The Definitions Regulation NMS Runs On

Every duty in this unit is written in these terms. A quotation is protected only if it is automated. A trade-through can only happen during regular trading hours. The display duty falls on a named list of firms rather than on the market generally.

So the definitions are not background. They are where most of the exam's separation between a right and a wrong answer lives.

Which Securities Does Regulation NMS Reach?

The Regulation NMS definitions open by tying the statute's term to their own. The term national market system security, as the Securities Exchange Act's national market system provision uses it, means any NMS security as Regulation NMS defines it.

An NMS security is any security or class of securities for which transaction reports are collected, processed and made available pursuant to an effective transaction reporting plan, or an effective national market system plan for reporting transactions in listed options.

An NMS stock is any NMS security other than an option.

That second term is the one to hold on to. The limit order display rule, the order protection rule and the sub-penny rule each run on NMS stocks, so a listed option sits outside all three.

Exam Tip: Gotchas

• The statutory phrase and the regulatory phrase name the same set. Regulation NMS builds no separate national market system security list. It points the statutory term straight at its own NMS security definition, so the two are one thing.
• An NMS security is the wider term. Options reported under a national market system plan for listed options are NMS securities. Removing options is exactly what narrows the set down to NMS stocks.

What Makes a Quotation Automated Rather Than Manual, and a Trading Center Automated?

An automated quotation is a quotation displayed by a trading center that does all five of these things:

• Permits an incoming order to be marked as immediate-or-cancel (IOC)
• Immediately and automatically executes an order marked immediate-or-cancel against the displayed quotation up to its full size
• Immediately and automatically cancels any unexecuted portion of such an order without routing the order elsewhere
• Immediately and automatically transmits a response to the sender of such an order indicating the action taken with respect to it
• Immediately and automatically displays information that updates the displayed quotation to reflect any change to its material terms

A manual quotation is any quotation other than an automated quotation. Failing any one of those five conditions is enough to make a quotation manual.

An automated trading center is a trading center that meets four requirements:

• It has implemented such systems, procedures and rules as are necessary to render it capable of displaying quotations that meet the automated quotation requirements
• It identifies all quotations other than automated quotations as manual quotations
• It immediately identifies its quotations as manual quotations whenever it has reason to believe that it is not capable of displaying automated quotations
• It has adopted reasonable standards limiting when its quotations change from automated to manual, and from manual to automated, to specifically defined circumstances that promote fair and efficient access to its automated quotations and are consistent with the maintenance of fair and orderly markets

Exam Tip: Gotchas

• The five automated quotation conditions are conjunctive. A venue that executes and cancels automatically but sends the sender no response is displaying a manual quotation, however fast the rest of its system runs.
• The fourth automated trading center requirement carries two trailing clauses, not one. The venue's standards must promote fair and efficient access to its automated quotations, and they must also be consistent with the maintenance of fair and orderly markets.

Which Quotations Are Protected?

A protected bid or protected offer is a quotation in an NMS stock that satisfies all three of these:

• It is displayed by an automated trading center
• It is disseminated pursuant to an effective national market system plan
• It is an automated quotation that is the best bid or best offer of a national securities exchange, or the best bid or best offer of a national securities association

A protected quotation means a protected bid or a protected offer. Best bid and best offer mean the highest priced bid and the lowest priced offer.

The national best bid and offer (NBBO) is built from those same words. For an NMS stock, the national best bid and the national best offer are the best bid and best offer for that stock calculated and disseminated on a current and continuing basis by a competing consolidator, or calculated by a self-aggregator.

A proviso settles ties. Where two or more market centers transmit identical bids or offers for an NMS security to the plan processor, a competing consolidator or a self-aggregator, the best bid or best offer is set by ranking all those identical bids or offers first by size, the largest size ranking highest, and then by time, the one received first in time ranking highest.

Exam Tip: Gotchas

• Only a venue's own best price can be protected. The third limb reaches the best bid or best offer of an exchange or an association, so the depth of book sitting behind that price carries no protection at all.
• A manual quotation is never protected. The third limb requires an automated quotation, so a venue that has flagged itself manual has taken its quotation out of protection until it flags back.
• The tie-break runs on size before time. A student who reaches for time priority first inverts it; the largest size ranks highest, and time only separates identical bids or offers of the same size.

Who Is a Trading Center, and How Is That Different From a Market Center?

Two lists of venues sit close together, and only one of them carries the order protection duty.

A trading center is a national securities exchange or national securities association that operates a self-regulatory organization (SRO) trading facility, an alternative trading system (ATS), an exchange market maker, an over-the-counter (OTC) market maker, or any other broker or dealer that executes orders internally by trading as principal or crossing orders as agent.

A market center is any exchange market maker, OTC market maker, alternative trading system, national securities exchange, or national securities association.

An SRO trading facility is a facility operated by or on behalf of a national securities exchange or a national securities association that executes orders in a security or presents orders to members for execution.

