OTC Market Makers - Nasdaq and OTC Markets
With the New York Stock Exchange (NYSE) single-Designated Market Maker (DMM) model covered, let's look at the competing dealer model used in Nasdaq and over-the-counter (OTC) markets.
Nasdaq Market Makers
Unlike the NYSE's one-DMM-per-stock structure, Nasdaq allows multiple competing market makers per security:
- Each market maker must register with Nasdaq and maintain continuous two-sided quotes (bid and ask)
- Market makers trade from their own inventory as principals (dealers)
- Competition among market makers is designed to produce tighter spreads and better prices for investors
Exam Tip: Gotchas
Nasdaq market makers are dealers (principals), not brokers (agents). They trade from their own inventory. If the exam asks about capacity, Nasdaq market makers always act as principal.
Nasdaq Market Maker Obligations
-
Continuous two-sided market - must maintain bid and ask quotes during regular market hours
-
Honor quoted prices - must execute at quoted price for at least the minimum quotation size
-
Fair and orderly market - must engage in dealings reasonably calculated to contribute to orderly markets
-
No inconsistent practices - must not make bids, offers, or transactions inconsistent with fair dealing
-
A market maker that fails to meet its obligations may be subject to withdrawal of quotation privileges
OTC Equity Securities Market Makers
Market makers in OTC equity securities (non-Nasdaq OTC) must comply with Financial Industry Regulatory Authority (FINRA) rules:
- Must maintain quotations in inter-dealer quotation systems (e.g., OTC Link operated by OTC Markets Group)
OTC Markets Group Tiers
OTC Markets Group operates three tiers with different disclosure requirements:
| Tier | Name | Disclosure Level | Risk |
|---|---|---|---|
| OTCQX | Best Market | Highest disclosure standards; third-party sponsor required | Lowest risk tier |
| OTCQB | Venture Market | Securities and Exchange Commission (SEC) reporting or equivalent; annual financial certification | Moderate risk |
| OTC Pink | Open Market | Ranges from "Current Information" to "No Information" | Highest risk; includes penny stocks and shell companies |
- Penny stocks (generally priced under $5) and companies in bankruptcy cannot qualify for OTCQX
Exam Tip: Gotchas
OTCQX has the highest disclosure standards; OTC Pink has the lowest (including "No Information" companies). Penny stocks cannot qualify for OTCQX regardless of their disclosure level.
Minimum Quotation Size Requirements
- Market makers quoting OTC equity securities must honor their quotes for at least the minimum quotation size
- Minimum size varies by the price level of the quotation
- Higher-priced securities have smaller minimum share requirements
- Lower-priced securities require larger minimum share sizes
NYSE DMM vs. Nasdaq/OTC Market Makers
| Feature | NYSE DMM | Nasdaq/OTC Market Makers |
|---|---|---|
| Number per security | One DMM | Multiple competing market makers |
| Capacity | Both agent and principal (not in same trade) | Principal only (dealers) |
| Price discovery | Auction process | Competing dealer quotes |
| Spread dynamics | Single DMM sets spread | Competition drives tighter spreads |
Exam Tip: Gotchas
The key structural distinction: NYSE = one DMM per security acting as both agent and principal. Nasdaq/OTC = multiple competing market makers acting only as principals.