What Is Backing Away?

The term backing away refers to the failure by a market maker in a security to honor the quoted bid and ask prices for a minimum quantity. Backing away constitutes a serious violation of industry regulations. The Financial Industry Regulatory Authority (FINRA) uses an automated market surveillance system to enable the resolution of backing-away complaints in real-time. Backing away is usually frowned upon and can lead to disciplinary action against the market maker who has backed away.

Key Takeaways

  • Backing away is the failure of a market maker in a security to honor the quoted bid and ask price.
  • Backing away is a violation of industry regulations and is attempted to be resolved by FINRA in real-time.
  • Market makers that back away can have disciplinary action brought against them.
  • There are certain situations where a market maker does not have to abide by their original quote rules, such as sending in a quote change before an order is placed.
  • A backing away complaint must be brought within five minutes of occurrence and FINRA can bring forth disciplinary action after repeated occurrences.

Understanding Backing Away

Let’s say that an investor wants to buy 1,500 shares of Company X. Bank Y is the market maker for this stock and advertises at 9:00 a.m. on Tuesday that the bid for Company X’s stock is $35.67 and its asking price is $36.

The investor places an order to buy 1,500 shares at $36, but Bank X suddenly backs away from the price, claiming that the bid is now $35.97 and the ask is now $36.50. This is in violation of the firm-quote rules established by the Securities and Exchange Commission (SEC), Financial Industry Regulatory Authority (FINRA), and other regulatory bodies that require market makers to execute orders at their displayed quotation, and could result in disciplinary action.

However, there are some circumstances under which a market maker does not have to abide by these firm-quote rules. One such circumstance might be if the market maker sends a quote change to the exchange before an investor presents an order. Another might be if the market maker is in the process of filling an order and changes the stock price before it is, or should reasonably be, aware that another order has been placed; it does not have to fill the new order at the old price.

Backing Away Complaint

Backing away constitutes a breach of SEC Rule 11Ac1-1 or the "firm quote rule," which requires a market maker to execute an order presented to it at a price at least as favorable as its published quotation, up to its published quotation size. Broker-dealers and market makers must also follow SEC Rule 11Ac1-4, which is known as the "limit order display rule."

A potential backing-away complaint has to be brought to the attention of the regulation department of the specific exchange where the violation occurred within five minutes of the alleged offense. Otherwise, it may be difficult for department staff to obtain a contemporaneous trade execution from the market maker.

FINRA does not pursue immediate disciplinary action for an individual backing-away complaint where a contemporaneous trade execution from the market maker is obtained or offered. However, department staff keep a record of such transgressions and repeated non-compliance with the firm quote rule could result in disciplinary action. Disciplinary action can include fines, suspension, and any other penalties decided upon by the appropriate regulatory body.

Backing Away Impact on Investors

When a market maker backs away from a quoted price, the impact results in the investor buying at a higher price or selling at a lower price than quoted. First and foremost, this is a dishonest practice, and secondly, it can negatively impact the financial position of small investors that cannot absorb the difference between the intended price and actual price.

Exchanges are meant to take the complaints seriously but not all complaints are always registered. Some exchanges specify that backing away is not widespread and only a few traders engage in the activity. With the advent of electronic trading across multiple platforms, investors are able to bypass traditional brokers and execute trades for themselves at prices they are comfortable with provided to them in real-time.