What Is an Executing Broker?

An executing broker is a type of financial dealer or broker that is responsible for the finalization and processing of an order that is entered by a client. As part of the process, brokers of this type will evaluate the order to make sure it is in line with current policies and procedures and in compliance with any regulations set by the market in which the order will be traded. Only after the executing broker is satisfied that the order is appropriate does he or she move on to actually execute the order on behalf of the client, and place it for trade in the marketplace.

The function of an executing broker is somewhat different from that of a clearing broker. Clearing brokers typically have direct interaction with investor clients and manage the processes of conferring with those clients on potential trades. By contrast, the executing broker is focused on what happens after the customer has requested that a specific trade be placed for execution. In this sense, this type of broker-dealer is functioning as a gatekeeper that determines if the structure of the order meets current regulations and is considered legal and appropriate for trade. Unlike the clearing broker, who is focused on aiding the customer in gaining wealth, the executing broker is concerned primarily with the compliance of the order in terms of meeting legal and marketplace standards.

When an executing broker finds that a particular order is not in compliance with the standards set by a market or exchange, or in some way is not fully compliant with governmental trading regulations, that broker will reject the order. In most instances, this means returning the rejected order to the clearing broker, along with the reasons for the rejection. This provides the clearing broker to revisit the issue with the client, restructure the order so that it is in compliance with both market and governmental standards, and resubmit the order for execution.

The work of the executing broker benefits the marketplace, the brokerage and ultimately the investor. By focusing on the legalities related to an order, the broker protects the market from being damaged in some manner, possibly to the point of adversely affecting other investors. At the same time, the efforts of the broker help to protect the brokerage from being censured by government trade officials and possibly losing standing in a marketplace for a period of time. This type of broker also helps to prevent investors from unknowingly breaching trading regulations and possibly facing fines or even imprisonment as the result of the inappropriate order.

If you've ever bought or sold shares of stock, you understand how these basic processes work — at least on the surface. You select the number of shares (or fractional shares) you purchase or sell, then your trade is executed by your broker or investment app. But there are complexities behind the scenes that the average investor never sees. Clearing brokers are important players in the market, so it's beneficial to understand what they do.

To understand how a clearing broker functions, you first need to know how clearing corporations work. These organizations are affiliated with a stock exchange and are responsible for confirming, settling and delivering transactions. Also known as clearinghouses, they ensure that all trades are settled properly and in a timely manner.

When a clearing corporation executes trades, it acts as an intermediary. This may sound a little strange, but it's behaving as both buyer and seller. How? Well, the clearinghouse facilitates all transactions from both sides, performing critical tasks that finalize each transaction. During these processes, the clearinghouse has some important duties:

Clearing brokers serve as liaisons between clearinghouses and investors. As members of financial exchanges, they ensure that securities trading happens as smoothly as possible. These brokers execute buy and sell orders while keeping custody of accountholders' securities and assets. To do their jobs, they must be extremely knowledgeable about the securities market. They must also research and verify information associated with each transaction they handle.

Clearing brokers work with clearing corporations for the correct handling and transfer of funds during each buy or sell order. They're the only brokers who are authorized to clear transactions. In a securities exchange, a clearing broker clears trades for multiple broker-dealers within a securities exchange. They may also work with introducing brokers, who advise their clients on buying or selling but send actual orders to clearing brokers to execute.

Executing brokers are Trading Members of the exchange. Clearing brokers, on the other hand, can fall into one of two categories: Professional Clearing Members or Trade-cum-Clearing Members. What's the difference? Professional Clearing Members cannot perform trades: Their only jobs are to clear and settle trades for other Trading Members. In contrast, Trade-cum-Clearing Members can both trade on their own and clear others' trades.

Executing brokers are also broker-dealers, acting as introducing brokers that make securities trading decisions on behalf of their clients. They rely on clearing brokers for the successful completion of transactions. Without all these back-office functions, it's hard to imagine how the world's securities exchanges would even work.

Prime brokers have a complex set of duties. Every day, they organize and expedite intricate, large-scale trading orders. But how exactly do they fit in with the securities market? To answer that question, we must first understand how prime brokerages work.

Simply put, a prime brokerage is a bundled collection of services. It's a type of package deal offered by major financial institutions to their hedge fund clients. Such packages often include cash management, securities lending, custody of assets, daily account statements, risk management, securities financing and cash financing. The particular mix of services differs depending on the financial institution and the client, but the chief goal is to enable the hedge fund to succeed.

Why are such services critical? Let's consider the basics of hedge funds for just a moment. Each hedge fund is a managed pool of investments operating through an extensive range of strategies to exceed typical market returns. They often include higher-risk investing tactics that conservative investors typically shy away from. Some examples include purchasing more of a particular asset using borrowed money or investing in derivatives. These are just some examples of how fund managers "hedge their bets," hence the key strategy of hedge funds.

If a prime brokerage is a bundle of select services, then a prime broker is an entity offering those services. Executing brokers, on the other hand, are responsible for processing buy and sell orders for prime brokers. Executing brokers are trading members of a securities exchange, with each one specializing in specific kinds of trades — equities, futures and so forth. Prime brokers often work with executing brokers to perform the actual trading.