The SEC issued an order (the “Order”) approving rule proposals by U.S. stock exchanges and by FINRA (collectively, the “SROs”) designed to strengthen the minimum quoting standards for market makers and effectively eliminate “stub quotes” in the U.S. equity markets (the “Stub Quote Rules”).
Under each SRO’s rules, a market maker is required to continuously maintain during regular business hours a two-sided quotation (i.e., be willing to buy and sell) for each security in which it makes a market. 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 in a security; however, under certain circumstances orders may be executed against the stub quotes. According to the SEC, executions against stub quotes represented a significant proportion of the trades that were executed at extreme prices on May 6, 2010, contributing to the “Flash Crash,” and subsequently had to be broken. The approval of the Stub Quote Rules is one of a number of steps, including the implementation of a stock-by-stock circuit breaker pilot program for stocks in the S&P 500 and Russell 1000 indices (the “Circuit Breaker Program”), taken by the SEC to reduce the chances that events similar to the events of May 6 could happen again. For a discussion of the SEC’s approval of the Circuit Breaker Program please refer to the June 15, 2010 and the September 21, 2010 editions of the Alert.
The Stub Quote Rules would require market makers in exchange-listed equity securities to maintain continuous two-sided quotations during regular market hours that are within a specified percentage band of the national best bid and offer (“NBBO”). The band would vary in accordance with the following criteria:
For equity securities subject to the Circuit Breaker Program, market makers will be required to enter quotes that are not more than 8% away from the NBBO.
For the periods near the opening and closing when the Circuit Breaker Program is not applicable, that is, before 9:45 a.m. and after 3:35 p.m., market makers in these equity securities must enter quotes no further than 20% away from the NBBO.
For exchange-listed equity securities that are not included in the Circuit Breaker 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 Stub Quote Rules would also make certain amendments designed to standardize the SROs’ rules related to price quotations. Additionally, the FINRA rules are amended to explicitly state that among the obligations of each market maker is the obligation to assist in the maintenance of fair and orderly markets.
The Stub Quote Rules become effective on December 6, 2010.