series 55 notes

note: series 55 renamed to series 57 in 2016 
 
################################## 
#####   Nasdaq Stock Market  ##### 
################################## 
 
Act of 1934 
- regulates OTC in secondary mkts. 
- established SRO: self-regulatory organization (e.g. FINRA who rules broker/dealer) 
 
# key terms 
market center             : e.g. exchanges, ECNs, ATSs 
exchange                  : national and regional. (SEC-registered/regulated) 
market maker              : FINRA member firms 
broker                    : intermediary/agent 
dealer                    : principal/proprietary 
market participant        : BD, institutional, retail 
NMS stock                 : listed stock (NYSE, Nasdaq, etc) as opposed to OTC stock 
NBBO, inside mkt          : L1 aka protected quotes 
trade report              : as is 
clearing agent            : as is 
transfer agent            : who can remove legend for restricted stock 
registrar                 : monitors securities to prevent unauthorized issuance 
qualified block positioner: a BD who buyes/selles blocks of stock worth $200k from a single source. QBP must have min net capital of $1min 
 
 
quotation            execution          (executing party reports)    reporting system 
------------------------------------------------------------------------------------- 
Nasdaq (L1,2,3)    Nasdaq exec system    "locked in" in 10 sec       FINRA/Nasdaq TRF (8am - 8pm)   # all together called "Nasdaq mkt center" 
OTCBB/OTC pink     voice                 via ACT, within 10 sec      ORF (8am - 8pm) 
ADF                private conn NW       within 10 sec               ADF (8am - 18:30) 
 
note: the consequence of "within 10 second" reporting rule means you may get a valid regular trade reported until 16:00:09.999 but by that time, the exch may already have disseminated the official close message (M), which can be confusing. because the very last trade price you got from continuous trading hours may not match the price of M message. 
 
specialist : MM on NYSE floor (almost extinct), now called "designated market maker" 
           : in NYSE, one stock has one MM, but in Nasdaq, one stock has many MMs 
 
 
MM capacity: 
- agent              : matching two clients. gets commission. 
- principal          : mark-up/down.  when MM buys, then it marks down the price, the diff is the fee. 
- riskless principal : buys and sells to the customers at the same price (vice versa). thus riskless. technically it is principal, but functionally agent. 
 
Reg NMS: 
- applies to ONLY NMS stock 
- order protection 
- order access 
- ticksize 
- mkt data 
 
Nasdaq MM membership : a firm must be a FINRA|NYSE member first. 
 
FINRA rule 5250: 
- MM cannot get paid by issuer/promoter(or ANY of its affiliate/benefitiary) to publish quotes or market make. 
- purpose is to prevent fake public interest for the stock 
- still OK to get paid for usual investment banking service 
 
Nasdaq maket center 
- quotation : L1,2,3 
- execution 
- reporting (locked-in : automatic reporting) 
 
to begin MM in Nasdaq: Nasdaq rule 4612 
- must register in Nasdaq system 
- once effective, can begin quote on the same day, or within 5 business days (otherwise re-register after 20 days) 
 
in Nasdaq, market maker must; 
- two-sided firm quotes: e.g. MSCO: 10.00-10.25  (or 10.00-25) 
-- backing away : not honoring the quote (serious violation of FINRA regulation) 
- order size in "round lot" of 100 shares 
- during mkt hours     : 09:30-16:00 
 
odd lot  : less than a round lot (e.g.  17 shares) 
mixed lot: round lot + odd lot   (e.g. 177 shares) 
 

# nasdaq ticksize 

  stock price  | min ticksize 
------------------------------ 
 $1.00 or more | $0.01          #  two decimal places 
 less than $1  | $0.0001        # four decimal places 
 
price improvement is for "taker of liquidity" : always the second party 
e.g. 
quote 12.55-57 
if an investor sends a sell order at 12.50, then he gets to sell at 12.55. 
 

# pricing obligation for NEW quote : "designated percentage" (from NBBO) # if no NBBO, then from tp 

 8% | Tier 1 : S&P 500 or Russel 1000          # 20% during mkt open and close (09:00-09:15 & 15:35-16:00) 
28% | Tier 2 : non-Tier1 & price $1.00 or more 
30% | Tier 3 : non-Tier1 & price less than $1.00, and ALL rights & warrants 
 

# pricing obligation for EXISTING quote : "defined limit" 

- everything is the same, but add 1.5% in all cases 
 
Peg order: peg to a certain percentage 
- offset can be set (like $0.05) 
- must be displayed 
- must be attributable 
- must have a limit price 
 

# MPID : mkt participant ID 

- 4 letter code (assigned bt FINRA) 
- primary MPID                 : must have two-sided firm quotes 
- additional/supplimental MPID : given if FINRA approves. OK to quote one-sided or even withdraw. used for dark pool, OTC, ATS etc 
 
Nasdaq hours 
-------------------- 
system hours   : 04:00 - 20:00                   # order can be entered/modified/cancelled 
extended hours : 08:00 - 09:30, 16:30 - 20:00    # execution OK 
normal hours   : 09:00 - 16:30                   # execution OK 
 
NOTE: modification that changes the price or increase the size will get a new timestamp (lower priority) 
      BUT, modification that reduces size only will NOT affect the priority 
 
Nasdaq Order Type (per rule 4755) 
- attributable order     : MPID must accompany the order 
- non-attributable order : MPID annonymous. "NSDQ" is displayed aside price/size 
- "reserve" order        : Nasdaq allows MM to show only part of the order, and the rest hidden in reserve, once the displayed order is filled, the specified chunk from the reserve is displayed. 
- non-displayed order    : not displayed, but the rest of the function is the same. but lower fill priority to other orders. 
 
priority: 
- displayed order 
- non-displayed order (including reserve order) 
- discretionary portion of discretionary orders 
 
anonymity in clearance and settlement: 
- normally, your counter-party is anonymous EXCEPT 
-- both sides consent 
-- both sides are one same firm 
-- court order 
-- clearing agency declines to guarantee a trade 
 
Order Routing 
- NBBO: 
--- Nasdaq may send your order to BATS, then your order gets a new timestamp and gets processed under the rules of BATS, while Nasdaq continues to process the other orders. IF your order does not get filled at BATS, and comes back to Nasdaq, it will get a NEW timestamp. 
- Routing Broker: 
--- once Nasdaq routes an order, nobody can change the order details. 
- order cancellation & error account : 
--- Nasdaq may cancel orders if technical issues, and if it executes wrongly, it keeps it in its error account. 
 
OR strategy 
-- DOT  : eligible for NYSE mkts during open & close cross. if not filled, then returns to Nasdaq. 
-- DOTI : same as DOT, but does NOT return to Nasdaq 
-- STGY : 
-- SCAN : 
 
 

#  terminating(withdrawing) quotes    # individual security-by-security based 

 
Voluntary (= un-execused) termination: 
- registration terminated 
- must wait for 20 biz days to re-register 
EXCEPT: 
- corporate action (dividend, split, etc) 
- trading halt (if resumed, then must reinstate quote before close) (if Nasdaq aproves, then may wait till next day) 
- if withdraw quotes, but insert within the same day, then OK. 
 
Execused (involuntary) termination: 
- contact Nasdaq Market Watch 
- up to 5 biz days 
-- religious holiday (requested at least 1 biz day prior) 
-- vacation (for firms with less than 3 MMs, must provide a list of securities, at least 1 biz day prior) 
-- system issues (contact Nasdaq Market Operations) 
- up to 60 days 
-- legal dispute (e.g. with clearing agency) 
- indefinitely 
-- investment banking (e.g. underwriting new IPO, M&A, etc) 
 
Accidental Withdrawal: 
quoted names      allowed mistakes 
---------------------------------- 
  1 to 250      |     2 
251 to 499      |     3 
500 or more     |     6 
 
===> Nasdaq will scrutinize if it was really an accident. 
 

# locked or crossed order book 

- prohibited to enter quotes that lock/cross in NMS stock. 
- if MM keeps locking/crossing, then Nasdaq may removes MM. 
 
