How To Master Supervision Of Trading And Market Making

How To Master Supervision Of Trading And Market Making On The Series 24 Exam

and Become a General Securities Principal

One of the keys to passing the series 24 exam is to make sure that you have a complete understanding of how supervision of trading and market making will be tested on the Series 24 Exam. This article which was produced from material contained in our series 24 textbook and will help you master the material so that you pass the series 24 exam.

Handling and Displaying Customer Limit Orders

If a market maker accepts customer limit orders it must handle the order in accordance with The Limit Order Display Rule. If a market maker accepts a customer’s limit order that would improve its quoted price the market maker must update its quote to reflect the customer’s limit order. A market maker is required to update its quote within 30 seconds of receiving the customer’s order. The 30-second time frame only applies to normal market conditions and does not include the opening or reopening of a security after a halt.

Example:
In the market for XYAD listed below the inside market is 15.00 bid and 15.05 offered. The size of the bid is for 500 shares and there are 300 shares offered.

XYAD
Bid          Ask         Size
15.00      15.05      5 X 3

If market maker 2 who is the best bid received a customer’s limit order to buy 200 shares at 15.02 the market maker would have to update its quote and the market would look as follows:

XYAD
Bid          Ask         Size
15.02      15.05      2 X 3

If market maker 2, who is the best bid, instead had received a customer’s limit order to buy 1000 shares at 15.00, the market maker would have to update its quote by adding the customer’s size to its current quote and the market would look as follows:

XYAD
Bid          Ask         Size
15.00      15.05      15 X 3

If the customer’s limit order is equal in price to the firm’s displayed quote but is less than 10% of its displayed size the firm does not have to update the size of its quote to reflect the customer’s order. Orders that are not required to be displayed include:

• Odd lot orders
• All or none orders
• Block orders for at least 10,000 shares or $200,000 in market value
• Orders sent to a qualifying ECN
• Orders sent to another market maker that complies with the display rule
• Orders that the customer request not be displayed
• Orders that are immediately executable

In order for an ECN to be considered a qualifying ECN under the ECN Display Alternative Rule, the ECN must communicate its quotes to NASDAQ and must allow access to its quotes to broker dealers who do not subscribe to the ECN’s service. The ECN may charge a fee to non-subscribing broker dealers who execute orders against its quotes. If a broker dealer sends a customer’s limit order to a qualifying ECN to be displayed it does not need to improve its quote in NASDAQ. If the broker dealer sends a customer order a non-qualifying ECN, the market maker must update its quote to reflect the customer’s order. A qualifying ECN is also known as a linked or eligible ECN. The broker dealer who sends a customer’s order to a qualified ECN may not trade ahead of the customer’s order displayed by the ECN at a price that would satisfy the customers limit order.

The Consolidated Audit Trail System / CATS

In order to ensure that customer orders are transmitted to the marketplace in a timely manner, the FINRA developed the Consolidated Audit Trail System (CATS). The CATS system tracks an order through each stage of its life from receipt to execution or cancellation. Each firm is required to synchronize clocks used for reporting to the National Institute of Standardized Time’s atomic clock and must display time in hours, minutes and seconds.

Firms are required to submit daily electronic CATS reports to FINRA. CATS reports must be made the same day an order was received or on the day information becomes available to the firm. Daily electronic CATS reports can be made for single or multiple orders. Information collected on the CATS report includes:

• Customer
• Date and time of receipt
• Order ID
• Terms of the order (i.e. buy, sell, security, price, shares, account type and handling instructions)
• If the order was received manually or electronically
• If the order was routed manually or electronically
• Where the order was routed for execution
• Any modifications to the order including the date and time of any modifications
• Execution information including partial executions, price, date, time and capacity in which the firm acted in the trade

The Manning Rule

In addition to displaying the customer’s limit order, a firm who accepts limit orders must protect that order. A firm may not compete with a customer’s limit order by executing an order for its own account at a price that would satisfy the customer’s limit. If the firm executes an order for its own account at a price that would satisfy the customer’s limit order the firm must execute the customer’s order at the same price and for the same number of shares within 30 seconds. Broker dealers who route orders to ECNs, or other firms to be displayed, must still protect the customer’s limit order and are not relieved of their obligations under The Manning Rule. Orders from institutional customers and orders for 10,000 shares and having value of more than $100,000 are not required to be protected under The Manning Rule. If the firm accepts limit orders that will not be protected under The Manning Rule, the firm must disclose the conditions at the time the order is accepted. If the market-making desk is holding a customer’s limit order that is subject to The Manning Rule, no trading desk anywhere within the firm may knowingly execute a proprietary order that would compete with the customer’s order. If the firm has sufficient barriers between its trading desks and the other desk does not have knowledge of the customer’s order, the other desks are not bound by The Manning Rule. If prior to displaying a customer’s limit order that is better than the inside market, the firm receives an offsetting market order, the firm must execute the market order at a price that at least equals the price of the limit order its holding. Only customer orders entered for at least one round lot between 9:30 AM and 6:30 PM EST are required to be protected under The Manning rule.