A market maker receives an institutional customer's order and, with no arrangement in place, fills it on a net basis. Straight afterwards a trader telephones the customer, explains how net executions work and records the customer's oral agreement to the trade. How does the execution stand under FINRA Rule 2124?

It complies, because oral consent obtained by telephone is one of the consent methods open to an institutional customer

It falls short, because the disclosure and the consent both had to be in place before the net transaction was executed

It complies, provided the recorded call is made on the trade date itself and before the transaction goes on to settle

It falls short, because an institutional customer can consent to net executions only through a negative consent letter sent to it

A market maker receives two customer orders, one for an OTC equity security and one for a corporate bond. It fills each by buying from another dealer and reselling to the customer at a higher price, with no separate charge. Which of the fills does FINRA Rule 2124's net transaction framework reach?

Both fills, the rule reaching any principal trade in which the customer's price differs from the dealer's price

The bond fill, the rule treating a net price on fixed income as the case where compensation is hardest to see

The equity fill, the rule's net transaction being defined by reference to an order in an equity security

Neither fill, the rule reaching only orders large enough that the market maker must work them over time

After receiving a customer's order to sell 500 shares of an OTC equity security, a market maker sells 500 shares to a different customer of the firm at $12.05 and then buys the first customer's shares at $12.00. Does this fit FINRA Rule 2124's definition of a net transaction?

Yes, the definition takes in a trade with another customer as well as one with another broker-dealer

No, the market maker's other trade must be with another broker-dealer in the interdealer market

No, a trade between two of the firm's own customers is an agency cross whatever prices each one pays

Yes, but only if the other customer has also consented to having its own order executed on a net basis

A market maker bought 2,000 shares of an OTC equity security for its inventory last week. Today a customer asks to buy 2,000 shares, and the market maker sells them to her from that inventory at a price above what it paid, with no separate charge. Is this a net transaction as FINRA Rule 2124 defines one?

Yes, any principal sale to a customer at a price that differs from the market maker's own cost is a net transaction

No, the definition requires the market maker's trade with the other party to follow its receipt of the customer's order

Yes, the difference between the two prices being built into her price without any separately identified commission

No, a sale from inventory becomes a net transaction only once the customer has consented to a net execution

In a net transaction a market maker's compensation is embedded in the difference between the prices of two linked trades. A riskless principal transaction also pairs a purchase and a sale back to back. What sets the riskless principal transaction apart?

The member's first trade is usually made on an exchange rather than with another dealer over the counter

The customer typically pays the member a commission as agent, the member never owning the shares

The member's compensation must be disclosed to the customer on the trade confirmation

The member's compensation is paid by the dealer on the other trade rather than by the customer

A customer is filled on a net basis without being told how net transactions work. Which mistaken belief about the trade is FINRA Rule 2124's disclosure requirement designed to head off?

That an exchange set the price of the trade, the market maker merely passing that exchange price on to the customer

That a separate commission is still owed to the market maker and will be billed to its account once the trade settles

That the market maker held the order for a time before filling it, so its price reflects a later state of the market

That the market maker filled it as a pure agent at the market price, with no added cost built into that price

FINRA Rule 2124 requires a market maker both to disclose how net transactions work and to obtain the customer's consent. What does the consent achieve that the disclosure alone would not?

It ensures the customer has agreed to the net method rather than having it applied without its knowledge

It gives the customer a right to cancel the trade before settlement if the net price later proves to be unfavourable

It lets the market maker leave the price of the trade off the confirmation that it then sends to the customer

It entitles the customer to be told the market maker's interdealer price in writing after every net trade

When a retail customer opened her account she signed a form consenting to have all of her future orders executed on a net basis. A market maker now wants to fill her latest order that way. What does FINRA Rule 2124 require of it?