 
# Opening/Closing Cross : 
- determines open/close prices. NOOP/NOCP 
- open cross  : 09:28 - 09:30 
- close cross : 15:50 - 16:00 
- helps identify order imbalance. 
  e.g. seller's mkt : more buyers than sellers, thus op tends to get higher 
- All nationally listed securities (NYSE, Nasdaq, Arca) are eligible to participate in this Nasdaq open/close crossing. 
 
- special order types for Open/Close crossing. 
[open cross] 
-- MOO : market on open  (exec at op) 
-- LOO : limit on open   (exec at op if meets limit, otherwise cancel) 
-- OIO : opening imbalance only. aka late 'market' order to offset whicever side of order book that is imbalanced. 
 
===> MOO & LOO cannot be entered/modified/cancelled after 09:28 
===> OIO cannot be modified/cancelled after 09:28 but still OK to "enter" 
 
[close cross] 
-- MOC : market on close (exec at ccp) 
-- LOC : limit on close  (exec at ccp if meets limit, otherwise cancel) 
-- CIO : closing imbalance only. late mkt order that gets executed only to offset imbalance. 
 
===> MOC & LOC cannot be entered/modified/cancelled after 15:50 
===> CIO can be cancelled 15:50-55 for legitimate errors. cannot be modified/cancelled after 15:55, but still can be entered. 
 
NOII : net order imbalance indicator 
- shows for every symbol 
-- imbalance share/side 
-- far clearing price      : ONLY considers on-open/close orders 
-- near clearing price     : considers ALL orders 
-- current reference price : indicative auction price, the price that will minimize the imbalance. 
 
A halt cross : 
- similar to open cross. 
- NOII disseminates imbalance share/side, clearing prices, current reference price 
- Quote Only period, then (usually 5 min later), Trade Resumption (cross completes, exec at indicative current ref price). still the same TRF. 
- Quote Only period is extended automatically for 1 min if volatility (10% or 50 cents, whichever is greater) 
 
 

#  ADF : alternative display facility (by FINRA) 

- quote & trade reporting 
- no order routing 
- no execution 
 
ADF trading hours #  08:00 - 18:30 (core hour is 09:30 - 16:00) 
 
- ADF market participant : FINRA member firms that are approved for ADF trading 
  (aka "Registered Reporting ADF Market Maker") 
- ADF ECN : FINRA member that operate ECN, and ADF MP 
- ADF trading center : refers to either of the above. 
 
to register as ADF trading center, FINRA member must; 
- submit 2 docs 
-- certification record (proves the ability to obey Reg NMS) 
-- participant agreement (to submit quotes and trades to ADF. usually submitted 6 months in advance) 
- get certificate of good standing from FINRA 
- comply with net capital requirements, and other rules 
- deposit $250,000 in escrow. (doubles if request for accelerated registration) 
- ADF MM must plan to direct at least 75% of its quotes/trades to ADF, otherwise the deposit gets taken away. 
 
Quotation requirements/obligations 
- firm two-sided quotes for round lot 
- ticksize (same as Nasdaq) 
- "designated percentage" and "defined limit"  (exactly the same as Nasdaq) 
 
Trade or Fade 
- if MM shows $10.00 bid for 3 round lots, and receives sell order for 5 round lots. 
- then the MM has choices 
(1) fill 3 round lots, then display another bid at lower than $10.00 
(2) fill 5 round lots, then display whatever value below its ask. 
===> either case, must maintain bid quote 
 
Certificate: 
- Registered Reporting ADF ECNS must post at least one marketable quote/order on both sides(bid/ask) every 30 calendar days. 
- otherwise FINRA revokes the ADF certificate. 
 
Quote Termination 
- Execused Withdrawal 
-- same as Nasdaq (except for vacation, which any ADF MM can apply for, whereas only 3-or-less-MM firms could do in Nasdaq) 
- Unexecused (voluntary) Withdrawal 
-- withdraw quotes and not enter for 5 min, or not enter quotes after 30 of trade halt resumption 
-- if done, cannot reregister for 20 biz days (just like Nasdaq) 
NOTE: exception is if ADF MM has a trouble with clearing agency, then it may reregister even without waiting for 20 biz days. 
 
System Outage Limit 
- ADF trading center/ECN gets suspended for 20 biz days IF un-execused system outage happens 3 times in a 5 day window. 
- FINRA determines if the outage is execused or un-execused. (normally only out-side-of-control outage is execused) 
- ECN must submit the doc to explain if the outage is to be execused, in the same day of outage, or next day EOD if the outage happens outside mkt hour. 
 
Quote/Order access requirement: 
- ADF trading center must 
-- provide direct electronic access to other ADF and BDs 
--- direct electronic access means the ability to execute 
--- indirect means the ability to OR 
-- provide similar access to quotation of NMS stock at a similar cost, to those by exchanges 
-- automatically update quotation as orders get executed 
-- ensure a situation where any particular party cannot benefit by having a faster/efficient access. 
-- notify FINRA at least 14 cal days in advance if going to deny any BD access. 
 
Trade Report 
- contains the usual (unique order ID, ticker, side, size, price, time in force, etc) 
- must be sent to FINRA by 18:30 
- orders originating from national exchanges (NYSE|Nasdaq) need NOT be recorded 
 
Reporting Agent Agreement: 
- ADF MM firm/ECN may out-source reporting work to a Reporting Agent. but still takes responsibility if reporting work blows up. 
 
 
 
############################### 
######    OTC Equities    ##### 
############################### 
 
- Non-exchange equity "quotation" facility 
- execution is done over voice 
- reporting done via ACT (to ORF) 
 
1934 Act, rule 15c2-11 
- form 211 (shows how the firm did due diligence, and ready to quote OTC equity) 
-- file at least 3 biz days before first quoting. 
- due deilgence 
-- prospectus & registration statement, OR, offering circular or private placement memorandum, OR, most recent 10K(annual report) & 10Q (quarterly) & 8K (current) reports 
--- otherwise, collect the equivalent info (balance sheet, senior mgmt, business details, etc) 
-- update info at least annually 
 
Exception for form 211 
(1) customer's unsolicited order 
(2) delisted stock. on the day or next day of delisting only. 
(3) piggybacking : "frequency of quotation test" 
                  - quotes at least 12 out of last 30 days 
                  - no more than 4 consecutive days of no quote 
NOTE: if MM begins quoting a security, then the security no longer satisfies frequency of quotation test, the MM can still continues to quote. 
      if MM who filed form 211 drops, then the piggybacking MM can still continue to quote. 
 
Ineligible : no MM, must file form 211 
Eligible   : some MM, but frequency of quotation test is FAILED 
Active     : piggybackable 
 
 

#  lot size 

 
bid or ask price  |  round lot shares 
-------------------------------------- 
$0.0001           |  10000 
$0.1              |  5000 
$0.2              |  2500 
$0.51             |  1000 
$1                |  100         # remember 
$175              |  1           # these 
 
===> possible ask is in one tier, and bid is in another. 
 

#  ticksize  :  min price increment 

 
similar to Nasdaq 
 
stock price  |  ticksize 
-------------------------- 
>= $1.00     |  $0.01       # same as Nasdaq 
>= $0.0001   |  $0.0001     # same as Nasdaq 
>= $0.000001 |  $0.000001   # this is only in OTC 
 
 
Prohibition of locking/crossing order book 
- member firms must be reasonably careful. (just like for NMS stock) this is a FINRA rule. 
 
Quote Display 
- if a member displays quote for an OTC equity on multiple systems (e.g. both OTCBB & OTC pink), then it must display the SAME price on both. 
 

