Brattle Senior Associate Sujay Dave and Principal Emeritus George Oldfield have coauthored a Law360 article that discusses the differences between exchanged-based and over-the-counter (OTC) market-maker practices, and why it is important for prosecutors to understand these differences.
In the article, “How Prosecutors Misconstrued OTC Market-Making Practices,” the authors describe how parallel exchange and OTC markets exist for many financial contracts. Exchanges for small orders of a financial instrument are typically order-driven, and the market-maker often acts as an agent for their client. In contrast, large block orders of the same instruments are predominantly traded OTC by institutional investors on a quote-driven basis, and market-makers trade for their own profit.
The differences between quote- and order-driven markets became pivotal in a series of recent federal court cases against market makers in OTC markets, which involved allegations of dishonesty, front running, and a breach of duty to the market maker’s counterparty. Government prosecutors essentially argued that a market-maker in a quote-driven OTC market should be able to provide the same execution profile for a bespoke block trade as that which occurs for a small round lot trade in an order-driven market.
However, in the majority of these cases, the courts sided with the market-makers. They concluded that OTC market actions that might appear to be illegal in an order-driven market may actually be customary trading practices in a quote-driven, allowing market-makers to remain competitive and manage risk. The authors conclude that in order to determine whether actions are a result of routine practice or unfair trading, prosecutors need the proper context and an understanding of how these markets operate efficiently.
The full article, “How Prosecutors Misconstrued OTC Market-Making Practices,” can be found below.