Preferenced orders & liability orders

Thank you for the question. This topic can be tested in several ways. Additionally, preferenced orders can be confused with directed orders. Let's take a look at both types of orders and when each is a liability order. 

First, it is important to understand why an order entry firm or market maker would want to enter a preferenced order. When multiple firms are displaying the best bid or offer for a security, the NASDAQ system will route the order to the firm that displayed the best price first. Many firms have an arrangement to receive rebates for sending orders to certain market makers. So if there are 3 market makers offering the same price, the firm would want to send the order to the firm that will pay it for the order. In this case, the firm would enter a preferenced order to route the order to that particular firm.

Firms may only send preference orders to market makers who are on the inside market. In these cases the preferenced order is a liability order and the firm is obligated to execute the order. 

If a firm tries to enter a preferenced order for a firm that is not on the inside market, it will be rejected by the system and it is NOT a liability order. 

A directed order on the other hand, may be sent to a market maker who is on the inside market or away from the inside market. It is like sending a message to see if the firm would be interested in trading at the price indicated. If the firm is on the inside market and the price matches the displayed price, it is a liability order and it must be executed by the receiving firm. If the firm is away from the inside market, the receiving firm may reject the order without any liability to trade at that price.