Nothing further, her written consent at account opening covering every later order of the kind that it describes

Her written consent to this particular order, the form she signed at account opening serving as no lasting authority

Her oral consent to this order, recorded by the firm, the earlier written form supplying the written element

A written reminder of her account-opening consent, sent to her ahead of this order being executed on a net basis

A small private company with only modest assets, and no business as a bank, an insurance company, an investment company or an investment adviser, opens an account with a market maker. How does FINRA Rule 2124 classify the company when the market maker considers executing its orders on a net basis?

As outside Rule 2124 altogether, the rule's consent requirements reaching only natural persons and institutional accounts

As an institutional customer, Rule 2124 treating every business entity as institutional whatever its size or assets

As a non-institutional customer, a category taking in every customer whose account is not an institutional account

As institutional for its larger orders and non-institutional for smaller ones, the size of each order deciding it

A retail customer ticks a box on a signed form acknowledging that she received a market maker's disclosure document about net transactions. Nothing on the form or in the firm's records shows that she engaged with what the document says. How does FINRA Rule 2124 treat the form as her consent to a net transaction?

Not as consent, the rule requiring the disclosure to be read aloud to her by telephone and the call to be recorded

As valid consent, a signed written acknowledgement of the disclosure being all that the rule requires of a retail customer

As valid consent once a principal of the firm countersigns it, the principal's review supplying the evidence of understanding

Not as consent, since it must evidence her understanding of the order's terms and not merely her receipt of a disclosure

A market maker intends to rely on a negative consent letter to execute an institutional customer's orders on a net basis under FINRA Rule 2124. What must the letter do?

Explain clearly the terms for handling the customer's orders on a net basis and give it a meaningful chance to object

Explain the net method and give the customer thirty days to object, that being the period the rule fixes for every letter

Set out the market maker's interdealer price for each order and allow the customer five business days in which to object

Explain the net method, give a chance to object, and be sent to the customer again before each of its orders is netted

A market maker sends one negative consent letter about net transactions to its institutional and its retail customers alike, and none of them objects. May it now execute orders on a net basis for both groups under FINRA Rule 2124?

For the institutions only, retail customers first needing a second letter that repeats the same disclosure in plainer terms

For the institutions only, retail investors not being assumed able to judge such a letter or see what not objecting means

For both groups, a retail customer's silence counting as consent once a principal of the firm has countersigned the letter

For both groups, provided each retail customer was also sent a written reminder of the letter before its first net order

An institutional customer wants a market maker to execute its small routine orders on a net basis but to handle its large block orders another way. How does FINRA Rule 2124's negative consent letter accommodate that?

The letter may cover part of the orders only after the customer's instructions are filed with FINRA in advance

It cannot; a negative consent letter covers every order, so the split needs written consent order by order

The letter may cover all or only part of the customer's orders, as the customer instructs the market maker

The letter may exclude block orders, but only those above a size that the rule itself sets for every customer

A market maker relies on the oral method of disclosure and consent for an institutional customer. On each order it obtains the customer's oral consent by telephone, but it keeps no record of the calls. How does that stand under FINRA Rule 2124?

It falls short, the oral method being open only where a fiduciary manages the customer's account with discretion

It complies, oral consent given order by order being one of the methods the rule makes available to institutions

It complies, provided the customer later confirms in writing that it consented, within a reasonable time of each order

It falls short, the oral method requiring the member to document the customer's understanding and consent on each order

FINRA Rule 2124 lets a market maker obtain consent to net transactions from a registered investment adviser that holds trading discretion over a customer's account, rather than from the customer. What is the reason for allowing this?

The adviser makes the account's trading decisions, so consent from each underlying customer would be impractical and at odds with its role

The customer has given up the protection of Rule 2124 by granting discretion, so the adviser's consent is no more than a formality

The adviser's agreement with the customer already contains a consent to net execution by any market maker that the adviser uses

The adviser pays the account's trading costs out of its own fee, so the market maker's compensation never reaches the customer

A registered investment adviser that qualifies as an institutional account under FINRA Rule 4512(c) holds trading discretion over 400 accounts belonging to individual retail clients. How may a market maker meet FINRA Rule 2124's disclosure and consent requirement for net transactions in those accounts?

