Principal vs Agency trades

Reading through ethics. Can someone explain the difference between principal and agency trades? Thanks

Wow, is this really on the CFA syllabus? But anyway, the difference is that a principal trades for his own account. An agent only trades on behalf of other parties. So for example, if I sell 100 shares of HMW Corporation to a principal, he will hold those 100 shares in his own inventory. Whether or not he wants to hedge the shares is up to him - it’s his account. An agent does not have his own account. If I sell 100 shares to an agent, he must be acting on behalf of a client, who is the true buyer. The implications are that the principal is able to take risk, i.e. long/short positions and might charge a mark up or mark down from its own inventory to make money off the spread. An agent, on the other hand, is not capable of taking on risk. Agents make money by charging commissions for trades that they execute. Some parties act in either principal or agent capacities, depending on the trade.

A principal trade is a transaction involving a spread or a discount. An agency trade involves the payment of a commission. Commission that the investment manager obtains through agency trades must still benefit clients, but not necessarily the exact client that the commission came from. The book says that “over a reasonable period of time” the client should receive benefit of research purchased with brokerage from other clients. With principal trades, the IM needs to determine if the trade is subject to specific fiduciary requirements that require that exact brokerage to benefit that specific clients account. If these requirements are not present, then the IM may use the brokerage in a manner similar to agency trades as long as the practice is disclosed and the IM obtained previous consent from the client to undertake this practice. Hope it clears it up a little bit.

kevin.venanzi is right, there are nice definitions in the CFAI vol. 1 in the Ethics section, Soft Dollar Standards reading (3 I think).