Quick Answer
The statute names three market makers: a specialist permitted to act as a dealer, a dealer acting in the capacity of block positioner, and a dealer that holds itself out as willing to buy and sell a security for its own account on a regular or continuous basis. FINRA's definitions then set status market by market.
Market maker is not one status. A statute defines it broadly, FINRA defines who holds it in a particular market, and the net capital rule defines it again for its own computation. Answering an exam question starts with working out which of those the question is asking about.
What Does the Statute Say a Market Maker Is?
The Securities Exchange Act defines a market maker as three separate things:
- Any specialist permitted to act as a dealer.
- Any dealer acting in the capacity of block positioner.
- Any dealer who, with respect to a security, holds himself out as being willing to buy and sell that security for his own account on a regular or continuous basis. The statute puts the manner in a parenthetical: by entering quotations in an inter-dealer communications system, or otherwise.
The third limb carries the qualifiers the exam tests. The holding out is with respect to a security, the trading is for the dealer's own account, and the basis is regular or continuous.
Exam Tip: Gotchas
- The statute's third limb reads "or otherwise." Entering quotations in an inter-dealer communications system is one way of holding out, not the only way, so a dealer can meet the definition without a posted quote.
- The statutory basis is regular or continuous, in the alternative. An option that requires both misstates this definition, though it may correctly state the Alternative Display Facility definition below.
- A block positioner is a market maker by the statute's own text. The second limb reaches any dealer acting in the capacity of block positioner, with no quoting requirement attached.
Which FINRA Definition Sets Status in the OTC Market?
The OTC equity definitions supply the FINRA term. An OTC Market Maker is a member of FINRA that holds itself out as a market maker by entering proprietary quotations or indications of interest for a particular OTC equity security in any inter-dealer quotation system. That includes any system the SEC has qualified under the penny stock automated quotation system provisions.
The definition then limits the status. A member is an OTC Market Maker only in those OTC equity securities in which it displays market making interest through an inter-dealer quotation system.
The same rule defines the direct counterpart. A Non-Market Maker is a member of FINRA that is not an OTC Market Maker with respect to a particular OTC equity security.
Exam Tip: Gotchas
- Status runs security by security, not firm-wide. A member is an OTC Market Maker only in those securities in which it displays market making interest through an inter-dealer quotation system.
- An indication of interest is enough to hold out. The definition names proprietary quotations or indications of interest, so a firm need not post a two-sided priced quote to fall inside it.
- Membership is part of the definition. The term reaches a member of FINRA, so a non-member trading the same security is outside it.
Which Terms Does the OTC Definition Rest On?
Three defined terms carry the weight.
| Term | Definition |
|---|---|
| Inter-dealer quotation system | Any system of general circulation to brokers or dealers which regularly disseminates quotations of identified brokers or dealers |
| OTC equity security | Any equity security that is not an NMS stock as Regulation NMS defines it, provided, however, that the term does not include any Restricted Equity Security |
| Restricted Equity Security | Any equity security that meets the definition of restricted security in the restricted securities resale safe harbor |
Following the first delegation gives the national market system boundary. Regulation NMS defines an NMS stock as any NMS security other than an option, and an NMS security as any security or class of securities for which transaction reports are collected, processed, and made available under an effective transaction reporting plan, or under an effective national market system plan for reporting transactions in listed options.
Exam Tip: Gotchas
- The OTC equity definition is a subtraction followed by a second subtraction. It takes every equity security that is not an NMS stock, then removes any Restricted Equity Security.
- A Restricted Equity Security is carved out whatever else it is. The proviso removes it from the OTC equity security definition even where the security is not an NMS stock.
- The quotation system definition asks who is identified. The system must regularly disseminate quotations of identified brokers or dealers, and must be of general circulation to brokers or dealers.
Who Is a Registered Reporting ADF Market Maker or ADF ECN?
The ADF definitions give the Alternative Display Facility (ADF) its own status terms, and they are narrower than the statute's.
