Series 57 Study Textbook

Mastering Customer Limit Order Handling On The Series 57 Exam

Equity Trader Examination

One of the keys to passing the Series 57 exam is to make sure that you have a complete understanding of how customer limit order handling will be tested on the Series 57 Exam. This article which was produced from material contained in our Series 57 textbook and will help you master the material so that you pass the Series 57 exam.


Handling and Displaying Customer Limit Orders

If a market maker accepts customer limit orders, it must handle the order in accordance with The Limit Order Display Rule. If a market maker accepts a customer's limit order that would improve its quoted price, the market maker must update its quote to reflect the customer's limit order. A market maker is required to update its quote within 30 seconds of receiving the customer's order. The 30-second time frame only applies to normal market conditions and does not include the opening or reopening of a security after a halt.

Example:

In the market for XYAD listed below the inside market is 15.00 bid and 15.05 offered. The size of the bid is for 500 shares and there are 300 shares offered

 

XYAD

 

 

 

Bid

Ask

Size

 

15.00

15.05

5 x 3

MM 1

14.90

15.10

10 X 10

MM 2

15.00

15.20

5 X 5

MM 3

14.85

15.05

2 X 3

MM 4

14.95

15.15

15 X 15

MM 5

14.98

15.18

10 x 10

If market maker 2 who is the best bid received a customer's limit order to buy 200 shares at 15.02 the market maker would have to update its quote and the market would look as follows:

 

XYAD

 

 

 

Bid

Ask

Size

 

15.02

15.05

2 x 3

MM 1

14.90

15.10

10 X 10

MM 2

15.02

15.20

5 X 5

MM 3

14.85

15.05

2 X 3

MM 4

14.95

15.15

15 X 15

MM 5

14.98

15.18

10 x 10

If market maker 2, who is the best bid, instead had received a customer's limit order to buy 1000 shares at 15.00, the market maker would have to update its quote by adding the customer's size to its current quote and the market would look as follows:

 

XYAD

 

 

 

Bid

Ask

Size

 

15.00

15.05

15 x 3

MM 1

14.90

15.10

10 X 10

MM 2

15.00

15.20

15 X 5

MM 3

14.85

15.05

2 X 3

MM 4

14.95

15.15

15 X 15

MM 5

14.98

15.18

10 x 10

If the customer's limit order is equal in price to the firm's displayed quote but is 10% or less than its displayed size, the firm does not have to update the size of its quote to reflect the customer's order.

Orders that are not required to be displayed include:

  • Odd lot orders
  • All or none orders
  • Block orders for at least 10,000 shares or $200,000 in market value
  • Orders sent to a qualifying ECN
  • Orders sent to another market maker that complies with the display rule
  • Orders that the customer request not be displayed
  • Orders that are immediately executable

In order for an ECN to be considered a qualifying ECN under the ECN Display Alternative Rule, the ECN must communicate its quotes to NASDAQ and must allow access to its quotes to broker dealers who do not subscribe to the ECN's service. The ECN may charge a fee to non-subscribing broker dealers who execute orders against its quotes. If a broker dealer sends a customer's limit order to a qualifying ECN to be displayed it does not need to improve its quote in NASDAQ. If the broker dealer sends a customer order a non-qualifying ECN, the market maker must update its quote to reflect the customer's order. A qualifying ECN is also known as a linked or eligible ECN. The broker dealer who sends a customer's order to a qualified ECN may not trade ahead of the customer's order displayed by the ECN at a price that would satisfy the customers limit order.

TAKE NOTE!
A firm that does not want its customer orders executed against its own quotes may turn on the Anti Internalization Qualifier (AIQ) feature. This will prevent a customer's order entered by the firm from being executed against its own quote.

Anonymously Displaying Customer Orders

At times there may be reasons that a market maker does not want to change the price of its displayed quote or want to add the customer's order to its displayed size. In these situations, the market maker may anonymously display the customer's order through the "NSDQ" function available through the NASDAQ system. The NSDQ function is available to all market makers and displays the total number of shares routed to the NSDQ function at the best price by all participants. Orders routed to the NSDQ function cannot be attributed to the market maker who received the order. As a result orders that are displayed anonymously are considered "non attributable" orders. Orders that appear with the market participant's ID are considered attributable orders since other market participants know the identity of the firm entering the order.

The Manning Rule

In addition to displaying the customer's limit order, a firm who accepts limit orders must protect that order. A firm may not compete with a customer's limit order by executing an order for its own account at a price that would satisfy the customer's limit. If the firm executes an order for its own account at a price that would satisfy the customer's limit order the firm must execute the customer's order at the same price and for the same number of shares within 60 seconds. Broker dealers who route orders to ECNs, or other firms to be displayed, must still protect the customer's limit order and are not relieved of their obligations under The Manning Rule. If the firm has a payment for order flow, clearing agreement or any other understanding with the firm that it routes orders to for execution the firm receiving the order must protect and provide price improvement for the orders. Orders from institutional customers and large orders for 10,000 shares and having value of more than $100,000 are not required to be protected under The Manning Rule. If the firm accepts limit orders that will not be protected under The Manning Rule, the firm must disclose the conditions at the time the order is accepted. If the market-making desk is holding a customer's limit order that is subject to The Manning Rule, no trading desk anywhere within the firm may knowingly execute a proprietary order that would compete with the customer's order. If the firm has sufficient barriers between its trading desks and the other desks do not have knowledge of the customer's order, the other desks are not bound by The Manning Rule. If prior to displaying a customer's limit order that is better than the inside market, the firm receives an offsetting market order, the firm must execute the market order at a price that at least equals the price of the limit order it's holding. Only customer orders entered for at least one round lot between 9:30 AM and 6:30 PM EST are required to be protected under The Manning rule.

Undisplayed Customer Limit Orders

If a firm is holding an undisplayed customer limit order and subsequently receives an offsetting market order the firm must price improve the market order by crossing it with the undisplayed customer limit order. If a market maker is holding an undisplayed customer limit order to purchase 500 shares of TYUI at 20.10 when the market for the stock is 20.05 – 20.10, and the firm receives a market order to sell 500 share of TYUI the firm may not execute the market sell order at 20.05 but must price improve the order by executing it against the undisplayed limit order it is holding to purchase 500 shares of TYUI at 20.10. The firm could purchase the 500 shares for its own inventory only if it purchased the shares at a price that is greater than the customer's limit price. If the firm purchased the stock at 20.10 it would owe the customer a fill on their limit order at 20.10.