By written consent from the adviser on each order, the retail standard following the status of the underlying clients

By a negative consent letter to the adviser, covering net executions in every discretionary account it manages

By the adviser's oral consent on each order, the negative consent route being closed wherever the accounts are retail

By a negative consent letter to the adviser, covering only the accounts of those clients who are themselves institutional

A member firm is registered as a market maker in several OTC equity securities but not in Stock X. Now and then it fills a customer's order in Stock X by buying the shares from another dealer and reselling them to the customer at a higher price. FINRA Rule 2124's disclosure and consent framework does not reach those trades. What obligations does the firm still carry on them?

It must obtain the customer's written consent to each trade under Rule 2232, which takes over that role

It must have a principal approve each such fill in advance, in place of the consent Rule 2124 would require

It must still price the trade fairly under Rule 2121 and confirm it accurately under Rule 2232

It must report each trade to FINRA as an agency cross, the trade falling outside Rule 2121's pricing test

FINRA Rule 2124's disclosure and consent framework applies to market makers and not to a member that now and then takes a principal position to fill a customer's order. What reason has FINRA given for that limit?

Only market makers deal with retail customers, so only their customers need the protection that the consent framework gives

Members that are not market makers act as their customers' fiduciaries, whose duties already govern the prices they charge

Customers of members that are not market makers may cancel any principal fill on its trade date, which protects them instead

SEC Rule 10b-10(a) already makes such a member disclose its price difference to the customer on the confirmation

FINRA has warned firms about taking advantage of the way net trades are reported. A market maker does so for the express purpose of making a security look more heavily traded than it is. How may FINRA treat that conduct?

As acceptable provided each report is accurate, FINRA looking at the figures reported and not at why the firm chose that structure

As a violation of the trade reporting rules alone, no conduct rule such as the one against manipulative devices reaching the practice

As a matter for the SEC alone, since FINRA's rules give it no power to treat the reporting of net trades as misconduct

A market maker executes a customer's order on a net basis. What does FINRA Rule 5310's best execution obligation require of the net price it charges the customer?

It must meet the best execution standard only where the customer has asked the firm to check other markets' prices

It must be as favourable to the customer as possible under the market conditions prevailing at the time

It must be shown on the confirmation beside the price of the firm's other trade, for the customer to judge

It must be measured against the firm's own quotation alone, other markets' prices playing no part in it

FINRA Rule 2124 requires a market maker to retain its consent documentation in accordance with FINRA Rule 4511's general books and records requirements, and sets no period of its own. For how long must the market maker keep a negative consent letter it has relied on?

For as long as the customer's account stays open, and for one further year after the account closes

At least three years, after which it may be destroyed once the customer's account has been closed

At least six years, the default period Rule 4511 sets for records with no other period specified

Until FINRA's next routine examination of the firm has reviewed the letter and closed its findings

Why does FINRA Rule 2124 require market makers to retain the documentation of the consents they obtain from customers?

So FINRA can work out from the consents on file the regulatory fees that the firm owes on its net transactions

So a customer who later disputes a net price can recover the market maker's markup by reference to the stored consent

So the firm can show the SEC the interdealer price behind each net trade in its annual audited financial statements

So examiners can check compliance against the consents actually obtained rather than rely on the firm's account of its practice

When written, order-by-order consent for non-institutional customers was proposed as NASD Rule 2441, one commenter argued that a disclosure signed before every trade would tell customers nothing that available market information did not. On what ground did NASD keep the requirement?

Market information would not help a customer see whether a member was trading net or what that meant for it

The burden of obtaining written consent order by order was judged to be slight, so the cost objection fell away

Market information then covered exchange-listed securities only, leaving customers no price data on OTC equity securities

Written consent was the only record that would show the customer had first been offered an agency execution

A market maker that has chosen FINRA Rule 2124's oral method for an institutional customer sends the customer one comprehensive written statement of how it handles orders on a net basis, a statement that is not a negative consent letter. On each later order it takes the customer's oral consent without explaining those terms again. How does that stand?

