirement. They must maintain a minimum 00:23:59.730 --> 00:24:02.829 shareholder equity of 50 million. About half 00:24:02.829 --> 00:24:04.809 a million U .S. dollars, give or take. Right. 00:24:04.990 --> 00:24:08.390 It's a clear statutory barrier to entry. It ensures 00:24:08.390 --> 00:24:11.309 that only firms with a solid, demonstrable capital 00:24:11.309 --> 00:24:13.950 base can even get in the game and take on the 00:24:13.950 --> 00:24:16.309 risks of market making and handling client money. 00:24:16.490 --> 00:24:18.750 So the Japanese framework is built on stability, 00:24:19.049 --> 00:24:22.509 transparency and a capital floor. Who are the 00:24:22.509 --> 00:24:24.819 dominant players in that market? The concentration 00:24:24.819 --> 00:24:28.059 of power is very clear. The source lists Japan's 00:24:28.059 --> 00:24:31.180 big five, Nomura Securities, Daiwa Securities, 00:24:31.460 --> 00:24:34.319 SMBC Nikko Securities, Mizuho Securities and 00:24:34.319 --> 00:24:36.960 Mitsubishi UFJ Securities. The titans of Japanese 00:24:36.960 --> 00:24:38.960 finance. They really are. And just like in New 00:24:38.960 --> 00:24:41.160 York or London, pretty much every major commercial 00:24:41.160 --> 00:24:43.440 and foreign bank that operates in Tokyo also 00:24:43.440 --> 00:24:46.640 maintains its own local broker dealer or securities 00:24:46.640 --> 00:24:49.640 company subsidiary to access that market. So 00:24:49.640 --> 00:24:51.779 this whole deep dive really brings us to a crucial 00:24:51.779 --> 00:24:55.089 point of synthesis. We've defined the dual role. 00:24:55.269 --> 00:24:57.890 We've outlined the capital intensive duties of 00:24:57.890 --> 00:25:00.269 a market maker. And we've looked at the regulations. 00:25:00.670 --> 00:25:02.589 Now we have to look at the firms themselves, 00:25:02.930 --> 00:25:05.430 the global titans that really benefit from these 00:25:05.430 --> 00:25:08.509 rules, especially that 2004 leverage change in 00:25:08.509 --> 00:25:10.970 the U .S. Exactly. We're not talking about small 00:25:10.970 --> 00:25:13.549 firms anymore. We're talking about institutions 00:25:13.549 --> 00:25:16.289 whose collective balance sheets can influence 00:25:16.289 --> 00:25:20.009 global macroeconomic stability. The broker -dealer 00:25:20.009 --> 00:25:22.130 function is the engine that allows them to do 00:25:22.130 --> 00:25:24.980 that. It's what lets them hold those huge inventories, 00:25:25.019 --> 00:25:28.140 execute hedges instantly, and act as primary 00:25:28.140 --> 00:25:29.980 dealers for government debt around the world. 00:25:30.430 --> 00:25:32.369 And when you look at the list of the world's 00:25:32.369 --> 00:25:34.910 largest dealer banks, you're not just looking 00:25:34.910 --> 00:25:37.809 at a roster of famous names. You're looking at 00:25:37.809 --> 00:25:40.190 a list of the institutions that are managing 00:25:40.190 --> 00:25:43.789 systemic risk for the entire global economy every 00:25:43.789 --> 00:25:46.450 single day. They embody the scale and the concentrated 00:25:46.450 --> 00:25:48.690 capital we've been describing. Let's run through 00:25:48.690 --> 00:25:50.250 that list from the sources just to underscore 00:25:50.250 --> 00:25:52.450 the sheer size of these players. It's an impressive 00:25:52.450 --> 00:25:54.970 list. We have names everyone knows. Bank of America, 00:25:55.130 --> 00:25:59.329 Merrill Lynch. Barclays, BNP Paribas, Citigroup, 00:25:59.329 --> 00:26:01.750 and Credit Suisse. And it continues with key 00:26:01.750 --> 00:26:05.549 European and US players like Deutsche Bank, Goldman 00:26:05.549 --> 00:26:07.910 Sachs, a perennial powerhouse in this space, 00:26:08.029 --> 00:26:11.640 HSBC, and JPMorgan Chase. The list goes on. Morgan 00:26:11.640 --> 00:26:14.779 Stanley, Japan's dominant player Nomura, Germany's 00:26:14.779 --> 00:26:17.599 Commerzbank AG, and Societe Generale from France. 