#  OTCBB 

 
- a quotation system for OTC equities (domestic & foreign equities, ADRs, DPP/limited partnership, delisted stock, regional exch listed stock) 
-- as long as the security is CURRENT with SEC filing.(subject to 30-day grace period) 
-- canNOT have national exch listed names (i.e. NYSE, Nasdaq) 
- firms must register with FINRA to quote/market make OTC equities. 
- no automatic execution facility, thus every quote must come with a phone number, and exec done via phone/voice. 
 
quote type & requirements: 
- OK to be one-sided, or two-sided, but the shown quote must be "firm" within normal trading hour (09:30 - 16:00) 
-- Exception: DPP can be non-form/subject quotes. can be updated only twice a day, 08:30-09:30 & 12:00-12:30 
- otherwise must indicate as unpriced indication of interest. (e.g. bid wanted, ask wanted) 
 
removal of securities from OTCBB 
- if an issuer fails to file annual (10K) or qurterly (10Q) reports "three" times in a two year period. 
- if an issuer fails to file mandatory FINRA docs "twice" in a two year period. 
- an issuer can appeal to FINRA national adjudicatory council (NAC) 
 
- ATS (alternative trading system) 
- ECN 
 
OTCBB MM: 
- MPID is used, just like Nasdaq/ADF 
- must "clear and settle" via a registered clearing agency that uses a continuous net settlment system. 
 
 

#   OTC pink (aka OTC 'link') 

 
- yet another inter-dealer quote system, but even less strict than OTCBB 
- NO need to be current SEC filers. 
- OTCQX   : for companies with high fincncial standing. 
- OTCQB   : for companies still developing 
- OTC link: aka pink. ATS 
 
OTC pink quote requirements: 
- OK to one-sided, or two-sided, unpriced, subject to change (i.e. Not a firm quote) order. 
- subject quote MUST be indicated as such. 
 
OTCBB vs OTC pink 
- for OTCBB, issuers must be current SEC filer 
- priced quote on OTCBB must be firm, while pink can be 'subject' 
 
 
 
############################################ 
#####      Regulation of Markets       ##### 
############################################ 
 
2007 : RegNMS  (NMS = exchange listed) 
 
rule 610 : order access     # fee limit 0.3% per share 
rule 611 : order protection # NBBO.   "trade-through" is when MM executes customer order at inferior price than NBBO 
rule 612 : tick size        # min price increment. $0.01 for $1.00 or more shares 
                                                   $0.0001 for less than $1.00 shares 
 
a "protected quote" is the best bid/ask at each exch. it can be diff by exch to exch. 
 

#  exception to trade-thru 

- non regular way settled trades 
- trades done at open/close/re-open after trading halts, or when order book is locked/crossed 
- a stopped order (aka a stop stock transaction), i.e., when a MM guarantees a trade at a certain price for a short period. there could be a sperior ask/bid but ok to trade-thru on it, as long as satisfying the stopped order guarantee. 
- flickering quote (ok not to notice any bid/ask updates within the past 1 sec from the exec) 
- non-convertible preferred stock 
- qualified contingent trade (this is for a basket of stocks/other deriv trades. it may make sense to trade-thru from the whole porfolio perspective) 
- error correction trade 
- print protection trade (a form of correction to meet the NBBO) 
- intermarket sweep order(ISO) 
==> ISO means, lets say an order size is big, then it is inefficient to go check all venues (and their depth) to get the best exec from each exch, amounting to the total size of the order. 
==> so instead, just look only at the protected quote of each venue (= top of the order book), and ok to execute at those prices. 
 e.g. 
  you wanna buy 1000 shares of IBM.it's 34.00 (200 shares) at NYSE. it's 34.10 (800 shares) at BATS. then it's ok to buy those 200+800, although there can be 34.05 available at NYSE order book. because this was ISO, so you were only required to look at the top of the book of each venue. 
 (a surprisingly big portion of trades is ISO - i should do empirical analysis on this) 
 

#  quote rigging : when MMs coordinate maniuplate the inside mkt 

 

#  payment for order flow 

- exch or MM may pay broker/dealer to route orders to them. (still must adhere to the aforementioned rules) 
(usually, routing decision is based on price, speed of exec, likelihood of fails, etc) 
- must provide written disclosure to customer at account openining, annually therefter. 
- quaterly disclosure of the relationship with the BD 
 
## 
##  Trading Halts 
## 
- may be triggered by (1) Nasdaq, (2) FINRA(for nasdaq/OTC names), (3) SEC 
- issuer/MM must notify Nasdaq MarketWatch of any big news. (issuer at least 10 min before public release) 
- primary listing halt at NYSE/foreign exch may trigger halt 
- or any other unusual transaction may trigger 
 
 Nasdaq 
trade halt code | description 
---------------------------------- 
     T1         | halt: news pending 
     T2         | halt: news released 
     T3         | halt: resumption time (for quote & trade resumption, USUALLY 5-min apart) 
 
NOTE: during halt, participants can enter orders which will be held until T3 
      but MM CANNOT execute any trades. CANNOT pub new quotes. 
 
 OTCBB 
---------------------- 
  U1  : foreign regulatory halt 
  U3  : extraordinary event halt 
  H10 : SEC suspension 
 
NOTE: for OTC, after suspension, it is like a new listing again, so MM must file form 211 with FINRA again before publishing quotes. 
 
 
### 
###  upper limit lower limit (LULD) 
### 
 
"reference price" : last 5-min moving average 
==> updated every 30 seconds, ONLY IF the change is more 1% 
 
Tier 1: SP500, Russel 1000 names 
Tier 2: all other NMS stocks 
 
price range        |  price band 
------------------------------------------------ 
ref price > $3.00  |  5% for T1, 10% for T2 
ref price > $0.75  |  20% 
ref price < $0.75  |  the lesser of 75% or $0.15 
 
NOTE : price band "doubles" during mkt open (09:30-09:45) and close (15:35 - 16:00) 
 

#  limit state 

 
if the limit band is reached, then the stock enters "limit state" for 15 seconds. (no new ref price is calc'ed) 
during the 15 sec, trades can continue within the band, and if the quote (that caused the band breach) is executed/cancelled/modified, then limit state is over. 
if the quote remains, then 5 min trade halt begins. 
 

#  straddle state : when bbp-bap is over an either upper|lower band price. it means it may enter limit state soon. 

 

#  5-min trading halt 

- during the LULD 5 min halt 
-- No exec 
-- OK to update quotes 
-- OK to accept orders 
 
after 5-min, the primary mkt decides to re-open with the re-open price, or halt 5 more min 
after 10-min, each secondary mkt can decide to resume at its own discretion. 
 

#  Exception to LULD rule 

- non regular way settled trades (non T3) 
- stop stock transaction 
- benchmarked/derivatively priced 
- qualified contingent trade 
- error correction trade 
- print protection trade 
 
 
### 
###  market wide Circuit Breaker (CB) 
### 
 
CB       | SP 500  |  halt 
------------------------------- 
Level 1  |  7%     |  15-min  # ONLY before 15:25 
Level 2  | 13%     |  15-min  # ONLY before 15:25 
Level 3  | 20%     |  all day # applicable ALL DAY 
 
- each level can happen once per day 
- halts quotes/trades on ALL mkts, including OTC. 
- MM can quote again from the last 5-min of L1/2 
- customer can enter ordesr any time during L1/2 
 
 
### 
###  clearly erroneous transactions 
### 
 
FINRA may allow them to be cancelled. 
 
## 
## for Exch-listed stocks 
## 
 
- numerical guidelines 
 
 ref price  | during mkt hour | outisde mkt hour 
-------------------------------------------------- 
 rp < $25   |  10%            | double 
 rp < $50   |   5%            | double 
 rp > $50   |   3%            | double 
 
NOTE: "outlier" trade is "triple" the limit band, or beyond 52-week hi/lo 
 
 
- multi-stock events  # for multi-stocks, we have a combined numerical guideline 
 
number of stocks  |  band 
-------------------------------------- 
 5 - 19           | 10% from ref price 
 20 or more       | 30% from ref price 
 
 
- multi-day event   # FINRA may nullify the single stock over multi-days. (except for IPO/already settled trades) 
 

#  notification time limit 

- 30 min. (extra 30 min for outlier, or trades that got routed to other exch) 
NOTE: this 30-min window applies even outside mkt hour. 
 
 
## 
##   OTC securities 
## 
 
FINRA intervenes much LESS for OTC. 
 
- numerical guidelines (see p81) 
- system malfunctions 
- mkt condition (overall mkt, individual company news, volatility, volume, halt, corp action, IPO, etc) 
 
appeal : must happen 30 min from the nullfication. 
 
