Trade Through Protection

A trading center's duty is to establish, maintain and enforce written policies and procedures reasonably designed to prevent trade-throughs on that trading center of protected quotations in national market system (NMS) stocks that do not fall within an exception. The exceptions are therefore part of the duty rather than a separate escape route, and they are the part most often tested.

An exception is also not an exemption. A trade-through inside one of these nine categories sits outside the prevention duty on the rule's own terms, with no application and no Commission order involved.

Where Does Trade Through Protection Stop?

Protection reaches a protected quotation in a national market system (NMS) stock, during regular trading hours, and nothing else. Beyond that boundary the rule has already stopped before any exception is needed.

Inside that boundary, the nine exceptions do the remaining work. A trading center relying on one of them must still keep written policies and procedures reasonably designed to assure compliance with the terms of that exception, so relying on an exception is a documented decision rather than a silent one.

Exam Tip: Gotchas

• An exception does not switch the procedures off. The same sentence that sets the reasonably-designed prevention standard adds a second limb: where the venue relies on an exception, the procedures must also be reasonably designed to assure compliance with that exception's terms.
• A trade-through outside the definition never needs an exception. An after-hours print, a print in a listed option, or a print through a manual quotation is outside the rule already, so reaching for one of the nine is a sign the analysis started too late.

What Are the Nine Exceptions to the Prevention Duty?

Exam Tip: Gotchas

• The seventh exception, the nonquoted-price exception, is a conjunction and both limbs are needed. A price that is merely negotiated, or terms that are merely unusual, reaches nothing on its own; the price must not be based on the quote and the material terms must not have been reasonably determinable.
• The first exception, the systems exception, belongs to the displaying venue, not the executing one. It is the trading center showing the protected quotation that must have been experiencing the failure, material delay or malfunction.
• The eighth exception is a one-second window measured before the execution. The displaying venue must have shown a price equal or inferior to the trade-through price within that second, so a quotation that went stale minutes earlier does not qualify.
• A crossed protected market is an exception in its own right. Where a protected bid was priced higher than a protected offer at the time of execution, the trade-through falls outside the duty without any routing or marking.

What Does the Stopped-Order Exception Require?

The stopped-order exception is the only one on the list that adds conditions of its own, and all three must hold:

• The stopped order was for the account of a customer
• The customer agreed to the specified price on an order-by-order basis
• The price of the trade-through transaction was, for a stopped buy order, lower than the national best bid in the NMS stock at the time of execution, or, for a stopped sell order, higher than the national best offer in that stock at that time

The third condition reads in the direction that favors the customer. A guaranteed buy filled below the national best bid, or a guaranteed sell filled above the national best offer, is the shape the exception protects.

Exam Tip: Gotchas

• A blanket customer agreement does not satisfy the second condition. The customer must have agreed to the specified price on an order-by-order basis, so a standing arrangement covering future orders is not enough.
• The exception is limited to a customer's account. A stopped order for a firm's own account fails the first condition, however the price was guaranteed.
• The buy and sell tests point at different sides of the market. A stopped buy is measured against the national best bid and a stopped sell against the national best offer, which is the opposite pairing from the one most students expect.

How Do the Two Intermarket Sweep Order Exceptions Differ?

Two of the nine exceptions describe the same tool from opposite ends of the wire:

• The receiving side covers a trading center executing an order that arrives identified as an intermarket sweep order
• The sending side covers a trading center that effected the trade-through while simultaneously routing an intermarket sweep order to execute against the full displayed size of any protected quotation in that stock that was traded through

The receiving venue's exception runs on the execution of an order identified as an intermarket sweep order.

The sending venue's exception needs more than a mark: it must simultaneously route a sweep against the full displayed size of every protected quotation it trades through, and a separate paragraph requires the trading center, broker or dealer responsible for routing it to take reasonable steps to establish that the order meets the definition. That definition and that duty are covered in the lesson on intermarket sweep orders.

Exam Tip: Gotchas

• The sending side is measured against full displayed size. The simultaneous routing must be aimed at the full displayed size of the protected quotations traded through, so sweeping part of the displayed size does not reach the exception.
• The two sides are not interchangeable in a scenario. The venue that receives a marked order and the venue that sends the sweep are relying on different exceptions, with different facts to prove.

What Should You Check on Exam Day?

• Confirm the trade-through is inside the definition first: an NMS stock, regular trading hours, and a protected quotation.
• Read the seventh exception as two tests joined by "and", and reject a scenario that satisfies only the price limb or only the material terms limb.
• On a stopped order, check all three conditions, especially the order-by-order agreement and the customer account requirement.
• For a stale quotation, look for a display within one second prior to execution at a price equal or inferior to the trade-through price.
• Ask whether the venue sent or received the intermarket sweep order, because each side relies on a different exception.