Quick Answer
A firm controls trading through written trader mandates and Reg SHO aggregation units, then makes markets under two-sided continuous quotation standards. Reg SHO governs short-sale marking, locate, and close-out. Regulation NMS and the best-execution rule govern routing and protected quotations. The market access rule, Limit Up-Limit Down (LULD), and market-wide circuit breakers cap risk, and supervisors must detect and escalate prohibited activity.
The whole trading-desk supervision unit on one sheet: the structural controls, the marketplace rules, the volatility pauses, and the prohibited conduct the exam pairs together.
Structural Controls: Mandates and Aggregation Units
- A trader mandate is the written grant of authority (products, position limits, loss limits, counterparties, trading hours, prohibited strategies). It must be in writing AND enforced, not just documented.
- An aggregation unit under Regulation SHO nets long and short positions separately at the desk level, not firm-wide, for short-sale marking.
- A bona fide unit needs four things: a clearly defined trading objective, non-commingled positions, its own written plan, and trader separation (physical or distinct reporting lines).
- The net long determination is made at the aggregation unit level. A long desk and a short desk in the same security mark independently.
Market Making and Quoting
- Market makers must post two-sided continuous quotations priced within the Designated Percentage of the National Best Bid/Offer (NBBO) to bar stub quotes.
- Normal business hours are 9:30 a.m. to 4:00 p.m. ET; intermittent quoting violates the continuous standard.
- An unexcused withdrawal triggers a 20-business-day suspension (regulatory exclusion, not a fine). Equipment failure is a legitimate excused absence; trading losses are not.
- A passive market maker under Regulation M may match but not exceed the highest independent bid, capped at the lesser of 30% of average daily trading volume (ADTV) or two times the minimum quotation size (200 shares).
- Payments for market making are a bright-line ban: an issuer, promoter, or affiliate may not pay any consideration for quoting or acting as a market maker.
The One-Liners That Win Points
- A short sale is marked long, short, or short exempt at order entry. "Short exempt" means short under Regulation SHO but exempt from the alternative uptick price test; locate and close-out still apply.
- The locate must be documented before order entry, not before settlement. Bona fide market making is exempt from locate.
- The order protection rule bars trade-throughs of automated, top-of-book protected quotations at the NBBO; manual and depth-of-book quotes are not protected.
- Execution-quality reports are the market center's monthly duty; order-routing reports are the broker-dealer's quarterly duty and disclose payment for order flow.
- The market access rule bars unfiltered (naked) sponsored access: every order clears the broker-dealer's pre-trade controls first.
- The Manning rule bars trading ahead of an unfilled customer order at a price that would satisfy it.
Numbers to Lock In
| Item | Value |
|---|---|
| Unexcused quote withdrawal suspension | 20 business days |
| Passive market maker daily cap | lesser of 30% ADTV or 200 share lots |
| Short-sale fail close-out | start of trading on T+1 |
| Long-sale fail close-out | start of trading on T+3 |
| Threshold security | fail-to-deliver 5+ consecutive settlement days, 10,000+ shares AND 0.5%+ of shares outstanding |
| Alternative uptick rule trigger | 10% intraday decline from prior close |
| Alternative uptick duration | rest of trigger day plus next trading day |
| Best-execution regular and rigorous review | at least quarterly, security-by-security AND order-type |
| Sub-penny increment | $0.01 at $1.00+; $0.0001 below $1.00 |
| Market access controls | reviewed annually, CEO certifies annually |
| LULD band, Tier 1 (S&P 500, Russell 1000) | 5% (doubles at open/close and under $3.00) |
| LULD band, Tier 2 (other NMS) | 10% (doubles at open/close and under $3.00) |
| LULD mechanic | 15-second band breach triggers 5-minute pause |
| Market-wide circuit breaker Level 1 | 7% S&P 500 drop, 15-minute halt |
| Market-wide circuit breaker Level 2 | 13% S&P 500 drop, 15-minute halt |
| Market-wide circuit breaker Level 3 | 20% S&P 500 drop, halt for the day |
| Levels 1 and 2 cutoff | only before 3:25 p.m. ET |
| OTC piggyback quoting | 12 of prior 30 calendar days, no break over 4 consecutive days |
Memory Aid: Below-Market Orders Adjust Down
Memory Aid: Buy limit and Sell stop = adjust DOWN ("BLISS" doesn't apply; remember: orders BELOW market adjust). Sell limit and buy stop are above market: don't adjust for cash dividends.
Top Gotchas
- Locate is BEFORE order entry; close-out is AFTER a settlement-date fail. The exam walks a sequence and asks which requirement applies at each step. A locate is not a borrow; pre-borrow requires an actual borrow.
- A Level 1 or Level 2 circuit breaker at or after 3:25 p.m. ET does NOT halt trading. The market lets the close run. Only Level 3 (20%) halts late in the day, and it ends trading rather than pausing 15 minutes.
- Circuit breaker percentages come from the prior day's closing S&P 500. Levels 1 and 2 each trigger only once per day.
- LULD is single-stock; circuit breakers are market-wide. The 15-second test triggers the pause; the 5-minute halt is the consequence, and the reopening auction runs at the primary listing market.
- A trader who flips between aggregation units to mark a covered short as long commits a Regulation SHO sham-aggregation violation.
- A failure to escalate is itself a supervisory-system failure, separate from the underlying trading violation; on manipulation or front-running, the supervisor must freeze trading and preserve records immediately.
One-Breath Recap
A firm constrains trading with written, enforced trader mandates and Regulation SHO aggregation units that net long and short separately at the desk level, then makes markets with two-sided continuous quotes inside the Designated Percentage, policing withdrawals with a 20-business-day suspension. Regulation SHO marks every sale long, short, or short exempt, demands a documented locate before order entry, closes out short fails by T+1 and long fails by T+3, and imposes the alternative uptick rule on a 10% intraday drop. Regulation NMS and the best-execution rule govern routing, protected quotations, and the market-center-versus-broker-dealer reports. The market access rule blocks naked sponsored access with CEO-certified annual controls, LULD (15-second breach, 5-minute pause) and market-wide circuit breakers (7%, 13%, 20%) cap volatility, and the supervisor must detect and escalate prohibited conduct or own the supervisory-system failure.
Need more than the recap? This is a condensed summary. If it is not enough, read the full Order Entry, Routing, and Execution unit for the complete lesson.