Quick Answer
The NYSE Designated Market Maker (DMM) maintains a fair and orderly market with continuous two-sided quotes and steps back only during circuit-breaker halts. A firm quote obligates the market maker to trade at that price; a firm can act as agent (commission) or principal (markup/markdown), but never both in the same transaction.
Market makers are the firms that provide liquidity and maintain orderly markets. Understanding their roles, obligations, and the types of quotes they provide is essential for the settlement process.
Scope note: This unit reviews DMM obligations, quote types, and principal/agency capacity only as background for settlement mechanics. The full regulatory treatment, including the DMM's affirmative obligation to trade against the trend and negative obligation to step back when public interest is sufficient, the DMM-vs-Nasdaq structural comparison, and OTC market maker tiers, is taught in the Market Making and Quotations unit.
Designated Market Maker (DMM): NYSE
The DMM (formerly called the "specialist") is assigned to specific securities on the NYSE.
- Maintains a fair and orderly market in assigned securities
- Obligations include:
- Providing continuous two-sided quotes (both bid and ask)
- Facilitating price discovery during openings and closings
- Stepping in as buyer or seller when needed to maintain liquidity
- Must maintain a minimum quote size (size obligation)
- Securities must meet exchange listing requirements (financial thresholds, minimum shareholders) to be assigned to a DMM
Exam Tip: Gotchas
- DMMs provide two-sided quotes (both bid and ask), not just one side. A one-sided quote would not maintain an orderly market.
Market-Wide Circuit Breakers
DMM obligations are suspended during market-wide circuit breakers. Under the market-wide circuit-breaker rules, trading halts when the S&P 500 declines from the prior day's close:
| Level | Decline | Action |
|---|---|---|
| Level 1 | 7% | Trading halted for 15 minutes |
| Level 2 | 13% | Trading halted for 15 minutes |
| Level 3 | 20% | Trading halted for the remainder of the day |
- Level 1 and 2 halts only trigger if they occur before 3:25 PM ET
- Level 3 halts trading for the entire remaining day regardless of time
Exam Tip: Gotchas
- Circuit breaker Level 3 (20% decline) halts trading for the rest of the day, regardless of when it occurs. Levels 1 and 2 only trigger before 3:25 PM ET.
Types of Quotations
| Quote Type | Meaning | Obligation |
|---|---|---|
| Firm quote | The market maker is obligated to buy or sell at the quoted price for up to the quoted size, subject to limited stated exceptions | Must honor |
| Subject quote | Subject to confirmation; the market maker may not honor the quote and must identify it as "subject" | No obligation until confirmed |
| Nominal/informational quote | For informational purposes only; not executable | No obligation |
| Bid wanted (BW) | Requesting bids from other dealers; used when a dealer wants to sell | Soliciting interest |
| Offer wanted (OW) | Requesting offers from other dealers; used when a dealer wants to buy | Soliciting interest |
Exam Tip: Gotchas
- A "firm quote" means the market maker MUST trade at that price. It is the only quote type that creates an obligation. A "subject quote" requires confirmation first. These two are often confused.
Principal vs. Agency Transactions
Every transaction involves the broker-dealer acting in one of two capacities:
| Capacity | Role | Compensation | Example |
|---|---|---|---|
| Principal (dealer) | Trades from own inventory | Markup (on sales) or markdown (on purchases) | Firm sells stock from its inventory to customer |
| Agent (broker) | Executes on behalf of customer | Commission | Firm routes customer order to exchange for execution |
- A firm cannot act as both principal and agent in the same transaction
- The capacity must be disclosed on the customer confirmation
- Markup: the amount added above the prevailing market price when selling to a customer as principal
- Markdown: the amount subtracted below the prevailing market price when buying from a customer as principal
Exam Tip: Gotchas
- A firm cannot be both agent AND principal in the same transaction. If the firm sells from its own inventory (principal), it earns a markup. If it routes to an exchange (agent), it earns a commission. Never both.
SEC Order Handling Rules
- Market makers must display customer limit orders that improve their quote
- Applies to National Market System (NMS) securities
- Designed to ensure customer orders receive best execution
- If a customer's limit order would narrow the spread, the market maker must either execute it or display it
Transaction Reporting
- Market makers must report transactions per exchange and FINRA rules
- Over-the-counter (OTC) market makers in NMS stocks report through the Trade Reporting Facility (TRF)
- FINRA's quotation-and-trade-reporting rules and NMS-stock trading rules govern these activities
Prohibited Trading Practices
FINRA's other-trading-practices rule bars conduct that creates a false or artificial appearance of activity or price in an NMS stock:
- Successively higher purchases or lower sales intended to influence price
- Wash sales (trades with no real change in beneficial ownership)
- Matched orders placed with knowledge that a substantially offsetting order exists on the other side
- Knowingly managing or financing a manipulative trading pool, or knowingly circulating false or misleading price-moving information
- Excessive proprietary transactions in an account the member has an interest in, given its financial resources or the market
- Promising that a transaction will influence a security's closing price
A joint account trading a designated NMS stock in which a member or associated person has an interest must be promptly reported to FINRA, including its participants, profit-and-loss interests, purpose, carrying/clearing firm, and the account's written agreement.
Exam Tip: Gotchas
- A wash sale and a matched order both create a false appearance of trading activity, but a wash sale involves no real change in ownership while a matched order relies on a pre-arranged offsetting order from another party.
What Should You Check on Exam Day?
- Know that only a firm quote creates an obligation to trade; a subject quote needs confirmation and a nominal quote is informational only.
- Apply the circuit-breaker levels correctly: Level 1 and 2 (7% and 13%) only halt trading before 3:25 PM ET, while Level 3 (20%) halts trading for the rest of the day regardless of time.
- Remember a firm can never act as both agent and principal in the same transaction, and that OTC market makers in NMS stocks report through the TRF.