"Nasdaq" listed Options: (note it's Nasdaq, not FINRA) 
- comes with its price band (see p83) 
- both parties must agree to adjust or cancel within 10 min. (or 30 min if one party is not nasdaq option mkt participant) 
- if no bid for at least 5 sec, AND, if no bid for the same class one strike price above/below has no bid, then option trade can be nullified. 
(otherwise) 
- instead of nullifying, the adjustment is made. 
- determination/adjustment based on "theoretical price" not trade price 
- catastrophe error : even bigger price band. (a party must notify Nasdaq MktWatch by 08:30 am EST next day) 
 
NOTE: clearly erroneous equity trades, FINRA always cancels. but only for Nasdaq options, Nasdaq may allow adjustment. 
 
 
### 
###  Reg SHO 
### 
 
short sell : order marking 
(1) long 
(2) short 
(3) short exempt 
 
short sell is long if: 
- actually owns the securities, or bought securities only pending settlement. 
- exercised convertible bonds/options/futures. 
- BD does short sell as part of arbitrage/hedge strategy for index trade or block-long-position. # block pos = $200k or more 
- BD may mark long if NYSE is down 2% from prev day close 
 
===> otherwise mark it "short". 
 

#  BD aggregation 

- an entire firm should aggregate its net position, and mark every short sell order accordingly 
EXCEPT when each trading desk/unit is operating completely independent with its own strategy, etc, and that is proven. 
 

#  short sell price "down bid (aka uptick)" restrictions 

- if an NMS stock drops 10% from prev day close, then the lowest short sell price is NBB + 1 tick. (except done for arbitrage/hedging, or odd lot trades) 
- this restriction lasts for the day and the entire NEXT day. 
 

#  short-exempt  (ok to downbid short sell) 

- if executed above NBB 
- MM does it for arbitrage/hedge or odd lot 
- done by long owner who is waiting for delivery 
- BD doing riskless principal transaction 
- vwap 
- done for over-allotment of IPO (or follow on issues) : aka green shoe 
 
## 
##  locates requirement 
## 
- definitive borrowing arrangesment 
- available securities list (must update every 24 hours) 
 
# threshold securities 
- a stock that fails to deliver for 5 consecutive settlement days. 
- if it persists 13 days, BD must buy to unwind short pos. 
 

#  closing out short sell pos (by buying/borrowing) 

- short sell                  : T+4  before mkt open 
- long sell / MM quotes       : T+6  before mkt open 
- restricted stock (rule 144) : 36th calendar days from trade date 
 
 
## 
##  short interest reporting 
## 
- twice a month (settled as of 15 and EOM, due 18:00 two biz days later) 
- details gross short pos the firm has settled. (in both proprietary and customer account, for all venues.) 
exempt 
-- green shoe short sell 
-- short sell done for client with prime broker (cos prime broker will file the report) 
 
 
 
############################################## 
######     Handling Customer Orders      ##### 
############################################## 
 
FINRA rule 2110 
 
## 
##  types of orders 
## 
- market order  (BBO, cross the spread) 
- collard order 
--- Nasdaq converts mkt order into collard order where the order gets cancelled if the exec price would be 5% or $0.25 (whichever is greater) away from BBO at the time of order entry. 
--- EXCEPT during mkt open/close/halt crossing 
 
- limit order 
--- marketable limit order (== can be filled immediately) 
- stop order       # after reaching a threshold price, then becomes mkt order 
- stop limit order # after reaching a threshold price, then becomes limit order 
 
NOTE: conceptually, stop order is to stop/cut "loss" order. so if you are long, and your stop (loss) order should trigger once price goes below the threshold, to ensure loss-cut. 
 
NOTE: typical exam question: 
execution at: 
below best ask | above best bid 
------------------------------- 
buy limit      | sell limit 
sell stop      | buy stop 
sell stop limit| buy stop limit 
 
 
- discretionary order 
-- another limit order but with a discretionary range to go up/down. 
-- e.g. a buy limit order at $12.46 with a discretionary range of $0.03, meaning he is willing to pay up to $12.49. 
NOTE: displayed price will be $12.46.  and once a match-able order comes on the other side, then a discretionary order becomes IOC. 
 
- pegged order 
-- primary peg.  # pegged to the same side of the best bid/ask price. always displayed. 
e.g. a primary peg to sell at $10.00. then if best ask is beyond $10.00, like $10.05, $10.09, the order pegs to $10.05, $10.09 accordingly. but if best ask goes below $10.00, then the peg stays at $10.00. 
-- market peg    # pegged to the opposite side of the best bid/ask price. i.e. marketable. this is immediately executed (assuming enough size) 
-- midpoint peg  # always UN-displayed (may exec at "sub penny" increment) 
 
NOTE: both primary peg and midpoint peg can have an "offset" amount. then BOTH (including primary peg) becomes "not-displayed" 
 
- Minimum Quantity Order  # aka Minimum Acceptable Quantity (MAQ) 
-- a limit order with a condition that it executes only when at least a specified amount by a customer can be filled. 
-- NON-displayed 
 
 

#  time in force 

 
- mkt hour day order 
-- 09:30 - 16:00 
 
- system hour day order 
-- 04:00 - 20:00 
 
- mkt/sys hour GTC (goot till cancel) 
-- effective 1 year 
 
- mkt/sys hour IOC 
-- allows "partial" fill 
 
- GTMC (good till mkt close) 
-- till mkt close cross. then get cancelled 
-- if entered after mkt close, then becomes sys IOC 
 
- sys hour expire time 
-- customer can specify the exact expire time 
 

#  Nasdaq specific orders 

 
- price-to-comply order (aka post-only order) 
-- if it would cross/lock NBBO, then Nasdaq would adjust the bid/ask price to $0.01 away from NBBO, then keep "non-displayed" bid/ask at the lock price. 
- price-to-comply post order 
-- if it would cross/lock NBBO, then Nasdaq would adjust the bid/ask price to $0.01 away from NBBO, then there is no non-displayed bid/ask. 
 
- supplimental order 
-- non-displayed limit order that has lower priority than other displayed/non-displayed order at the same price. 
-- only executed at NBBO against incoming orders that are "same" or "smaller" size. i.e. must fill the entire matching order on the other side. 
-- any remaining odd lot is cancelled 
-- entered 04:00 - 16:00 
-- executable only during normal mkt hour 
==> some MM does this to get rebate for providing liquidity. 
 
 
### 
###  order tickets  # pre-execution 
### 
 
must include 
 
- stock name 
- price instruction (if any) 
- share size 
- order type (mkt, limit, stop, etc) 
- customer account number 
- time of order receipt, entry, and execution     # NOTE: exec time is only required at order ticket 
- registered rep ID 
- execution price 
- notation on if the order is discretionary/unsolicited, etc 
 
### 
###  trade confirmation   # post-execution 
### 
 
- BD name/addr 
- sell or buy 
- price 
- CUSIP 
- share size 
- settlement date 
- trade time 
- delivery/payment instruction 
- which venue 
- disclose any control relationship 
- disclose odd-lot fee 
- capacity of BD (agent or principal) 
-- if agent, commission fee, payment for order flow 
-- if principal, mark-up/down, whether BD is MM in the security, riskless principal or net basis. 
 
NOTE: upon customer req, BD has 5 days to supply data. 
 
 
## 
##  alternative periodic reporting / quarterly statements 
## 
 
BD may skip providing every-transaction-based report, and instead provide a periodic one if 
- customer has pre-agreed periodic trade plan 
- transaction is for money mkt fund (monthly written statement is mandatory) 
 
e.g. quarterly statements 
- within 5 days of each queater end. 
- must include 
-- security trans info (ticker, price, size, date) 
-- dividend 
-- total trade size of each stock 
-- renumeration for BD 
 
 
### 
###  limit order display rule 
### 
 
RegNMS rule 604 (for NMS stock) 
FINRA rule 6460 (for OTC stock) 
 
must display (its own and) its customer orders within 30 seconds. 
 