It complies, the single written statement supplying the disclosure and the oral consent on each order supplying the consent

It falls short, the oral method requiring the terms of handling to be explained afresh to the customer for each order

It complies, provided the written statement is sent to the customer again at least once a year while the method is used

It falls short, a written disclosure statement obliging the market maker to take the customer's consent in writing as well

Firm A, a broker-dealer, routes its retail customer's order, marked net, to Firm B, a market maker, which fills the order on a net basis. Which firm bears FINRA Rule 2124's disclosure and consent obligations toward the customer?

Both firms, each having to obtain the customer's own written consent before the order is filled

Firm B, as the market maker that executed the net trade, whichever firm the order came from

Firm A, as the originating broker-dealer, Firm B owing no such obligation to Firm A's customer

Firm B, but only once Firm A has passed the customer's written consent on to it with the order

An individual customer with total assets of $70 million asks a market maker to execute her orders in OTC equity securities on a net basis. Which ways of obtaining her consent does FINRA Rule 2124 allow?

Any of the three institutional methods, but only after she certifies in writing that she is an accredited investor

Written consent on each order only, an individual being a non-institutional customer whatever her total assets

Written or oral consent on each order, a negative consent letter being closed to any individual customer

Any of the three institutional methods, a negative consent letter among them, her account being an institutional account

What do FINRA rules provide about net trading and about the prices at which a firm executes the initial and the offsetting trades of a net transaction?

They neither prohibit net trading nor mandate the prices at which the firm executes either of the two trades

They cap the gap between the two trades' prices at a fixed percentage of the first trade's price

They require the customer's price to be set before the firm's other trade, so the customer knows it in advance

They permit net trading only where an order is too large to be filled in full at the price then quoted

A firm is holding a customer's limit order to sell 100 shares at $40.05. It then buys 1,000 shares of the same security from another firm at $40.00 and sells them to a different customer on a net basis at $40.10. What does FINRA Rule 5320 require of the firm as to the held order?

Nothing yet, the benchmark being $40.00, the price exclusive of the differential, which is below the order's $40.05 limit

It must execute the held order, the net price of $40.10 being the benchmark, a price that would satisfy the order

Nothing yet, a trade made on a net basis with a customer who consented to it falling outside Rule 5320's protection

It must execute the held order, but at $40.00, the price at which the firm made its own purchase from the other firm

A market maker buys 2,000 shares of an OTC equity security from another firm at $25.00 and sells them to its customer on a net basis at $25.06. At what price does the market maker report its sale to the customer?

At $25.00, with the six-cent differential reported in a separate field as the market maker's remuneration

At $25.03, the midpoint of the market maker's two prices, the six-cent differential being split between its two trades

At $25.06, the net price the customer paid, with the six-cent differential included in it

At the best offer quoted in the security when the sale was made, whatever price the customer paid

A market maker fills a customer's order on a net basis, buying the shares from another firm and selling them to the customer at a different price. Which of those trades are reported for public dissemination?

Neither of them, a net trade's two trades being reported to FINRA for regulatory purposes and kept off the tape

Only the sale to the customer, the two trades being reported as one transaction in the manner of an agency trade

Only the purchase from the other firm, the sale to the customer being reported to FINRA for regulatory purposes

Both of them, the purchase from the other firm and the sale to the customer each being disseminated

FINRA Rule 2124 | Financial Regulation Courses

SERIES 7 | FINANCIAL REGULATION COURSES

FINRA Rule 2124 — Net Transactions with Customers — requires any FINRA member firm that acts as a market maker and executes a transaction with a customer on a net basis to first provide disclosure to and obtain consent from that customer before the net transaction is executed — establishing a tiered disclosure and consent framework that applies different requirements to non-institutional customers and institutional customers, ensuring in both cases that the customer understands the nature of a net transaction and has consented to that execution method before the market maker uses it in connection with the customer's order.

