Monday, November 8, 2010
The SEC approved new rules proposed by the exchanges and FINRA to strengthen the minimum quoting standards for market makers and effectively prohibit "stub quotes" in the U.S. equity markets.
A stub quote is an offer to buy or sell a stock at a price so far away from the prevailing market that it is not intended to be executed, such as an order to buy at a penny or an offer to sell at $100,000. A market maker may enter stub quotes to nominally comply with its obligation to maintain a two-sided quotation at those times when it does not wish to actively provide liquidity. Executions against stub quotes represented a significant proportion of the trades that were executed at extreme prices on May 6, and subsequently broken.
The new rules address the problem of stub quotes by requiring market makers in exchange-listed equities to maintain continuous two-sided quotations during regular market hours that are within a certain percentage band of the national best bid and offer (NBBO). The band would vary based on different criteria:
- For securities subject to the circuit breaker pilot program approved this past summer, market makers must enter quotes that are not more than 8% away from the NBBO.
- For the periods near the opening and closing where the circuit breakers are not applicable, that is before 9:45 a.m. and after 3:35 p.m., market makers in these securities must enter quotes no further than 20% away from the NBBO.
- For exchange-listed equities that are not included in the circuit breaker pilot program, market makers must enter quotes that are no more than 30% away from the NBBO.
- In each of these cases, a market maker's quote will be allowed to "drift" an additional 1.5% away from the NBBO before a new quote within the applicable band must be entered.
The new market maker quoting requirements will become effective on Dec. 6, 2010.