Except: 
- marketable 
- customer requests not to. 
- odd lot 
- block size order (more than 10k shares or $200k for NMS,  10k shares or $100k for OTC) 
- de minimis change (customer order is less than 10% of the existing quote size for the price) 
- all or none order 
- immediately routed to other venues/MM 
 
 
### 
###  Manning Rule (aka FINRA rule 5320)  : limit order protection  (this and the above order "display" rule are the core of the regulation) 
### 
 
- prohibits FINRA member firms from prioritizing its own trades(called "trading ahead") over customer orders (both NMS & OTC) 
- a member firm cannot exec the security at the same/better price before customer orders. 
NOTE: if done immediately (= 60 seconds), then it's ok to do its own trade first, then customers (but must trade at least the same size) 
 
- in effect during normal mkt hours. (if customer gets authorized to trade outside normal mkt hours, then order protection applies there too) 
 

#  EXCEPTION to Manning Rule 

 
- "trade along" : (aka TAOK) (aka trade ahead legally) 
e.g. when a customer sends a buy order at price X, the firm may buy the security (for its own account) at price X, before filling the customer order ONLY IF: 
-- for institutional clients, or 
-- for 'large' orders (10k shares or $100k. NOTE to be distinguished from a 'block' order which is $200k) 
==> must written-notify at (1) account opening, AND (2) annually thereafter 
==> must verbally give clients an opportunity to opt out, on every order. 
===> (NO individual client at all times) 
 
- "no knowledge" : if the firm makes sure that certain trading desks have no knowledge of conflicting client orders. 
- riskless principal trades : but in this case, must mark the trade as such. 
- intermarket sweep order (ISO)  # the firm MUST have a supervisory system to reconstruct time sequence of the order. 
- odd lot / error correction 
 

#  Minimum Price Improvement 

- min ticksize at which MM must improve the quote to not violate the Manning Rule. 
- just like ticksize table. (see p117) 
 
$0.01 increment for over $1.00 stock 
ALSO, for OTC, it's the lesser of $0.01 or 1/2 of the inside mkt spread 
 
### 
###  Net Transaction (aka Net Basis Trade) 
### 
 
- just like riskless principal trade. but done at diff prices, so making profits. 
e.g. 
a client sends a buy order at $12.00, then MM scours the mkt, then buys at $11.45, thus making $0.15 profit. 
 
==> must get client approval. 
 
For Institutional clients (includes individual with over $50 mil): 
(1) negative consent letter (written notice) 
(2) oral order-by-order confirmation 
(3) written order-by-order confirmation 
 
For Retail clients: 
- ONLY written order-by-order confirmation 
 
For Discretionary account: 
- depends on the fiduciary(rep), not the real owner of the account. 
- if fiduciary is an investment firm, then it is an institutional client, so on. 
 
 
 
### 
###  FINRA 5% policy 
### 
 
- a guideline, not a rule. 
- does NOT include municipal, IPO stock. 
- relavant factors: 
-- type of security (follow industry standard) 
-- liquidity (the more popular, the less mark up) 
-- the price (the higher, the lower mark up) 
-- transaction size (the bigger, the less mark up per share) 
 
- mark-up calculated based on "inside mkt", NOT trade price 
e.g. a MM displays quotes $6.70-71, and sells to a customer at $6.84. 
     mark-up is $0.13. percentage is 0.13/6.71 
 
==> similarly, when MM buys, then mark-down percentage is calc'ed using best bid price. 
 
 
### 
###  Extended Hours Trading 
### 
 
08:00 - 09:30 
16:00 - 20:00 
 
a member firm must send customers "extended hours trading risk disclosure statement" to illulstrate 6 risks. 
 
(1) lower liquidity 
(2) bigger volatility (gap risk for stop order) 
(3) changing prices (when crossing normal - extended hours) 
(4) unlinked mkts (diff venue may show significantly diff quotes) 
(5) news announcements (earnings, gov stats, tend to get announced during extended hours, adding to bigger volatility) 
(6) wider spread 
 
 
### 
###  Ethics # Rules for handling customer orders 
### 
 
Best Execution: (due diligence) 
- factors to consider: 
-- type of order 
-- macro/micro mkt condition (economy, liquidity) 
-- various venues 
-- conditions set by customer 
NOTE: we USED TO (but not any more) have three-quote-rule whereby MM must contact at least 3 other BDs to check best quotes. 
 
- directed order 
-- when a customer asks the order to be routed to a parcitular venue for execution. (then MM does not have to care about other venues) 
 
- execution quality 
-- MM must review, at least quarterly, for each order type(mkt, limit, etc), for each venue, to improve (exec price, speed, fill rate, cost, etc) 
 
## 
##  prohibited activities 
## 
- manipulation 
-- false rumors 
-- stock pool (two or more traders acting together on both sides, to influence price) 
-- pre-arranged matched trades : aka 'churning', aka 'wash trades', one trader (and his colluder) doing both sides, to inflate trade volume, to promote penny stocks. 
-- pump and dump scheme : false rumor to inflate the price, then sell to profit 
-- spoofing quotes : display quotes only to withdraw quickly. 
-- layering: sending layers of orders on one side of the book with no intention of executing, just to create the illusion of liquidity, then later sending orders on the other side of the book to execute. 
 
- complex products (structured/derivatives) 
-- must make suitable recommendations 
 
- inter-positioning 
-- MM cannot have any inter-positioner (who may be willing to pay MM) between MM and customer, if customer does not benefit. 
 
- front running 
-- MM has non-public/insider info of block trade in advance, and bets its orders to profit. 
 
- joint account 
-- if a member firm employee is in a joint account, it must be reported to FINRA. (otherwise rule violation) 
 
- marking open/close prices 
-- prohibited to attempt to manipulate open/close prices (e.g. suddenly sending super cheap orders to bring down prices before close) 
-- because open/close prices are an important benchmark. 
 
- investment advisor (IA act of 1940) 
-- an IA can be an individual or a firm 
-- cannot defraud (obviously) 
-- cannot use any testimonials (ads that guarantee stuff) 
-- must disclose if IA has its own proprietary account. (but for unsolicited customer order, no need to disclose) 
--- then must get written consent before each transaction 
-- general disclosure : must disclose fees, incentives behind recommendation, etc 
-- disclosure of all info : cannot selectively disclose info. (must disclose all performance/return including fees) 
 
 
## 
##  Uniform Practice Code (UPC) Rules 
## 
 
- FINRA rule for operations & trade settlement. 
 
settlement : the process of transferring securities and cash between the buyer and seller of an agreed upon transaction. 
             mostly electronically done. transfer agent just changes its owner record. some owner name is under "street name". 
             equity trades are done by NSCC. 
 
NSCC : national securities clearing corporation (subsidiary of DTCC) 
DTCC : depository trust and clearing corporation 
 
CNS : continuous net settlment. NSCC/DTCC uses a CNS system to "net" calc the BD's position. so it's convenient. no need to deliver/settle at trade-by-trade basis. CNS also makes adjustments after dividends, corporate actions, too. 
 
ex-clearing settlement: a manual trade comparison. 
 
regular equity                : T+3 
stock option, gov. securities : T+1 
cash settlement               : T+0 
seller's option : at least one day notice prior to delivery 
buyer's option  : buyer decides the settlment date 
 

#  when-, as-, if-issued contracts (aka WI) 

 
most commonly "when-issued" contracts are when BD sell securities that are not priced/traded yet. (e.g. IPO shares) 
 

#  ex- (latin for 'without') 

 
ex-date      # first date on which the owner can no longer receive dividend 
ex-dividend  # settle after dividend record date 
ex-rights 
ex-warrants 
 
announcement/declaration date: BOD 
ex-dividend date: ex-date  (under T+3 environment, this is 2 days before record date) 
record date : an owner on this will receive the div 
payable date: when payment is actually made. usually 3 weeks afer record date 
 
NOTE: the above is for dividend worth less than 25% of the share price. (almost all div events) 
      the only real exception is stock split (which can be considered a type of div, semantically) 
      e.g. 2-for-1 split is like 100% div. then ex-date is the day after payable date. 
 
NOTE: for ADRs, UPC committee will announce ex-date. 
 

