Regulated Market Maker Exemption
The Formal Definition
A statutory carve-out under SEC Regulation SHO (specifically Rule 203) that permits bona fide market makers to engage in short-sale transactions without obtaining a pre-trade locate, designed to facilitate liquidity during volatile market conditions.
Exemption Mandate: Bona Fide Market Making Activity = Short Sale Permitted Without Prior Share Borrow / Locate
Cole Barrett's Reality Check
The Unvarnished Bottom Line"If an ordinary trader shorts a stock without borrowing the shares first, it is an illegal naked short. But if a designated market maker does it, it is a legal 'liquidity exemption.' While designed to keep markets moving during volatility, quantitative internalizers use this carve-out to trade ahead of real supply and demand."
Interactive Simulator: Test the Math
Real-World Example: Scenario Breakdown
Examining the real numbers for: Retail buying surge of 500,000 shares in a thinly floated momentum equity
| Execution Metric | Standard Short Seller (Subject to Locate Mandates) | Bona Fide Market Maker (Reg SHO Exemption) |
|---|---|---|
| Fee / Rate | $1.00 fee | $0.00 internal |
| Spread / Buffer | Required by Reg SHO to locate verified borrowable shares before shorting | Used market maker exemption to short 100,000 shares without a locate |
| Execution / Status | Locate pool empty; broker rejected short sale order | Provided immediate selling liquidity to absorb retail buy orders |
| Total Cost / Result | Strict compliance with federal locate rules | Legally bypassed the short-sale locate requirement |
How Brokers Weaponize This Term
Market makers rely on the bona fide market maker exemption to internalize retail volume on hard-to-borrow stocks, collecting wide spreads while avoiding the locate fees retail traders must pay.
Broker Evaluation Matrix
Cole Approves
Interactive Brokers: Provides institutional transparency into live market-maker short volume ratios and daily short-sale locate availability.
Read Audit →Cole Flags / Avoids
Wholesale PFOF Desks: Routes client orders to internalizers that rely on market maker exemptions to trade against retail momentum flows.
View Trap Details →Frequently Asked Questions
What defines 'bona fide' market making under Reg SHO?
The market maker must continuously publish two-sided quotes at or near the market and stand ready to buy and sell on a regular basis.
Can market makers keep naked short positions open indefinitely?
No. Under SEC rules, if a failure to deliver (FTD) occurs and persists for a specified number of settlement days, mandatory close-out rules apply.