Series 7 – Trading Securities

Exchanges
 Exchange (Auction) Market: NYSE and other exchanges (listed securities)

 Second (OTC) Market: Interdealer (unlisted securities), negotiated

o Nasdaq: Global Select, Global Market and Capital Market
o Non-Nasdaq. Pink sheets/OTCBB  penny stocks <$5
 Third (OTC listed) Market / Nasdaq Intermarket: exchange-listed securities are traded OTC. B/D registered as OTC market
makers in listed securities. All NYSE and most regional exchange listed securities are eligible for OTC trading. Trades are
reported on Consolidated tape within 10 seconds of execution
 Fourth Market: for institutional investors in which large blocks of stock, both listed and unlisted, trade in transactions unassisted by
B/D through ECN (electronic communication networks). ECNs are open 24 hs and act solely as agents.
Other Exchanges
 Regional exchanges: listing requirements are less stringent, companies listed are usually smaller/newer
 Nasdaq OMX PHLX: hybrid of both electronic and floor-based trading in equity, index and currency options

 Quote: 21.50-21.55 19 x 7  willing to buy 1,900 shares for 21.50

 Trading hours: 9.30am-4pm EST (after-hours market is less liquid)
 Listed markets: central market-places and trading floor facilities. Double-auction markets
 OTC market: no central marketplace, interdealer network, negotiated market
 Dark pools of liquidity: large volume transactions that occur on crossing networks or alternate trading systems (ATS). Execute large
block orders without impacting public quotes or price. Orders can be place anonymously.
 Trade Reporting Facility (TRF): automated trade reporting and reconciliation operated on the Automated Confirmation Transaction
(ACT). Handles trades negotiated between brokers.

Broker/Dealer Roles most firms act as both, but not in the same transaction

Broker Dealer
Agent Principal – Position Trading
Commissions (always disclosed) Markup / Markdown - net price (never disclosed, only for Nasdaq securities)
Not a market maker May make markets and take positions in securities

 Delisting: NYSE reserves the right to delist issuers who fail to meet min maintenance criteria, go bankrupt, abnormally low share
price/volume and corp actions. Companies can delist voluntarily with BoD approval
Floor Personnel
Only NYSE members can trade on the floor. Now they can also handle non-NYSE-listed stocks.
 Commission House / Floor Broker (CHB): execute orders for clients and for their firm’s accounts
 Two-Dollar Broker: when floor brokers are busy
 Registered traders: members of the Exchange who trade primarily for their own accounts, they may not execute their own trades
while holding an unfiled public order
 Specialist DMMs: maintains a fair and orderly market in a stock. Principal and agent. As a principal cannot buy stock at a price that
would compete with current market (“trading ahead”). As an agent, acts as auctioneers. DMMs receive rebates on fees charged by
the exchange whenever their quotes result in trades. Cannot execute discretionary trades
o Supplemental Liquidity Providers (SLPs): may operate and compete with the on-floor DMM, trade for their own
account only. They must maintain a bid/offer in an assigned stock at least 10% of the trading day, unlike DMMs who
are required to maintain a two-sided market at all times. They receive rebates on fees from the exchange on SLP
quotes that result in trades, but not as large as those for DMMs
 When more than one broker enters the same bid/offer, it goes:
1. Priority – first order in
2. Precedence – largest
3. Parity – random drawing
Market-Wide Circuit Breaker Rules (MWCB)
 During a market halt, while no trading can occur, investors can still cancel existing (open) orders
 Trading halts initiated by
o Listed securities: exchange or SEC

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o OTC stock: Nasdaq or FINRA

 Risk arbitrage: M&A – buy the target stock and short the acquirer stock
Type of Orders
Guarantees
Price Execution
Market Executes immediately at mkt price  
Limit Limits the amount paid / received for securities. Min price for sell, max price for buy.  
Stop Becomes a market order if the stock reaches or goes through the stop price  
Stop Limit Entered as a stop order and changed to limit order if the stock hits or goes through the stop
price
 
Order entered at
SLoBS (Stop Limit / Buy Stop)
Market Price
BLiSS (Buy Limit / Sell Stop)  adjusted for dividends on ex-date

