One size does not fit all. That’s what the Financial Industry Regulatory Authority (FINRA) discovered when it set out to adapt its Manning rules to over-the-counter trading. Dealers complained that rules designed for the listed markets would unfairly pinch their bottom lines when trading certain OTC names. So FINRA made some adjustments.
Manning prohibits dealers from trading against incoming orders at prices equal to or less than any contra-side customer limit orders they may be holding. That’s known as trading ahead. The rule applies to trading in listed securities today, and will be extended to OTC securities next month.
If they want to trade with those incoming orders, dealers must “price improve” them, or trade at prices better than the competing limit order.
In listed trading, dealers must price improve orders for stocks trading over a dollar by a penny. For orders in stocks trading less than a dollar, the least amount of price improvement they must give is one cent or half the spread, whichever is less.
Those rules apply to limit orders in stocks priced inside the best bid or offer. There are also rules for limit orders priced outside the BBO and where there is no inside market.
The problem with the rules for the OTC dealers was that many of the stocks in which they make markets sell for less than a penny. Some even sell for less than one thousandth of a cent!
For those stocks, dealers told FINRA, its sub-dollar price improvement standards would be overly burdensome. Paying half the current spread might be too much.
FINRA now proposes to stratify the penny stock universe into four tiers for purposes of Manning.
Orders for stocks selling for less than a penny but more than one-tenth of a cent, for instance, need only be price improved by one-tenth of a cent or half the spread, whichever is less.
If one-tenth of a cent is less than half the spread, the dealer fares better (pays less) than he would have under the original proposal.
FINRA will also liberalize its rules for OTC stocks trading over $1.
That’s because these stocks can be quoted and traded in sub-penny increments. Therefore, dealers only need price improve the incoming order by half the spread if it equals less than one cent.
FINRA also plans to loosen the requirements for price improving incoming orders in stocks when the limit order is priced away from the inside.
