Principal vs. Agency Capacity

The exam loves a scenario-to-label question: it describes the trade mechanics and asks for the capacity and the compensation. The tell is the source of the security — if the firm reaches into its own inventory, it’s acting as principal/dealer and earns a markup (on buys) or markdown (on sells); if it shops the order to a third party, it’s an agent/broker earning a commission. A firm fills any given trade in one capacity, never both, and the confirmation must spell out which (SEC Rule 10b-10).

Don’t confuse the spread (a dealer’s principal compensation built into bid/ask) with a commission, an agency add-on disclosed separately. Best execution is a classic trap: under FINRA Rule 5310 it’s owed on every order regardless of capacity — principal status never lowers the duty. And the 5% policy is a guideline, not a hard cap (Rule 2121; some older banks still treat 5% as a ceiling) — fairness turns on type of security, price, and execution effort. Hook: Agent = Add-on commission; Principal = Price baked in.