#  order adjustment 

 
- really only talking about limit order (= limit order, stop order, stop limit order) 
- for fwd split, cash div, any orders (except explicit DNR) "below" the current mkt price(i.e. buy limit) will be adjusted down. 
NOTE: adj made before mkt open on ex-date 
NOTE: even after adjustment, the time priority over the new orders is retained. 
- for reverse split, ALL open orders are "cancelled". 
 
 
 
 
##################################### 
######     Trade Reporting      ##### 
##################################### 
 
"executing" VS "contra" parties 
 
trade reporting facility/technology (TRF) of NMS stock 
- FINRA/NYSE TRF      # both 
- FINRA/Nasdaq TRF    # run by FINRA, with indentical rules 
- ADF 
 
ACT : nasdaq TRF software 
 
for OTC stock 
- ORF 
 
"browse" : when a member firm queries FINRA TRF to review its trades, it is called "browse" 
 

# TRF reporting deadline 

 
when TRF is open (8am-8pm) : within 10 seconds of execution 
when TRF is closed         : by 08:15 of next business day 
 

#  modifiers 

 
.T  # trade executed outside normal mkt hours, reported in time 
.U  # trade executed outside normal mkt hours, and reported late (overwrites .T) 
.Z  # trade executed inside normal mkt hours, and reported late (like passing the 10 sec limit) 
 
.C  # cash trade (T+0 settlement) 
.N  # next day settlement 
.F  # intermkt sweep order (ISO) 
 
.Q  # nasdaq official open price 
.M  # nasdaq official close price 
.X  # cross trade 
.W  # vwap/stopped stock   (inludes both stop stock/vwap announce time and the actual exec time) 
 
.J  # sub-penny designator 
.P  # prior reference price 
e.g. a trader receives a mkt order from a client at 10am, but forgets to exec till 2pm, then the firm will probably honor the 10am price (if favorable to the client), then .P is attached. 
     MUST include both reference time and exec time 
     .P is also used for mkt-on-open-order that gets filled late (due to illiquidity or whatever reason) 
     because .P trade can be for error correction, it is exempt from RegNMS 611 Order Protection Rule 
 

#  Form T : when electronic submission is not possible, then manually file a form T to report your trade 

 

#  who is responsible for reporting ? 

- "executing party" : who receives/executes(no routing) the order. 
- if exec party is unclear, because of back & forth negotiation, then the "seller" is responsible, unless two parties agree who is gonna report. 
 

#  "give-up" relationship 

- a member firm reporting on behalf of other firms. 
- must have a written agreement btwn the parties, submitted to FINRA in advance. 
- trade is still under MPID of the original firm. 
- if not reported, then BOTH firms can get displinary action. (but especially on the original party, not its agent firm) 
 

#  MM capacity 

(1) agency              # report excludes commission 
(2) principal           # report excludes mark-up/down 
(3) riskless principal  # treat two legs as ONE trade. or treat the first as agency/principal, 
                        # then mark the 2nd leg as riskless principal, identified as "non-tape" / "non-clearing" 
                        # idea is to avoid double-counting 
(4) give-up 
(5) step-out            # a firm trades, but allocates positions (partially or wholly) to other firms. 
                        # often cos the client has an account on other firms. 
 

#  transactions EXEMPT from TRF 

 
basically any trades that show prices significantly away from the mkt that skew the stats are exempt. 
 
- IPO (includes follow-on, but NOT shelf offering) 
- options/rights/warrants exercised trades 
- private placement 
- a tender offer (public takeover bid) 
- M&A, bankruptsy, or a form of special discounted payment from a company to other, etc 
 

#  inclusion of transaction fee 

e.g. a firm sells 100 shares of ABC stock to other firm at $15.00, with $0.03 commission fee. the report may say $15.00 per share, OR $15.03 per share including the fee. 
 
 
 
### 
###  Reporting of Trade Cancellation 
### 
 
(1) executed during normal mkt hours 
-- if cancelled during normal mkt hours, then within "10 seconds"   # otherwise you need .Z code 
-- if cancelled after mkt hours, then by 20:00 NEXT day (T+1) 
 
(2) executed outside normal mkt hours 
-- if cancelled by 20:00, then report by 20:00 
-- if cancelled after 20:00, then report 20:00 NEXT day (T+1) 
 
(3) trade cancelled after trade date 
-- if cancelled before 20:00, then report by 20:00 of the day 
NOTE: trades cancelled after the trade date is called "reversed" 
 

# cancellation time 

- the earliest of (1) one party(exec or contra) informs the other it is cancelled. (2) both parties agree to cancel. (3) the member with reporting responsibility cancels the trade. 
 
### 
###  Transaction Reporting to ADF 
### 
 
- the same as TRF, except 18:30 close time. 
 
 
### 
###  Transaction Reporting by ATS 
### 
 
alternative trading system : still must report to either TRF|ORF. 
Every firm that acts as ATS must have an MPID (or 2 MPIDs, one for equity, one for fixed income). 
 

#  Exemption from trade reporting by ATS 

 
- among ATS subscribes 
see p162 for the full list. 
 

#  ATS weekly trade volume/count reporting to FINRA: mandatory SEC rule 

 

#  ATS daily trade volume : "may" disseminate to the public daily. 

 
a member firm that wants to advertize trade volume in its dark pool may do so ONLY if it reports it to TRF. 
(a dark pool in general is an ATS that does not disseminate its quotes to other mkt centers) 
 
mandatory : MPID of executor == MPID of reporter 
 
 
### 
###  OATS : order audit trail system   (operated by FINRA) 
### 
 
report submitted to FINRA 
 
Exemptions 
[orders] 
- orders received from outside customers. internally driven prop desk orders are not required to be reported to OATS. 
[firms] 
- firms that engage in ONLY non-discretionary orders, routes orders to other firms 
- firms that are NYSE members that trade only on NYSE-trading-floor 
[securities] 
- restricted securities (rule 144) 
- DPP (direct participation programs) 
- foreign OTC 
 
## 
##  member biz "clock synchronization" 
## 
- member firms must synchronize their clocks (used to timestamp their trades/reporting, OATS, etc) within 1 sec of NIST. 
  (not all clocks. e.g. their coffee room clock can be out of sync) 
 
## 
##  OATS record 
## 
 
to be kept for 6 years. 
 
must include 
- order identifier 
-- order origination/receipt 
-- order entry/transmission (to other firm/department within the same firm) 
-- order execution, modification, cancellation 
(timestamp to be kept for all) 
- MPID of BD 
 
===> basically record everything. (ticker, action: buy/sell ,type: mkt/limit/stop/stop limit, time in force, executing dept within the firm, rep name, account: retail, institutional, employee, etc) 
 
## 
##  OATS submission deadline 
## 
 
- OATS business day : 16:00:01 to 16:00:00 of next mkt day. 
e.g. Mon 16:00:01 to Tue 16:00:00 is one OATS day. 
e.g. Fri 16:00:01 to Mon 16:00:00 is one OATS day. 
 
any trade that happens during an OATS day is due by 08:00am ET of next OATS day. 
 

#  reporting agent 

 
just like a give-up relationship, a member firm might elect a "reporting agent" which does OATS reporting on its behalf. 
if OATS submission is late/not done, then the member firm takes the primary responsibility. 
 

#  OATS CNH (cash not held) 

 
- orders where a customer specifies a dollar amount but not share size are recorded in OATS as "CNH" 
 

#  "bunched" : when multiple orders are aggregated prior to execution, OATS term for it is "bunched" 

 
NOTE: a trade can have many OATS reports, one for each phase. 
 
 
 
############################################ 
#####      New Issue Market (1933)     ##### 
############################################ 
 

# Nasdaq 3 Tiers  (mostly determined by mkt capitalization, revenue/earnings, cash flow, asset, etc) 

 
- Nasdaq Global Select Market  # biggest 
- Nasdaq Global Market 
- Nasdaq Capital Market        # smaller 
 
need $4.00 bid price initially, then $1.00 bid continuously. 
need at least 2 mkt makers continuously. 
 
## 
##  Quid Pro Quo allocation 
## 
e.g. BD is NOT allowed to make special discounts/profits for a transaction with clients, in return for un-related future IPO share allocation. 
 