Net transactions are a specific and important category of principal transaction in equity securities that market makers use in over-the-counter equity markets — the market maker, after receiving the customer's order, first buying or selling the securities in a separate trade with another broker-dealer or another customer and then completing the customer's order at a different price. Understanding what a net transaction is, why it requires specific disclosure and consent, and how those requirements differ between retail and institutional customers is directly examined on the Series 7 qualification examination.

Rule 2124 was adopted from its predecessor NASD Rule 2441 — which had become effective October 2, 2006 — without material change, with effect from December 14, 2009, and was last amended effective December 5, 2011. Regulatory Notice 18-29 — issued September 12, 2018 — reminds firms of their obligations under the trade reporting rules and the other FINRA and SEC rules that apply when they effect OTC trades in equity securities on a net basis, Rule 2124 among them, and works through an example of how a net transaction is structured and reported, while the questions and answers FINRA published in Notice to Members 06-47 when the rule was adopted address how the disclosure and consent requirements apply.

What Is a Net Transaction — The Definition

Rule 2124(e)(2) defines a net transaction precisely — a principal transaction in which a market maker, after having received an order to buy or sell an equity security, purchases or sells the equity security at one price from or to another broker-dealer or another customer, and then sells to or buys from the customer at a different price.

The net transaction structure involves two linked but separate trades — the market maker's trade with another broker-dealer or another customer at one price, and the customer transaction at a different price — with the market maker's compensation being the difference between the two prices rather than a separately identified commission. This embedded compensation structure is the defining feature of net transactions — the customer pays or receives a price that reflects the market maker's markup or markdown from the price of its other trade, but that markup or markdown is not separately disclosed as a commission would be in an agency transaction.

A concrete example illustrates the mechanics clearly. A retail customer places a market order to buy one thousand shares of an OTC equity security. The market maker buys one thousand shares from another dealer at forty dollars per share. The market maker then sells those same one thousand shares to the customer at forty dollars and ten cents per share. The ten-cent-per-share difference — totalling one hundred dollars — is the market maker's net compensation for the transaction. The customer has paid forty dollars and ten cents, not forty dollars plus a separately identified commission — the market maker's spread is embedded in the net transaction price.

The critical distinction from a riskless principal transaction is important for examination purposes. In a riskless principal transaction the member also buys and then sells in a back-to-back sequence — but in a riskless principal transaction the member's compensation must be disclosed on the customer confirmation under SEC Rule 10b-10. In a net transaction the compensation is embedded in the price difference between the two linked trades.

The disclosure and consent requirement of Rule 2124 addresses a specific investor protection concern — customers who receive execution at a net price may not immediately recognise that the market maker has embedded its compensation in the price spread, or that the execution methodology used involves the market maker taking a principal position rather than acting as a pure agent.

Transparency about execution methodology matters to customers for several reasons. A customer who understands they are receiving a net execution knows that the market maker's compensation is embedded in the price rather than separately charged — enabling them to evaluate the true total cost of the transaction. A customer who does not understand the net execution methodology may believe they are receiving a pure agency execution at market price with no additional cost — a misunderstanding that could lead them to assess the transaction's economics inaccurately.

The consent requirement serves the additional function of ensuring the customer has agreed to the net execution methodology — rather than having it applied without their knowledge. A customer who has been properly informed about net transactions and consents to receiving net executions has made an informed decision that they accept the embedded compensation structure — whereas a customer who receives net executions without disclosure has had the execution methodology chosen for them without their knowledge or agreement.

Rule 2124(b) establishes the most demanding consent standard — applicable to all non-institutional customers who are not institutional accounts as defined in FINRA Rule 4512(c). For non-institutional customers — retail investors, and any other customer whose account is not an institutional account — the member must obtain written consent on an order-by-order basis prior to executing each net transaction.

The written requirement for non-institutional customers reflects the higher level of investor protection appropriate for retail investors who may be less familiar with execution mechanics and less equipped to assess the implications of net versus agency execution without written documentation of their understanding. The order-by-order requirement prevents a blanket consent obtained at account opening from serving as indefinite authorisation for all future net transactions — each net execution requires fresh specific consent from the retail customer.

