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December 18, 2007

2007 Review: FINRA's OTC Compromise

The Year in Trading

By Gregory Bresiger

OTC dealers were able to make an effective case that their sub-penny trading was hurt by Manning rules. So the Financial Industry Regulatory Authority tailored its Manning rules on over-the-counter stocks.

Manning prohibits front-running, which is trading against incoming orders at prices equal to or less than any contra-side customer limit orders they may be holding. FINRA's new take on Manning eases rules by dividing penny stocks into several tiers.

FINRA made changes because some dealers complained that the price-improvement rules were too stringent for OTC stocks that sell for less than a dollar or less than a penny.

OTC dealers also contend that their unique economics are very different from the listed business. Dealers selling listed stocks must price-improve by a penny on stocks selling for more than $1.

Under FINRA's liberalization plan, orders for OTC stocks selling for less than a penny but more than one-10th of a cent need only be price-improved by one-10th of a cent or half the spread, whichever is less.

Dealers in these small issues of a dollar or less had been required to provide price improvement of 1 cent or half the spread, whichever was less. They grumbled that it was difficult to make money on many of these smaller issues, some of which sell for one-1,000th of a cent.

They also groused that FINRA's original sub-dollar price-improvement standards would have been draconian. Paying half the current spread would have been too much, they said.

FINRA agreed. It also plans to offer new, easier rules for OTC stocks trading at over $1. Liberalization is also needed here, dealers say, because these stocks can be quoted and traded in sub-pennies. So dealers will only be required to price-improve the incoming order by half the spread if it equals less than 1 cent.