What is Backing Away?
Backing away occurs when a market maker does not honor a quoted bid or ask price for a minimum quantity of a particular security.
How Does Backing Away Work?
John Doe wants to buy 1,000 shares of Company XYZ. The market maker for the stock is Bank ABC, and at 9:47 a.m. on Tuesday it advertises that the bid for Company XYZ stock is $25.27; the ask is $26.00. John Doe places his order to buy the shares, but suddenly Bank ABC backs away from the price, saying that the bid is now $25.95.
The Securities and Exchange Commission, the Financial Industry Regulation Authority (FINRA), and other regulatory bodies have 'firm-quote rules' that obligate market makers to execute orders presented to it at its displayed quotation and up to its displayed size.
A market maker doesn't always have to obey the firm-quote rule, however. If it sends a quote change to the exchange before there is an order presented, for example, it is not obligated to execute the trade at the previous quote. Additionally, if the market maker is in the process of executing a transaction and changes the price before it is aware of (or should be reasonably aware of) another order, then it does not have to fulfill the next order at the 'old' price.
This can be tricky, because market makers handle orders from multiple sources. But once a market maker becomes aware that it has received an order, it has to execute the order at the quote up to the displayed size. Canceling a trade within the minimum three-minute time period that the order is pending eliminates the order-maker's right to make a backing-away complaint.
Why Does Backing Away Matter?
Backing away is basically a bait-and-switch tactic in that the market maker does not honor its publicly quoted price at which is says it is willing to buy or sell shares (typically at least 100 shares). Regulators consider it a serious (yet common) infraction because ensuring that investors can buy and sell securities at their advertised prices is crucial to maintaining a fair and efficient trading system that has integrity. For this reason, regulatory bodies investigate backing-away complaints, though complainants have a very small window in which to complain to the market maker -- about five minutes from the time of the alleged infraction. The National Association of Securities Dealers (NASD) can suspend, bar and/or fine violators up to $100,000.