The consent must evidence the customer's understanding of the terms and conditions of the order — not merely a checkbox acknowledging that a disclosure was received. The written consent must demonstrate that the customer actually comprehends what a net transaction is, how their execution will be structured, and what the implications are for their transaction economics. A consent that a customer clearly signed without reading or understanding — evidenced by the absence of any meaningful engagement with the disclosure content — does not satisfy Rule 2124's requirements even if it is technically in writing and obtained on an order-by-order basis.

Rule 2124(c) provides institutional customers — defined by reference to the institutional account definition of FINRA Rule 4512(c) — with three alternative methods for satisfying the disclosure and consent requirement, reflecting the regulatory recognition that sophisticated institutional investors are better equipped to understand and manage net execution mechanics without the strictest retail safeguards.

The first method is the negative consent letter — a written disclosure document sent to the institutional customer that clearly explains the terms and conditions for handling customer orders on a net basis and gives the customer a meaningful opportunity to object. If the institutional customer does not object, the member may reasonably conclude that the customer has consented to net executions. This negative consent mechanism — where silence constitutes consent — is not available for non-institutional customers precisely because retail investors cannot be assumed to have the sophistication to meaningfully evaluate a negative consent letter and to understand the significance of not objecting.

The negative consent letter can cover all or a portion of the customer's orders as instructed by the customer — giving institutional customers flexibility to consent to net executions for some order categories while requiring alternative execution for others. This order-category specificity ensures that institutional customers can tailor their consent to match their specific operational preferences and execution quality requirements.

The second method is oral disclosure and order-by-order consent — the market maker verbally explains the terms and conditions of the net execution to the institutional customer on each order and obtains oral consent before executing. This method requires the member to document the customer's understanding and consent on an order-by-order basis — creating a paper trail that demonstrates each individual consent was obtained. The documentation requirement for oral consent is essential — without it the claimed oral consent would be unverifiable in a subsequent examination or dispute.

The third method is written order-by-order consent — the same standard applicable to non-institutional customers, available to institutional customers who prefer the certainty of written documentation for each net execution. Institutional customers may choose this method when their internal compliance requirements mandate written documentation of all execution methodology consents regardless of regulatory minimum standards.

Rule 2124(d) addresses a practically important situation — customers who have granted trading discretion to a fiduciary, such as a registered investment adviser, trust company, or other third-party manager. In these cases the member is permitted to obtain the required consent from the fiduciary rather than from the underlying customer directly.

This fiduciary consent provision recognises the operational reality of discretionary managed account relationships — the investment adviser or other fiduciary makes all trading decisions on behalf of the underlying customer and is the appropriate counterparty for execution methodology discussions. Requiring separate disclosure to and consent from the underlying customer for each net transaction in a discretionary account managed by a fiduciary would be operationally impractical and inconsistent with the fiduciary's role.

When the fiduciary itself qualifies as an institutional customer under Rule 4512(c) — as any investment adviser registered with the SEC or with a state securities commission does by its category alone — the member may meet the disclosure and consent requirements using any of the three institutional customer consent methods described in Rule 2124(c). A negative consent letter sent to the investment adviser can therefore cover net executions in all discretionary accounts managed by that adviser — a significant operational simplification for market makers executing net transactions across large numbers of discretionary accounts.

How the Requirements Were Settled — The Approval Record

When the requirements now in Rule 2124 were proposed as NASD Rule 2441, commenters objected that written, order-by-order consent from non-institutional customers would be impractical and costly, and one argued that having a customer sign a disclosure before every trade would provide no information not already available elsewhere. NASD acknowledged the burden of obtaining written consent order by order but kept the requirement, explaining that written disclosure and consent are important to ensure that information about a member's methods of compensation is provided to non-institutional customers and that those customers agree to those methods — and that the market information available to customers would not help a customer determine whether a member is trading net, or understand what trading net means for that customer.