00:26:17.819 --> 00:26:19.819 And to round it out, we see institutions like 00:26:19.819 --> 00:26:22.660 the Royal Bank of Scotland, UBS, Wells Fargo, 00:26:22.759 --> 00:26:24.980 and Bank of New York Mellon. That list is the 00:26:24.980 --> 00:26:27.400 system we just decoded. For every one of those 00:26:27.400 --> 00:26:29.240 giants, the broker -dealer function isn't just 00:26:29.240 --> 00:26:31.960 some ancillary service. It is the core trading 00:26:31.960 --> 00:26:34.539 mechanism that defines their entire market presence 00:26:34.539 --> 00:26:36.859 and risk profile. And the stability of the global 00:26:36.859 --> 00:26:39.079 financial system really does rest on their ability 00:26:39.079 --> 00:26:51.960 to perform those four duties of marketing. So 00:26:51.960 --> 00:26:54.700 after all that, what's the big takeaway for you? 00:26:54.779 --> 00:26:57.119 We've taken this technical term. broker dealer 00:26:57.119 --> 00:26:59.660 and hopefully made it clear that it's the central 00:26:59.660 --> 00:27:02.440 actor in the whole ecosystem. I think so. We've 00:27:02.440 --> 00:27:04.720 clearly separated the broker, the agent with 00:27:04.720 --> 00:27:08.440 a duty of best execution from the dealer, the 00:27:08.440 --> 00:27:11.519 principal, the risk taker with the duty of market 00:27:11.519 --> 00:27:14.180 making. We detailed how market making isn't just 00:27:14.180 --> 00:27:17.680 a vague idea, but a concrete, rigorous set of 00:27:17.680 --> 00:27:20.180 duties that requires a huge commitment of capital. 00:27:20.339 --> 00:27:22.500 And we mapped out the different regulatory landscapes 00:27:22.500 --> 00:27:25.740 in the U .S., U .K. and Japan, showing how each 00:27:25.839 --> 00:27:28.059 tries to police that fundamental conflict of 00:27:28.059 --> 00:27:30.119 interest. And we anchored it all on that critical 00:27:30.119 --> 00:27:33.119 systemic issue. How regulation itself shifted 00:27:33.119 --> 00:27:36.000 in 2004 to allow the biggest firms to take on 00:27:36.000 --> 00:27:38.640 even more leverage and therefore more risk. Right. 00:27:38.740 --> 00:27:40.400 And before we wrap up, I do want to leave you 00:27:40.400 --> 00:27:42.519 with one final provocative thought that connects 00:27:42.519 --> 00:27:45.259 all those threads, scale, risk and legal duty. 00:27:45.400 --> 00:27:47.279 OK, let's hear it. So consider this tension. 00:27:47.480 --> 00:27:49.740 We know the largest broker dears, those names 00:27:49.740 --> 00:27:51.920 we just read, were essentially given regulatory 00:27:51.920 --> 00:27:54.759 permission in 2004 to use more aggressive leverage 00:27:54.759 --> 00:27:58.480 models. Right. To facilitate massive market making 00:27:58.480 --> 00:28:01.900 volumes and compete globally. It increased their 00:28:01.900 --> 00:28:04.180 utility to the market, but also their risk. Exactly. 00:28:04.180 --> 00:28:06.660 The regulators effectively said, we trust you 00:28:06.660 --> 00:28:09.099 to manage your own risk so you can take on more 00:28:09.099 --> 00:28:12.250 of it. So my question for you is this. Given 00:28:12.250 --> 00:28:15.049 that enhanced risk profile and the incredible 00:28:15.049 --> 00:28:17.769 concentrated power these few firms now hold, 00:28:17.970 --> 00:28:21.750 how does their simultaneous non -negotiable legal 00:28:21.750 --> 00:28:25.410 duty of best execution, which they owe to every 00:28:25.410 --> 00:28:28.329 single one of their clients, interact with the 00:28:28.329 --> 00:28:31.609 massive systemic risks they have to manage just 00:28:31.609 --> 00:28:35.029 to keep the firm itself stable? Is the duty to 00:28:35.029 --> 00:28:37.390 get the best possible price for one client's 00:28:37.390 --> 00:28:40.500 100 share order? always compatible with the need 00:28:40.500 --> 00:28:43.160 to manage the systemic risk of a multi -trillion 00:28:43.160 --> 00:28:46.420 dollar balance sheet. It forces you to ask where 00:28:46.420 --> 00:28:49.240 the ultimate loyalty has to lie, to the individual 00:28:49.240 --> 00:28:52.119 client in that single transaction or to the stability 00:28:52.119 --> 00:28:54.720 of the entire system, which is now contingent 00:28:54.720 --> 00:28:56.759 on the survival of these incredibly leveraged 00:28:56.759 --> 00:28:59.240 giants. It's a very complex balancing act. It 00:28:59.240 --> 00:29:01.019 certainly is. A lot to think about there. Thank 00:29:01.019 --> 00:29:02.960 you for supplying the sources for this really 00:29:02.960 --> 00:29:05.079 fascinating Deep Drive. My pleasure. We look 00:29:05.079 --> 00:29:07.059 forward to seeing what you send us next time.