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Elaine Wah

Modern Markets, Modern Metrics - A Blog By IEX

In this blog by IEX's Elaine Wah, the newest public exchange looks to refute public claims that the metrics it uses are designed to inflate its own volume numbers and mislead people.

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September 30, 1998

How Trade-Reporting Rule Helps Market Makers

By Jeffrey L. Winograd

If approved, how would the proposed amendment to the riskless principal trade-reporting rule benefit market makers? The National Association of Securities Dealers provided the following examples in its recent filing published in the Federal Register:

Example 1. A market maker, MM1, holds a customer limit order that is displayed in its quote to buy 1,000 shares of ABCD at $10 a share. A second market maker, MM2, sells 1,000 shares to MM1 at $10. MM2 reports the sale of 1,000 shares as required under current rules. MM1 then fills its customer order for 1,000 shares. Under the proposed rule, the first trade would continue to be reported (by the selling firm MM2 in this case, as required under current rules), but the second leg between MM1 and the customer would not be reported, as it is deemed riskless.

If the first execution were through a Nasdaq facility which automatically generates a trade report to the tape, such as SOES or SelectNet, no member would report at all. Members may still need to submit a "clearing only" entry into ACT [Nasdaq's Automated Confirmation Transaction system] to complete a transaction with a customer, but these submissions are not to be entered for reporting purposes, and thus there will be no public trade report for this leg of a transaction.

Example 2. An institutional customer presents a large order to a market maker, MM1, to sell 100,000 shares of XYZZ, with instructions to work the order, subject to a price limit, rather than execute it immediately in its entirety. MM1 may attempt to solicit interest from other parties to fill the institutional order, in whole or in part. A second market maker, MM2, may find a willing buyer, but for only 75,000 shares, at a price of $12 a share.

MM1 may determine to fill the entire customer order for 100,000 shares at $12 at that time (exclusive of any markdown, commission equivalent or other fee) by trading the 25,000-share balance out of inventory. There will still be two separate trade reports under the proposal because only a portion of the customer execution is deemed riskless. The size of the trade reports, however, will be adjusted to exclude the riskless portion.

Specifically, instead of MM1 reporting these as a market-maker sell transaction of 75,000 shares, and then a market-maker buy from the customer for 100,000 shares, these trades would be reported under the proposal as a market-maker sell transaction of 75,000 shares, and then a market-maker buy from the customer of only 25,000 shares.

Example 3. In another variation of the above example, a market maker, MM1, while holding an institutional customer order and working it on the customer's behalf, may obtain several executions to satisfy the order by selling to other market participants at varying prices throughout the trading day. In this example, assume the entire order is filled with these individual executions.

Because MM1 is the seller in these executions, it has the trade-reporting responsibility and will continue to report under current rules each individual component trade with other market participants as they occur. Under the proposal, however, MM1 would not report a transaction with the customer, as the execution used to satisfy the order had already been reported to the tape, although the transactions may be confirmed out to the customer at an average price of the component executions, to the extent permissible under Securities and Exchange Act Rule 10b-10.