 Limit orders: SEC regulation NMS (National Market System) requires that firms holding customer limit orders not trade through or
ahead of orders
 DMM Display book: displays orders that cannot be immediately executed. Only round lots (100 shares) are placed on the book.
When an order specification is changed, it is done through a cancel and replace process.
 Erroneous execution: firm’s responsibility for bad execution
 Erroneous report: customer still has to pay. Reported to principal
Order Adjustments
 Do Not Reduce (DNR): order is not reduced by an ordinary cash dividend
 Orders placed below market orders (BLiSS) are automatically reduced for cash dividends
 All orders are adjusted for stock splits/dividends, whether place above or below market
 If there is a stock split/dividend, the DMM will adjust all open orders: ↑Q ↓P
 For reverse slits, all open orders are cancelled
Time-Sensitive Orders
 Day orders: default
 GTC: automatically cancelled if unexecuted on the last business day of April and the last business day of October
 At-the-open: executed on market open
 Market-on-close: executed at or as near as possible to the closing price in the OTC market. On NYSE, entered before 3.40 pm and
executed at the closing price
 Not-held order: market or limit order where the floor broker can choose the price or time of execution. May not be placed with
the DMM
 Fill-or-kill (FOK): fill immediately in its entirety, partial execution not accepted
 Immediate-or-Cancel (IOC): partial execution is acceptable, part not executed is cancelled
 All-or-none (AOC): do not need to fill immediately, GTC or day order
 Alternative Orders (OCO): One Cancels the Other
Short Sale Rules
 Regulation SHO - locate requirement. Firms must locate the securities for borrowing to ensure that delivery will be made on
settlement date. Not doing so is called naked short selling and is not permitted
 SEC requires that all sell orders be identified as either long or short. A long order means he has title to it or will receive by the
settlement date
 Shorting bonds: easier to short liquid corporate bonds than munis
Other stuff to know
 A large percentage of NYSE orders are processed through a Super Display Book (SDBK). Matches open orders before opening and
lets others to be handled by DMM.
 Consolidated Tape System (CTS): receives and validates the last sale price and size of listed equity securities transactions on all US
stock exchanges. Options transactions are not reported to the CTS.
o Network A: reports transactions in NYSE-listed securities wherever they are traded
o Network B: listed on NYSE AMEX, others
o Transaction prices do not include commissions/mark-up/mark-downs
 Digits & Vol Deleted: first digit of the price and the volume will be dropped
 Repeat prices omitted: only shows P that differ from last one
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 SLD: sale delay, it is out of sequence

 OPD: opening delayed
OTC NYSE
Negotiated Auction
Market Makers registered with SEC and FINRA DMM registered with SEC and must be Exchange members
Traded at many locations Traded only on NYSE floor
OTC
 Order Audit Trail System (OATS): records orders, quotes and other trade information from all equities that are traded on Nasdaq.
Tracks orders from time of order entry until execution/cancellation
 OTC Market Makers: Principal Only (not Agent). OTC has no specialists, firms wishing to make a market must register and receive
approval from FINRA
Quotes
 Firm Quote: default. MM stands ready to buy/sell one round lot / trading unit (100 shares of stock or five bonds).
 Firm for an hour with 5-minute recall
 Backing away: market maker refuses to do business at the price quoted – violation!
 Recognized quotation: any bid for less than a round lot must state the amount. If the bid/offer is made for multiple round lots, it
must also be good for a smaller number of units
 Subject quote: subject to reconfirmation by MM
 Qualified quotes: allow B/D to back away
o Workout quote: approximate figure
o Nominal quote: someone’s assessment where a stock might trade in an active market. Informative. If in print it must
be labeled as such
 OTC Pink and OTCBB: three-quote rule applies. Unless there are at least 2MM displaying quotes, B/D receiving orders to buy/sell
must contact a minimum of 3 dealers to determine price
 Wide speared indicates thin trading
 5% markup policy: guideline only, for markups/downs (principal) and commissions (agency). Does not apply to MF, variable
annuities, securities sold in public offerings (prospectus), nor munis
o In a proceeds transaction (sell one position; take the proceeds and buy another), the 5% markup is computed by
adding the compensation made by the dealer on the sell side + the buyside divided by inside market on the buy side
(best available quote)
 Dealer inventory costs: if an order is filled from a B/D’s inventory, the net price to the customer is based on the prevailing market
price, it has to be reasonably related to current mkt price
Quotation Services - Nasdaq
 Level 1: inside market only, available through a variety of vendors
 Level 2: current quote and quote size available from each MM, available to approved subscribers only
 Level 3: allows registered MM to update their quotes (+ level 1 and 2 access)

Unit 9 - Brokerage Support Services

Order Processing - OPMC
 Order department: wire room, order room. Transmits order to proper mkt
 Purchases & Sales (P&S): records transactions in a client’s account and handles billing, mails trade confirmations
 Margin/Credit
 Cashiering department (cage): receives and delivers securities and money. Sends certificate to transfer agents to be transferred
and registered and then forwards to clients
 A clearing corporation, such as the National Securities Clearing Corporation, can simplify the process
 Other departments involved:
 Reorganization department: handles transactions that represent a change in the outstanding security, i.e. tender offers, bond
calls, redemptions of pref stock, M&A
 Dividend department: credits customer accounts with dividends and interest
 Proxy department: sends proxy statements to customers whose securities are held in street name
 Stock record: maintains a ledger of stock owners and certificate’s location
 Receipt and delivery of securities: rep must be assured the customer can pay for or deliver the securities. If in street name, rep
must verify before executing sale
 Order memorandum: registered ppal must approve the order promptly after execution (no later than trading EOD)
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o Order confirmation: acct #, RR ID, solicited/unsolicited, discretionary/non-discretionary, # and share symbol,

action/option, order type (GTC, etc), time order received/entry and price of execution
 If a mistake is made, no change can be made without the approval of a principal. Kept in errors record for 3 years
o If trade is executed outside client’s instruction, it’s non-binding
 Trade confirmation: must be sent to client AT/BEFORE settlement date
 Customer account statement: must be sent at a minimum quarterly, monthly if there is activity in the account. Shows:
o Activity since last statement
o Securities positions (L/S)
o Account balances, debit/credit
 Disclosure of financial condition from member firm (most recent B.S. only, not I.S.): upon client request or member firm doing
business with them
Transaction Settlement Dates
Type of Security Settlement Date T+
Corporates (Equities & Bonds) / Munis / Agencies 2
U.S. government bonds / Options Premium 1
Cash Settlement (in any acct) / MM Securities Same day
Reg T 2 days after regular way
Seller’s Option No sooner than T+3

