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SEC, Exchanges Discuss Market Maker Rules

There have been reports this morning that the SEC is considering the promulgation of new rules for stock trading. Here's what my sources are telling me:

1) More rules for market makers. There will be rules proposed by the exchanges within the next several weeks to tighten the standards of what it means to be a market maker.

2) Expansion of circuit breaker program. The individual stock circuit breaker pilot program, which currently covers all stocks in the Russell 1000 as well as 300-plus ETFs, will be expanded within the next several weeks to cover all stocks and all ETFs. (Drill down on this topic: ETF 'Circuit Breakers' Could Stop Flash Crashes)

To date, none of the Exchanges have submitted any rule proposals on these issues to the SEC. However, the SEC has made it clear they want rulemaking in these areas.

More rules for market makers. Stub quotes — abnormally low or high bids for stocks — will likely be changed by new rules that require market makers to provide a real quote in the market. How this will be done is still being debated, but one possibility is to require the quote could, say, never be more than 10 percent away from the inside quote.

This goes to the heart of the issue: what does it mean to be a market maker? What standards should apply regarding providing liquidity?

There used to be more stringent requirements for market makers. Over time, those requirements got watered down to have only a quote in the market, which is how you get stub quotes. Those players who don't have a lot of quotes in the public market (firms who internalize order flow, for example) are the ones who place these stub quotes which are solely designed to meet market maker requirements. They were never really meant to be executed.

So why have them if there is a remote chance that someone can trade against them? And why have a market maker if there is not some meaningful requirements to be a market maker?

That's what the exchanges and the SEC are trying to address.

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