The oral method for institutional customers was itself added during that process. Commenters had asked that consent be obtainable orally on each order, with the disclosure given once in a single comprehensive statement. NASD added the oral route but did not consider a one-time disclosure appropriate for it — a member that chooses oral consent must explain the terms and conditions for handling the order to the institutional customer before each transaction, and must give the customer a meaningful opportunity to object to the execution of that transaction on a net basis — and the Commission found that resolution reasonable and consistent with investor protection.

One commenter also saw a potential conflict between the proposal and the trade reporting rule that governed how the price of a principal trade is stated on a trade report. NASD responded that the trade reporting requirements for net trades were not germane to the disclosure and consent rule and needed no change, and the Commission agreed that they were not implicated. The disclosure and consent obligation therefore sits alongside the trade reporting rules rather than modifying them — how each trade in a net transaction is reported is settled by those rules on their own terms.

The Scope Limitation — Market Makers Only

A critically important feature of Rule 2124 that is directly tested on the Series 7 examination is its application only to market makers — member firms that make markets in equity securities by standing ready to buy and sell for their own account. Regulatory Notice 18-29 explicitly confirmed that Rule 2124 does not impose disclosure and consent obligations on non-market makers.

A member firm that occasionally takes a principal position in an equity security to facilitate a customer order — but that is not registered as a market maker in that security — is not subject to Rule 2124's disclosure and consent requirements when it executes a net transaction. This is not because the firm has no disclosure obligations — it must still provide fair pricing and accurate confirmations under Rules 2121 and 2232 — but because Rule 2124's disclosure and consent obligations are not imposed where the compensation is already separately disclosed: SEC Rule 10b-10(a) requires a firm that is not a market maker, where after receiving the customer's order it buys or sells to offset a contemporaneous trade with that customer, to disclose on the confirmation the difference between the price to the customer and its own contemporaneous purchase or sale price, whereas a market maker's compensation on a net trade generally is not separately disclosed on the confirmation.

This market maker limitation connects Rule 2124 directly to FINRA's market making registration requirements and to the broader distinction between market makers and other broker-dealers in equity trading — a distinction that appears throughout the FINRA rulebook in contexts ranging from short selling to trading ahead of customer orders.

Whose Status Counts — Broker-Dealer Orders, Contrary Instructions and Large Accounts

The obligation runs to customers. In approving the rule the Commission recorded NASD's clarification that the rule does not apply to orders received from member firms and other registered broker-dealers, and that a broker-dealer that receives an order marked net, routed to it by an originating broker-dealer, has no disclosure and consent obligation to the customer of the originating broker-dealer for whom it is handling the order — in both cases the originating broker-dealer is responsible for adhering to the requirements. FINRA has since noted that the rule applies expressly only to transactions with or on behalf of a customer, meaning a person that is not a broker-dealer.

The fiduciary provision also carries a qualification that the rule text does not spell out. The look-through to the fiduciary was added to the proposal as an option for the member, and it is a default: absent instructions to the contrary, a member may look to the institutional or non-institutional status of the fiduciary, rather than that of the underlying account, when deciding which method of disclosure and consent is allowed — so that, as FINRA explained when the rule took effect, the institutional methods may be used for an institutional fiduciary notwithstanding the status of the ultimate customer.

Which customers are institutional is decided wholly by Rule 4512(c), to which Rule 2124(e)(1) refers, and that definition does not follow the everyday division between individuals and institutions. Besides banks, savings and loan associations, insurance companies, registered investment companies and registered investment advisers, it takes in any other person — whether a natural person, corporation, partnership, trust or otherwise — with total assets of at least fifty million dollars. An individual customer whose total assets reach that level therefore holds an institutional account, and a market maker may obtain that customer's consent to net transactions by any of the three institutional methods, including a negative consent letter.