## 
##  Spinning 
## 
- underwriter allocating IPO shares to corporate insiders (of public company or "covered nonpublic" companies) 
- covered nonpublic(private) company meets at least one of: 
-- income of at least $1 mil in the last fiscal year 
-- shareholder's equity of at least $30mil and two year operation history 
-- total asset/revenue of at least $75 mil in the last fiscal year 
- also applies to "materially supported" people of corp insiders. 
-- materially supported means same "residence" or 25% of "income" supported 
 
==> spinning is prohibited ONLY for 
(1) company : in investment banking service ? 
(2) person : insider info ? 
(3) promise : quid pro quo 
 
## 
##  Flipping 
## 
- an investor selling IPO shares within 30 days of acquisition. 
- BD will be using penalty bid (where BD has to return its commission to underwriter syndicate) 
- also flipper may be denied of participation in green shoe, future IPO allocation. 
 
"penalty bid" : when an investor sells back the new issues to BD, filling the stabilization bid. then the BD loses its concessions. 
 
## 
##  Lock-up period 
## 
 
- underwriter agrees with the insider of the issuer who holds IPO shares that the insiders won't sell shares for a lock up period (typically 180 days). so the price is stable, and it looks good PR-wise. details in prospectus. 
- there is not regulatory requirement, so underwriter may decide to cancel it later. 
- each lock up is done with each shareholder, so underwriter can cancel partially by talking to certain shareholders. 
- lock up can be tiered for diff levels of insiders (CEO, BoD, etc) 
- lock up also applies to "issuer-directed" shares which are the shares the issuer directly chooses the buyers, not thru underwriter. 
[expiration] 
- book runner MUST notifiy issuer/shareholder at least 2 days before exp of lock up. 
 
## 
##  IPO share allocation report 
## 
 
- syndicate mgr must provide IPO share allocation report (indication of interest, share size for each institutional investor, aggr share size for retail investors, etc) both BEOFRE & AFTER pricing to issuer's pricing committee(BoD otherwise). not to public. 
- returned shares by buyer must be: 
-- used to offset syndicate short pos 
-- offset any unfilled customer orders 
-- sold to secondary mkt, with profit donated to charity 
 
note: secondary mkt of IPO shares first must trade on its primary venue, then free to trade on other venues. 
 
 
### 
###  Regulation M : reg for new issue mkt 
### 
 
rule 101: reg for underwriters/syndicate (and any other distrib participants like BD) 
rule 102: reg for issuer/selling shareholders(functionally the same as issuer), and affiliated purchasers 
rule 103: nasdaq passive mkt making 
rule 104: stabilization 
rule 105: short sell, in relation to IPO 
 
subject security : security being sold 
reference security : security that can be converted to subject security 
covered security : both sub and ref sec. 
 

#  rule 101: reg for underwriters/syndicate (and any other distrib participants like BD) 

 
distrib participants cannot bid during "restricted period" that lasts till completion of distrib. 
 
ADTV : ave daily trade vol 
 
    threshold           |  restricted period     | notification to FINRA 
---------------------------------------------------------------------------- 
ADTV > $1mil  AND       |                        |                          # active traded securities 
public float > $150mil  |  no restricted period  |  1 day after pricing     # 
--------------------------------------------------------------------------- 
ADTV > $100k  AND       |  1 day before pricing  |  2 days before pricing   # one-day stock 
public float > $25mil   | 
--------------------------------------------------------------------------- 
otherwise               |  5 days before pricing |  6 days before pricing   # five day stock 
 
Exception from rule 101 
- odd lot 
- unsolicited order 
- de minimus (less than 2% of ADTV) 
- rule 144a (QIB), or non-US buyers 
 
 

#  rule 102: reg for issuer/selling shareholders(functionally the same as issuer), and affiliated purchasers 

 
basically, ppl cannot collude. 
 
syndicate mgr must notify FINRA 
- restricted period, one day before it begins 
- pricing(offer price and share size), no later than the COB day 1 
- amends on the above notification, immediately 
 

#  rule 103: nasdaq passive MM 

 
rule 103 allows passive MM in nasdaq during "restricted period". 
 
- Highest Independent Bid 
-- highest bid by MM who is NOT underwriter 
-- passive MM may NOT bid higher than the highest independent bid price 
 
- Net purchase limitation (for each day during restricted period) 
-- cannot exceed the greater of 200 shares OR ADTV of past 2 months. 
-- also the bid size cannot exceed the limit either. (because if it gets filled, then it might exceed the limit) 
(but if the remaining allowed size is odd lot, then you can still bid 1 lot) 
e.g. your net purchase limit is 400, and you already bought 350, then you can display bid 1 lot 
 
NOTE: when the highest independent bid increases, then MM may increase its bid. 
      when it drops, MM should try drop it. BUT before dropping MM may purchase the smaller of 2*min_quote_size(usually a round lot) OR the remaining shares for the net purchase limit, at that old highest independent bid price. 
 
NOTE: so passive MM may exceed net purchase limit if it's part of a single customer order, but then must withdraw from mkt for the rest of the day. 
 
ASIDE: in general, a passive order is an order that is not immediately marketable, i.e. not inside NBBO. and an aggressive order is. obviously, sending and cancelling many aggressive orders will be flagged as malignant act, like layering, spoofing, etc. 
 
 

#  rule 104: stabilization 

 
syndicate(or its agent) can bid IPO stock to stabilize the price. 
- no limit on duration. can go on forever. 
- must be announced in advance in prospectus, then notify SEC when actually doing it. 
- there MUST be at least one independent(non underwriter) MM that is quoting the stock 
- only one stabilization bid can be placed at a time 
- stabilization bid price 
-- CANNOT exceed offer price 
-- must be last independent trade price    (IF current best ask price is more than last trade price) 
-- must be current highest independent bid (if current best ask price is less than last trade price) 
 
"principal market" : mkt where the security trade volume is the biggest (for last 12 months) 
 
NOTE: both stabilization bid & penalty bid must be recorded (for 3 yrs). 
 

#  syndicate covering transaction 

- because stabilization bid must be notified to SEC, who will in turn make it public, it can impose a negative view in the mkt. 
- thus syndicate may instead resort to "syndicate covering transaction" which is basically syndicate buying shares from secondary mkt (no price restriction, no disclosure to the public) for filling oversold IPO green shoe shares(up to 15% of IPO) 
 
NOTE: for OTC equity, underwriter MUST give "written" notice to SEC both prior and post penalty bid & syndicate covering transaction 
 
 

#  rule 105: short sell in relation with a public offering 

- prohibits anyone who bought the stock within 5-business-day period preceeding the pricing day. 
- the idea is to prevent investor over-selling before a public offering. 
 
 
## 
##  share buy-back : safe harbor 
## 
- for the issuer to buy back its securities in secondary mkt, it follows the guideline to not cause any regulatory scrutiny. (safe harbor) 
[manner] : use one BD 
[timing] : avoid mkt open, avoid the last 30 min of trading. (10 min for stock with ADTV above $1mil AND public float of $150mil) 
[price]  : no greater than highest independent bid | last independent transaction price 
[volume] : up to 25% ADTV (from past four weeks) 
 

# buy-back report 

- repurchase must be in 10-K, 10-Q, and monthly/qurterly reports. 
 
NOTE: repurchases for securities pending M&A are exempt from safe harbor (which is still available during no valuation period). 
 
 
 
### 
###  Rule 144a (part of 1933) 
### 
 
- qualified institutional buyer (QIB) : at least $100 mil in asset 
  (also includes BD with at least $10 portfolio) 
 
QIB can freely buy/sell un-registered securities (e.g. high-yield bond, pre-IPO shares aka piggyback registration rights). 
 
