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 10, 2007

Manning Coming to the OTC Marketplace

By Peter Chapman

Expect more limit orders in the over-the-counter marketplace after November 26. That's the date the Financial Industry Regulatory Association (FINRA) extends its Manning interpretation to OTC equities. The rule, two years in the making, was originally to take effect in July.

However, FINRA delayed implementation in order to give broker-dealers time to adjust their systems.

Over-the-counter executives say the rule, which penalizes traders for trading ahead of limit orders in exchange-listed securities, will prompt OTC investors to use more limit orders.

"I think it will bring in more limit orders," Cromwell Coulson, chief executive of Pink Sheets, one half of the OTC market, says. "That is the real point of the rule," he adds.

Today, market makers handling Pink Sheets securities are not subject to rules that prevent them from trading ahead of customer limit orders. Those market makers handling OTC Bulletin Board securities, on the other hand, are.

In the OTCBB market, the other half of the OTC marketplace, traders have had to comply with FINRA Rule 6541 since 2001.

Rule 6541 is a close cousin to Manning, although its compliance parameters are somewhat looser.

Despite Manning's restrictions and the potential for trading houses to suffer from higher costs and lower revenues, dealers did not protest FINRA's decision. The Security Traders Association, for example, told FINRA it supported the expansion of Manning. "Everyone knew it was coming," says Steve Nelson, a principal in the White Plains, N.Y.-based The Nelson Law Firm and a member of the STA's New York affiliate. "It's not really shocking."

Manning does allow firms to trade around a customer limit order if the trader provides a minimum level of price improvement to the order.

For example, traders must price improve those orders that are inside the NBBO and priced at $1.00 or better by one cent or better. Those orders that are inside the NBBO and are priced at less than $1.00 must be price improved by the lesser of a penny or one half of the NBBO spread. Some brokers have concerns about the application of that provision to the OTC marketplace. So, FINRA is studying it.