9.3.2. Nasdaq Passive Market Making
Nasdaq is a negotiated market created by multiple market makers that post competing bid and ask prices over a computerized network. Because market makers are so central to Nasdaq’s functioning, Regulation M provides a way for distribution participants who are also registered Nasdaq market makers to perform both functions at once for the same security.
Why is a special provision needed for a firm to do both? Recall from the previous section that distribution participants are prohibited from inducing others to buy the security on the secondary market. But a market maker does this by definition. So Regulation M carves out an exception allowing a firm to make a market in a security for which it is also a distribution participant, so long as the market making is “passive.” Reg M defines a passive market maker as one whose market making meets these requirements:
• Price limitation. A passive market maker’s bids and purchases for the security may not exceed the highest independent bid at the time of the transaction. If all independent bids for the security fall to a price below the passive market maker’s bid, the market maker must promptly lower its bid accordingly.
• Purchase limitation. On each day of the restricted period, a passive market maker’s net purchases are limited to the greater of 30% of the security’s ADTV or 200 shares.
• Bid identification. A passive market maker must designate its bid as a passive market making bid.
• Reporting to FINRA. A passive market maker is required to notify FINRA in advance of i