11.2 The Secondary Market

The Securities Exchange Act of 1934

The secondary market is where already-issued securities trade among investors; the issuer receives no proceeds. It is governed by the Securities Exchange Act of 1934 (the "People Act"), which created the SEC and reaches the people and venues that trade.

Contrast the two foundational acts: the 1933 Act is the primary market / new-issue statute keyed to the prospectus; the 1934 Act is the secondary market / trading statute keyed to ongoing 10-K/10-Q/8-K disclosure.

Exchange Markets: NYSE

The New York Stock Exchange (NYSE) is an auction market: orders for a given stock compete at a central point, and the best bid meets the best offer. Each listed stock is assigned exactly one Designated Market Maker (DMM) (formerly the "Specialist").

DMM obligations:

• Maintain a fair and orderly market in assigned securities
• Add liquidity by buying when there are no buyers and selling when there are no sellers
• Manage the order book and facilitate the opening and closing auctions
• Act as both agent (working customer orders) and principal (own-account trades)

Exchange Markets: NASDAQ

NASDAQ is a negotiated (dealer) market with multiple competing market makers per security and no physical floor. Market makers post two-sided quotes and trade for their own accounts; competition among them tends to tighten spreads.

OTC Markets and Tiers

Securities not on a national exchange trade over-the-counter (OTC) through inter-dealer quotation systems. Quality descends through tiers:

The Four Markets

The Series 7 reliably asks you to label trades by "market."

A classic trap: a NYSE-listed stock executed away from the exchange in the OTC market is third market, not first.

ECNs, Dark Pools, and Quotes

Electronic Communication Networks (ECNs) match buy and sell orders electronically, enable after-hours trading, and display anonymous quotes. Dark pools let large institutions execute big blocks without pre-trade quote display, reducing market impact at the cost of transparency.

Quote terminology is examined constantly:

Memorize: investors buy at the ask and sell at the bid; dealers do the opposite. The National Best Bid and Offer (NBBO), disseminated by the Securities Information Processor (SIP), anchors a broker-dealer's best-execution duty.

Worked example: A stock is quoted 45.50 – 45.75. Buying 100 shares costs the ask: 100 × $45.75 = $4,575. Selling 100 shares yields the bid: 100 × $45.50 = $4,550. The $0.25 spread is the dealer's gross profit per share.

Listing Standards and Reporting Issuers

To remain on the NYSE or NASDAQ, an issuer must satisfy initial and continued listing standards (minimum share price, market value, shareholder count, and financial tests) and stay a current reporting company, filing the 10-K, 10-Q, and 8-K mandated by the 1934 Act. Failing the standards leads to delisting, after which the security typically migrates to the OTC tiers. A company that goes "dark" by ceasing SEC reporting often lands on the Pink market with limited information.

Settlement of Quotes: Firm, Subject, and Workout

Not every OTC quote is executable. The Series 7 distinguishes:

A dealer that publishes a firm quote and then refuses to honor it commits backing away, a FINRA violation.

Common Exam Traps

• Investors buy at the ask, sell at the bid; reversing this is the single most common quote error.
• A NYSE-listed stock crossed off-exchange is third market, not first.
• The NYSE assigns one DMM per stock; NASDAQ has many competing market makers, so do not say NASDAQ has a specialist.
• The 1933 Act = primary/new issues/prospectus; the 1934 Act = secondary/trading/10-K and created the SEC. Mixing these two is a frequent miss.
• Dark pools reduce market impact but lower transparency; they are still SEC-regulated, not unregulated.