A Registered Reporting ADF Market Maker is a member of FINRA that is registered as a FINRA market maker in a particular designated security. With respect to that security, it holds itself out, by entering quotations in the Alternative Display Facility, as being willing to buy and sell the security for its own account on a regular and continuous basis.
A member holds that status in only those designated securities for which it is registered as an ADF market maker.
A Registered Reporting ADF ECN is a member of FINRA that is an electronic communications network (ECN) electing to display orders in the ADF. The term also includes a FINRA member that is an alternative trading system (ATS) displaying orders in the ADF.
Both statuses end the same way. A member ceases being a Registered Reporting ADF Market Maker in a designated security, or a Registered Reporting ADF ECN, when it has withdrawn or voluntarily terminated its quotations, or when its quotations have been suspended or terminated by action of FINRA. The lesson on withdrawal of quotations and voluntary termination of registration works through both routes.
Three further ADF terms build on those:
- An ADF Market Participant, which the rule also calls a Market Participant, is a Registered Reporting ADF Market Maker or a Registered Reporting ADF ECN.
- An ADF Trading Center is either of those that is a Trading Center as Regulation NMS defines it and that is certified, under the ADF quote and order access rule, to display its quotations or orders through the ADF.
- A Registered Reporting Member is a Registered Reporting ADF Market Maker or a Registered Reporting ADF ECN, which is the same membership the participant term carries under a second name.
Regulation NMS defines a trading center as a national securities exchange or national securities association that operates a self-regulatory organization trading facility, an alternative trading system, an exchange market maker, an OTC market maker, or any other broker or dealer that executes orders internally by trading as principal or crossing orders as agent.
The full ADF definitions table and the access requirements behind that certification are covered in the unit on display, execution and trading systems.
Exam Tip: Gotchas
- The ADF market maker standard is regular and continuous. The statutory definition says regular or continuous, so the two standards do not match and a question can turn on which one it names.
- An alternative trading system reaches ADF status through the ECN term. The Registered Reporting ADF ECN definition expressly also includes a FINRA member that is an alternative trading system displaying orders in the ADF.
- Not every ADF Market Participant is an ADF Trading Center. The trading center status adds two conditions: being a Trading Center under Regulation NMS, and being certified to display quotations or orders through the facility.
How Is a Designated Market Maker Different Again?
The NYSE designated market maker rules add a fourth route. Any member who expects to act as a designated market maker (DMM) in a listed security must be registered as one, and the same rule states that DMMs are designated as market maker on the Exchange for all purposes under the Securities Exchange Act and the rules and regulations under it.
The Floor duties that come with that registration are covered in this unit's lesson on the role of the Floor broker.
The net capital rule supplies yet another definition, used only to decide how much capital a market maker must carry. It is covered in this unit's lesson on net capital requirements, and it is not the same test as any of the definitions above.
Exam Tip: Gotchas
- A designated market maker gets its status by Exchange designation. The rule designates DMMs as market maker on the Exchange for all purposes under the Securities Exchange Act, so no separate holding-out analysis is needed.
- Seven definitions of market maker are in play across this unit. The statute, the FINRA OTC definition, the FINRA ADF definition, the NYSE designation, the net capital rule's own test, and the credit regulation's qualified OTC market maker and qualified third market maker each answer a different question.
What Should You Check on Exam Day?
- Identify which definition the question needs. The statute, the FINRA OTC and ADF terms, the NYSE designation, the net capital rule, and the credit regulation's two qualified market maker terms each define market maker for a different purpose.
- Read the basis word carefully. Regular or continuous is the statute; regular and continuous is the ADF market maker.
- For OTC status, confirm the member displays market making interest in that particular security through an inter-dealer quotation system.
- Check an OTC equity security twice: not an NMS stock, and not a Restricted Equity Security.
- Confirm ADF Trading Center status adds two conditions to being an ADF Market Participant: Trading Center status and certification to display.