5.4.1. Market Makers
When dealers assume the risk of buying or selling out of their own account at posted bid-and-ask prices, they are creating a market for that security. For this reason, they are also called market makers. All Nasdaq and over-the-counter securities are traded through market makers, which provide liquidity and price discovery for buyers and sellers of that security.
In a negotiated market, multiple market makers offer price competition. In an auction market, every security has a single market maker, known as the Designated Market Maker (DMM), on any given exchange. Each listed stock is assigned a DMM by the exchange to facilitate the auction market for that security. DMMs execute principal transactions.
Recently, the NYSE has adopted a multi-dealer structure, in which DMMs must compete for business with a new class of market maker, called a Supplemental Liquidity Provider (SLP). SLPs must trade from offices outside the NYSE using computers, with the purpose of providing greater liquidity to securities traded on the NYSE.
The only time a non–market maker may execute a principal transaction in the OTC market is in the case of a riskless principal transaction. A riskless principal transaction occurs when a non–market maker receives an order from a customer and then buys stock from a market maker to fill the order, but instead of immediately delivering the stock to the client, he places the stock in a riskless principal account. The non–market maker then sells the stock from this account to the customer at a markup price. This type of a transaction is called a principal transaction because the non–market maker traded from his own account and then added a markup. It is riskless because the firm can immediately sell the security. This pair of transactions may be reported in the same manner as either one agency transaction (with a riskless principal capacity indicator) or two principal transactions (with one of the principal trans