What is the National Market System (NMS)?
Let me explain the National Market System (NMS) directly: it's the framework that promotes transparency in the free market by regulating how major U.S. exchanges disclose and execute trades. You should know that NMS handles equity trading and order fulfillment, including trading, clearing, depository, and quote distribution functions. It directly governs all formal U.S. stock exchanges and the NASDAQ market.
Key Takeaways
Here's what you need to grasp: the NMS ensures free market transparency through regulations on trade disclosure and execution. It facilitates fair information distribution by requiring exchanges to make bids and offers visible to individual and institutional investors alike. And remember, in 2005, the SEC introduced Regulation NMS to bolster the system and adapt to technological changes.
Understanding the National Market System (NMS)
I want you to understand that the NMS, created by the Securities Acts Amendments of 1975, is overseen by the National Association of Securities Dealers (NASD) and NASDAQ. It covers exchange-based trading like on the New York Stock Exchange and OTC trading on NASDAQ. Practically speaking, NASDAQ functions as an exchange, with negotiations happening directly among market makers.
To ensure fair information flow, the NMS mandates that exchanges display bids and offers (ask prices) to both retail and institutional investors. This boosts liquidity and leads to better prices, but it complicates executing large trades discreetly for institutions and big investors. Some argue this visibility has shifted such trading off-exchange, contributing to the growth of private exchanges known as dark pools.
Important Update
You should note this: on December 9, 2020, the SEC adopted new rules to modernize the infrastructure for collecting, consolidating, and disseminating market data for exchange-listed NMS stocks. These rules update and expand NMS market data content, among other changes. If you want more details, check the official sources.
NMS vs. Other OTC
Let me compare NMS to other OTC trading: NASDAQ represents the top tier of four OTC levels, where companies must meet strict criteria for capitalization, profitability, and trading activity. NASDAQ offers more comprehensive intraday trading info than lower OTC levels, including last-sale prices, daily highs and lows, cumulative volume, and bid/ask quotes. Market makers here report actual prices and share sizes within 90 seconds, unlike the non-real-time reporting for non-NMS, lower-tier OTC stocks.
NASDAQ operates as a decentralized OTC system but acts like a virtual exchange with full regulations, requirements, and safeguards from clearing houses. In contrast, other OTC markets have far fewer rules and protections. These markets divide into tiers: OTCQX, OTCQB, and Pink Sheets, with listing requirements easing at each level. All are less stringent than NMS-covered exchanges.
Regulation National Market System (Reg NMS)
The SEC recognized the need to strengthen NMS amid technological shifts, so in 2005, they issued Regulation NMS with four main components. First, the Order Protection Rule ensures you get the best price when your order executes, eliminating trades at worse prices. Second, the Access Rule improves access to quotations from NMS trading centers by requiring better linking and lower fees.
Third, the Sub-Penny Rule sets uniform quotes at no less than one cent increments for stocks over $1 per share. Fourth, Market Data Rules allocate revenue to self-regulatory organizations that enhance market data access. Arguably, the most critical is the order protection provision, which guarantees executions at the best available price, regardless of venue.
Critics point out that this forces transactions on venues with the lowest price, even if you prefer ones with faster execution or better reliability. They argue it leads to poorer outcomes for institutional orders when all costs are considered.