## 
##  rule 144 
## 
 
- restricted securities 
-- 6 month (or up to 12-month) holding period 
-- comes with a legend that says it is restricted, cannot be resold without SEC registration 
   (only transfer agent can remove the restrictive legend) 
 
- control securities 
-- owned by corporate insider(aka affiliates : officer/director/BoD/10% shareholder) 
-- no legend 
-- 90-day volume restriction: 
--- 1% of total outstanding shares, or 
--- ave weekly trade volume of past 4 weeks 
-- must file form 144 IF: 
--- selling more than 5k shares or $500k in any 3-month period (then the 90 day period begins) 
 

#  new issues in business combinations 

 
SEC registration is required for new issues that get generated via: 
- reclassification 
- M&A 
- asset transfer 
- exchange offers 
 
 
############################################# 
####    general securities regulation    #### 
############################################# 
 
regulation ATS (alternative trading system): 
- alt means of liquidity 
- often used for large block trade, away from the principal exch 
- participants are called "subscribers" 
- ATS is rather a BD, instead of an exch. (sort of, sometimes registered as exch tho) 
-- ECN 
-- OTC link (ATS within OTC pink) 
-- dark pool 
 

# registration requirement 

- file form ATS 20 days prior to day 1 (of operations, or any material change) 
- register as FINRA member 
- be part of NBBO 
- provide fair access and reasonable fee 
[exepmtion from resigration, and form] 
- ATS registered as an exchange 
- ATS exempted by SEC for low trade volume 
- ATS operated by SRO (e.g. FINRA) 
- ATS only dealing in gov securities 
 
[reporting requirement] 
- if, during at least 4 out of last 6 months, if at least 5% of NMS/OTC equity is traded on ATS, then it must be reported. 
- if 20% (instead of 5%), then extra obligation to check its system capacity, DR plan, etc, update SEC 
 
[order display] 
- must do NBBO advertisement to other venue. (if displaying quotes at all) 
  (exception is when ot displaying quotes to other subscribers) 
 
[fair(consistent) fees] 
- cannot charge investors differently. e.g. even if some access ATS directly, others access via other venue. 
 
[reporting on "form ATS-R"] 
- an ongoing report to SEC 
-- within 30 days of each quarter 
-- within 10 days of its termination of service 
 
[confidential info] 
- must keep info private (only to employees). 
- must monitor employee personal trading 
 
 
### 
###  disclosure of execution & order routing 
### 
 
mkt center : includes exch, OTC MM, ATS. 
 
Reg NMS rule 605: exec 
Reg NMS rule 606: OR 
 

#  Reg NMS rule 605: exec 

 
mkt center must disclose (monthly electronic/web report) on their exec quality 
- effective spread : 2 * the diff btwn tp & mp 
- rate of price improvement (i.e. when customer limit orders are filled at better price than public quotes) 
- fill rates 
- exec speed 
==> report categorizes stock-by-stock, then by order type(mkt order, limit order, etc), then by order size (0-500, 500-2000, 2000-5000, over 5000) 
 

#  Reg NMS rule 606: OR 

- BD must report (quarterly, electronically/web, written form upon customer request.) 
-- exclude special orders (e.g. AON, not-held, directed orders, ) 
-- categorized by 4 sections (NYSE, Nasdaq, other exch, options) 
-- for each section, must contain 
--- percentage of directed/non-directed orders, by mkt order, limit order, other orders 
--- (important) top 10 venues BD routes to, PLUS any other venues BD routes at least 5% of non-directed orders 
-- disclose if any order-flow-payment(rebate) relationship with any particular venue (or any other profit sharing setup) 
-- must disclose where every customer order got routed (for last 6 months), upon request. AND the fact that this duty exists must be notified to customer annually. 
 
 
### 
###  Suitability Requirement 
### 
 
FINRA rule 2111 defines: 
 
- customer specific suitability (KYC) : the usual (tax bracket, age, family situation, investment experience, etc etc) 
-- retail VS institutional (corporation or $50mil asset) 
-- NOTE: for institutional client, rep can assume KYC is satisfied if (1) inst client can evaluate risk independently (2) exercise trade judgement independently 
 
- reasonable basis suitability (common sense) 
- quantitative suitability (do maths) 
i.e. the biggest risk is when you dont know what you are dealing with. 
 
 
### 
###  Large Trader Reporting  (FINRA rule 13H) 
### 
 
Large Trader is anyone who trades NMS stock/options: 
(1) 2 mil shares or $20 mil,  in one day 
or 
(2) 20 mil shares or $200 mil, in one month 
===> then must register/report to SEC (who requests/monitors) 
===> must present LTID(large trader ID) to BD, whenever placing orders 
 
(for calc purpose, options are converted to underlying stock/dollar amount) 
 
Form 13H filing # NOT available to the public 
- ok to voluntarily file, even if not reaching the above threshold 
(contains business details, senior mgmt, partnership, other regulations it is subject to, location of prime brokerage, etc) 
- initial 
- annual 
- amended 
- inactive 
- reastivated 
- termination 
 
 
### 
###  Qualified Block Positioner 
### 
 
QBP: MM that trades $200k or more. ($1 mil net capital) 
- must be for a single purpose 
-- can be done a single trade or multiple trades 
 
### 
###  other misc FINRA rules 
### 
 
rule 5230: media (cannot pay in any way to influence) 
           EXCEPT: - clealy distinguishable paid advertisement 
                   - research reports 
                   - publication by underwriter, issuer, BD, for customer 
 
rule 5280: prohibits trade/inventory-adjustment ahead of research report 
          ==> thus, research analysts should NOT speak with trading desk (about the report) 
 
rule 5240: anti-intimidation (dont go gangster) 
 
rule 5290: order-splitting (aka trade-shredding) 
           - dont do it to increase commission/in-kind-payments(like rebates, credits, etc) 
           - still ok to get better exec price for a big order 
 
rule 6110: trading otherwise than on an exch 
           - basically a FINRA member firm who trades NMS stock on OTC must report it. 
 
 
### 
###  Penny stock 
### 
 
- "unlisted" stock trading less than $5.00 per share 
(rule 15g-2) 
- MM/BD must give "risk disclosure document" aka "suitability statement" at least 2 days before the first trade (aka cooling off period), and it must be signed by customer. it must be kept for 3 yrs. 
EXEMPTION: 
- for BD who: 
-- earned less than 5% of its revenue from penny stock in last 3 months, AND for at least 11 of last 12 months. 
-- has not done MM for the penny stock in the last 12 months. 
- for 'established customer' who (1) has a penny stock account for over 1 yr, OR (2) who traded 3 penny stocks on 3 diff days in the past year. 
- institutional investor 
- private placement 
- corporate insiders of the issuer (but not 10% but 5%) 
- UNsolicited trade 
 
- principal trade:  must give a quote if BD has done 3 bonafide trades to other BDs at the same ask price 
- agency trade : must get quotes from at least 3 MM 
- BD trade: must disclose aggr amount to customer 
-- active & competitive mkt : where aggr trade size by the same MM, in the last 5 days, does not exceed 20% of its whole. 
- must disclose sales commission to the rep, at or prior to the order receipt. 
 
 
### 
###  Books and Records 
### 
 
SEC rule 17a-3/4 requires BD to keep: 
- all order tickets, rep name, account, client 
- each registered rep history 
- customer accounts info, so SEC can investigate customer specific suitability / KYC compliance. (6 yrs) 
- signature for authorizing discretionary trades 
- any complaint (for 4 yrs) 
- records of gifts, trips 
- advertisement 
- principal (rep) list 
- stuff relevant to each physical office(could be state regulation) 
 
===> mostly, the mandatory retention period is 3 yrs (2 of which the records should be kept easily accessible) 
 
 
### 
###   insider trading 
### 
 
- cannot take advantage of material non-public info. 
- extends to tipper & tippee 
- constructive insider: outside council, consultants, etc 
- misappropriation(theft) theory : cannot steal MNPI 
- duty of trust : though the above general guideline exists, liability can be tricky. e.g. husband and wife share info all the time, so if either suddenly does insider trading based on their conversation, the other spouse may not be held liable. 
- Chinese wall 
- restricted(cannot deal) list / watch(can deal but beware) list / rumor list 
- firms must have procedure for prop / employee trading 
- penalty includes both : 
-- civil   : up to 3 times the illegal profit (aka treble damages) and perp's boss can be held liable too. # treble = triple 
-- criminal: up to $5 mil (or $25 mil for corporate) or up to 20yrs in prison. 
 
 

  1. 2015-08-16 12:34:38 |
  2. Category : financial
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