An SRO display-only facility is a facility operated by or on behalf of an exchange or association that displays quotations in a security, but does not execute orders against those quotations or present orders to members for execution.

An OTC market maker is any dealer that holds itself out as being willing to buy from and sell to its customers, or others, in the United States, an NMS stock for its own account on a regular or continuous basis otherwise than on a national securities exchange, in amounts of less than block size.

Regulation NMS takes alternative trading system from the Regulation ATS definitions rather than defining it here. Those definitions are covered in the unit on display, execution and trading systems.

Exam Tip: Gotchas

• An exchange is a market center outright and a trading center only conditionally. The market center list names a national securities exchange or association on its own terms; the trading center list reaches one only where it operates an SRO trading facility.
• The trading center list adds a category the market center list does not have. Any other broker or dealer that executes orders internally, by trading as principal or crossing orders as agent, is a trading center and carries the order protection duty.
• A display-only facility does not make its operator a trading center. It displays quotations and does neither of the two things an SRO trading facility does, so operating one does not pull the exchange or association into the trading center list.

How Do the Hours, Size and Customer Terms Work?

Regular trading hours means the time between 9:30 a.m. and 4 p.m. Eastern Time, or such other time as is set forth in the procedures established under the order execution disclosure rule. That rule is covered in the unit on creating, retaining and reporting required records of orders and transactions.

A round lot is not a fixed 100 shares. It is set from the stock's average closing price on the primary listing exchange during the prior Evaluation Period:

For round lot purposes only, the Evaluation Period means all trading days in March for the round lot assigned on the first business day of May, and all trading days in September for the round lot assigned on the first business day of November.

During that period the average closing price of an NMS stock on the primary listing exchange is measured by the primary listing exchange to determine the round lot for each NMS stock.

The assigned round lot is operative on the first business day of May for the March Evaluation Period and continues through the last business day of October of that calendar year. The November assignment runs from the first business day of November through the last business day of April of the next calendar year.

Any security that becomes an NMS stock during an operative period is assigned a round lot of 100 shares. That paragraph states no price condition, so a brand new stock does not run through the price tiers, which turn on a prior Evaluation Period it never had.

An odd-lot is an order for the purchase or sale of an NMS stock in an amount less than a round lot.

Block size, with respect to an order, means it is of at least 10,000 shares, or for a quantity of stock having a market value of at least $200,000. The rule states those as alternatives, so either branch alone qualifies.

That test is the Regulation NMS one. The OTC customer limit order display rule sets its own definition, at least 10,000 shares and a market value of at least $100,000, which is conjunctive and set at a lower dollar figure, so the two tests do not travel between the two display rules.

A customer is any person that is not a broker or dealer.

A customer limit order is an order to buy or sell an NMS stock at a specified price that is not for the account of either a broker or dealer, provided, however, that the term includes an order transmitted by a broker or dealer on behalf of a customer.

A customer order is an order to buy or sell an NMS security that is not for the account of a broker or dealer, but it does not include any order for a quantity of a security having a market value of at least $50,000 for an NMS security that is an option contract and a market value of at least $200,000 for any other NMS security.

A bid or offer is the bid price or the offer price a member of a national securities exchange or a member of a national securities association communicates to any broker or dealer, or to any customer, at which it is willing to buy or sell one or more round lots of an NMS security, as either principal or agent. It does not include indications of interest.

Exam Tip: Gotchas

• Customer limit order and customer order are two different terms. The limit order term runs on an NMS stock at a specified price, carries no market value cut-off, and expressly includes an order a broker or dealer transmits for a customer.
• The customer order thresholds pair a figure with a product. The $50,000 market value attaches to an NMS security that is an option contract, and the $200,000 market value to any other NMS security; an order at or above its threshold is not a customer order.
• A round lot of 100 shares is an assumption, not the definition. Above $250.00 average closing price the round lot steps down to 40, then 10, then a single share, and only a stock that becomes an NMS stock mid-period is assigned 100 outright.
• The bid or offer definition excludes an indication of interest. That exclusion is why the sub-penny rule has to name an indication of interest separately alongside a bid or offer and an order.

What Should You Check on Exam Day?

• Confirm the security is an NMS stock, not a listed option, before applying the display, order protection or sub-penny rules; all three run on NMS stocks only.
• Test a quotation against all three protection limbs: automated trading center, disseminated under an effective plan, and an automated quotation that is the best bid or offer of an exchange or association.
• Check whether the venue in the scenario operates an SRO trading facility; without one, an exchange or association is a market center but not a trading center.
• Read a round lot off the price tier: 100 shares at $250.00 or less average closing price in the prior Evaluation Period, and 100 shares outright for a stock that became an NMS stock during an operative period.
• Separate a customer limit order from a customer order; only the customer order drops out at $50,000 for an option contract or $200,000 for any other NMS security.