 Note that U.S. Treasury bills, notes and bonds, government agency securities, nonconvertible corporate debt and
municipal securities are EXEMPT from Reg T
 In trades between dealers, the buyer may accept or decline securities delivered before settlement date
 Interdealers trades settle:
o Government securities: federal funds
o Other securities: clearinghouse funds
 Seller’s option contracts: seller can settle as specified in the contract, or fi he wishes to do earlier it can be done after T+3 by
giving a one-day written notice to buyer
 When/As/If-issued: initial trade confirmation includes security description with contract price (yield) and trade date. Once issued,
the final confirmation states S.A.T. needs to be sent no later than settlement day. B/D confirmation needs to be sent no later than
T+1.
o Settlement date
o Accrued interest
o Total dollar amount (purchase price) due at settlement date
 DVP (delivery vs payment) / COD (collect on delivery)

Regulation T
 Extensions: B/D or clearing firm may request an extension from designated examining authority before the 4 business day. B/D
th

can ignore <$1,000 w/o violating Reg T requirements. If customer does not pay by end of extension period, B/D can request an
additional extension or sell the securities in a closeout transaction (and acct frozen for 90 days). To buy additional securities in a
frozen acct, it must have sufficient cash. To sell additional securities, it must have securities on deposit.

Proxy Department
 Proxy is automatically revoked if the stockholder attends the shareholder meeting
 Companies need to give shareholders information, previously reviewed by SEC
 Everyone involved, incl. proxy advisers, needs to be registered with SEC
 If the customer signs the proxy, but forgets to vote, member firm must vote as recommended by mgmt.
 If the client doesn’t vote by the 10 day before the annual meeting
th

o Minor importance: member may vote as it sees fit

o Major importance (M&A and issuance of additional shares): shares are not voted
DK
 Interdealer trades are submitted by each side to ACT (Automated Confirmation Transaction) System
 DK: issued if one side does not recognize the trade or one of the terms. The same term is used within a B/D when an order room
doesn’t recognize acct # in an order ticket
Due Bill

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 Sent when the wrong party received a dividend from the issuer

Rules of Good Delivery

 RR responsible for checking a security is in good delivery when a customer sells it
 It describes the physical condition of, signatures on, attachments to, and denomination of certificates involved in a securities
transaction
 Transfer agent is the final arbiter of whether a security meets the requirements
 Partial delivery: a broker to broker partial delivery must be accepted if the remainder of the delivery constitutes a round lot or
multiple thereof
 Good delivery clearing rule (100-share uniform units): if you can take the securities and make piles of 100 – for broker to broker
 Good delivery for bonds:
o Coupon/bearer: $1,000 / $5,000 denomination
o Fully registered: multiples of $1,0000 and no larger than $100,000
 No missing coupons: if in default, all unpaid coupons must be attached to be good delivery
 Assignment: each bond/stock certificate must be assigned (endorsed by signature) by the owner who is registered in the
certificate’s face (exact same name, no abbreviation except “Co.” and “&”). If jointly owned, all signatures are required
o Can be signed at the back or on a separate stock / bond power of substitution (can combine several certificates, but
needs to be for separate securities)
o Full explanation of any correction must be signed by the person that did it
o Signatures must be guaranteed by a party acceptable to the transfer agent (exchange member or national bank)
 Other legal docs required for transfer
o Sole proprietorships/partnerships: guarantee by B/D
o Corporates: corporate resolution
o Fiduciaries: certified copy of trust agreement or court appointment (minor signatures are invalid)
o Executor/administrator of an estate must endorse or give a stock power
 Physical condition: if mutilated/counterfeit, authentication must be obtained before the transfer agent can replace it, if damage is
large, needs a surety bond
 Fail to deliver: when sell-side B/D fails to deliver in good form by settlement date, seller won’t get payment
o Buy side B/D may buy the securities to close the contract and charge the seller for any losses
o Sell side B/D must buy the securities after 10 business days from settlement date (S + 10)
 Reclamation: when buying B/D discovers after accepting the certificates that they are not in good delivery form Securities are
sent back to selling B/D with Uniform Reclamation Form
o Minor irregularities: delivery date + 15 days
o Refused by transfer agent (whatever reason) or counterfeit/stolen: delivery date + 30 months
o If certificates (bonds) are subject to partial call: no limit for reclamation
o Never subject to reclamation: in-whole call and issuer goes into default after trade date