Internalization

Internalization. Internalization occurs when a securities trade is executed within a brokerage firm rather than though an exchange. For example, if you give your broker an order to buy, the brokerage firm, acting as dealer, sells you shares it holds in its own account.

Similarly, if you give an order to sell, the firm buys your shares. The transaction is reported to the exchange or market where the stock is listed but the trade is settled within the firm.

Your broker might choose an internalized trade, sometimes called a principal transaction, because it results in the fastest trade at the best price.

The firm keeps the spread, which is the difference between the price the buyer pays and the amount the seller receives. But if the spread is smaller than it would be with a different execution, you, as buyer or seller, benefit.

Your broker may also execute your order by going directly to another firm. In that case, the transaction is reported to the appropriate market just as an internalized trade is, but the recordkeeping and financial arrangements are handled between the firms.