A market maker publishes a firm two-sided quotation in an over-the-counter stock. A customer's order arrives at the quoted price and size, and the firm declines to trade. This conduct is:
- A.Permissible, because a published quotation is only an invitation to negotiate.Wrong. A firm quotation is a commitment, and treating it as an invitation would make quoted markets meaningless.
- B.Permissible, because the firm may decline any order it judges to be unsuitable.Wrong. Suitability governs recommendations made to a customer, not a market maker's duty to honor its own quote.
- C.Backing away, since a firm quotation must be honored at its price and size.Correct. Refusing to trade at one's own displayed quotation is the definition of backing away.
- D.Freeriding, since the firm avoided committing its own capital to the trade.Wrong. That term describes paying for a purchase out of the proceeds of its sale, an entirely different violation.
Why: The secondary market functions because displayed quotations mean something. A market maker publishing a firm bid and offer commits to buy at its bid and sell at its offer for at least the size displayed, and refusing to do so is backing away. The prohibition protects the integrity of quoted prices, since a market of quotes nobody honors supplies neither information nor liquidity. A firm that no longer wishes to trade at a price must update its quotation rather than decline an order arriving against it.
A market maker displays a firm bid of 12.40 for 500 shares. Another firm hits that bid with an order to sell 2,000 shares, and the market maker buys 500 and declines the rest. A second firm then tries to sell 300 shares at 12.40 and is told the market maker will no longer trade there. Which statement is most accurate?
- A.Both refusals are backing away, because a firm quote must be honored until the market maker changes itWrong. The first refusal concerned size the quote never promised, so it breaches nothing.
- B.Neither refusal is backing away, because a market maker may always decline any order it does not wantWrong. That would drain the firm-quote obligation of any content at all.
- C.The first refusal is proper because a firm quote binds only for its displayed size; the second is backing away unless the quote had been updated before that order arrivedCorrect. Size and currency of the quote are separate tests, and the two refusals fail them differently.
- D.Neither refusal matters, because the obligation runs only to orders from public customers rather than from other firmsWrong. Other firms are exactly the participants who rely on a displayed quote.
Why: A firm quote is a commitment to trade at the displayed price, but only up to the displayed size. Refusing the portion of a 2,000-share order that exceeds a 500-share quote is therefore proper, and the obligation on that quote was satisfied by buying the 500. The problem reappears only where the market maker refuses an order its still-displayed quote would cover, so declining a 300-share sale at a bid it is showing is backing away unless it had already updated or withdrawn that quote before the order arrived. Two conditions have to be held at once: the size the quote promised, and whether the quote was still standing when the order came in.