Connection to Trade Reporting and Best Execution

Rule 2124 operates alongside FINRA's OTC equity trade reporting requirements — under which a net transaction is not reported as one trade at the interdealer price: the market maker's trade with the other party and its trade with the customer are each reported for public dissemination, the trade with the customer at the net price. Regulatory Notice 18-29 addresses this trade reporting dimension explicitly — confirming that both trades must be reported for public dissemination (in its example, the market maker's purchase from another firm at forty dollars and its sale to the customer at the net price of forty dollars and ten cents), whereas only one leg of a riskless principal transaction is reported for public dissemination.

The trade reporting treatment of net transactions affects market data — the reported net price becomes part of the public price discovery record that other market participants and regulators use to assess market conditions. Accurate reporting of the net price is therefore both a regulatory compliance obligation and a market integrity requirement that ensures the public price record accurately reflects the prices at which customers are actually transacting.

Rule 2124 also connects to FINRA Rule 5310's best execution obligation — market makers executing net transactions must ensure that the net price charged to customers satisfies the best execution standard, which requires the member to use reasonable diligence to ascertain the best market for the security and to buy or sell in that market so that the resultant price to the customer is as favorable as possible under prevailing market conditions. Regulatory Notice 18-29 confirms that the net price is the price used to assess compliance with that obligation, and that the factors of particular relevance in evaluating the trade with the customer may include the prevailing market price at the time of execution and the terms and conditions of the order, such as whether the customer consented to trade on a net basis.

Net Trading Permitted, and Measured at the Net Price

FINRA rules do not prohibit net trading or mandate the prices at which a firm must execute the initial and the offsetting transactions. A firm that chooses to trade on a net basis must instead comply with every applicable rule — the trade reporting rules and Rule 2124 among them — and FINRA has stated that those rules are applied on the basis of the net price of the transaction, the net or reported price being the execution price for purposes of determining compliance.

Rule 5320's protection of held customer orders shows what that means in practice. Suppose a firm is holding a customer's limit order to sell 100 shares at forty dollars and five cents, and it then buys 1,000 shares of the same security from another firm at forty dollars and sells them to a different customer on a net basis at forty dollars and ten cents. In determining the firm's obligation under Rule 5320 the benchmark is the net price of forty dollars and ten cents, not the price exclusive of the differential — and because the firm has made a principal trade at a price that would satisfy the held limit order, it must execute that order.

FINRA has also warned that some firms may be improperly taking advantage of the trade reporting requirements for net trades for the express purpose of inflating trading volume. Depending on the facts and circumstances, such conduct may be treated as a violation of FINRA rules, including the rule against manipulative, deceptive or other fraudulent devices and the rule governing the publication of transactions and quotations.

Recordkeeping Requirements

Rule 2124(f) requires members to retain and preserve all documentation relating to consent obtained under the rule in accordance with FINRA Rule 4511's general books and records requirements — connecting the consent documentation directly to the six-year default retention period of Rule 4511 and the format and media requirements of SEC Rule 17a-4.

The recordkeeping obligation ensures that FINRA examiners can verify compliance with the disclosure and consent requirements by reviewing the actual consent documentation obtained from customers — rather than relying on the member's representations about its consent practices. The retention of negative consent letters, written order-by-order consents, and documentation of oral consents creates an evidentiary record that demonstrates the member's systematic compliance with Rule 2124 across its market-making activities.

Examination Relevance and Key Takeaways

FINRA Rule 2124 is tested on the Series 7 examination in the context of net transactions, market makers, disclosure and consent requirements, and the distinction between retail and institutional customer treatment.

The key points to retain are these.

FINRA Rule 2124 — Net Transactions with Customers — applies only to market makers executing net transactions in equity securities. A net transaction is a principal transaction in which a market maker buys or sells at one price from or to another broker-dealer or another customer and then sells to or buys from the customer at a different price — with the market maker's compensation embedded in the price difference rather than charged as a separate commission.

Before executing any net transaction the market maker must provide disclosure to and obtain consent from the customer. For non-institutional customers — retail investors and any other customer whose account is not an institutional account — written consent on an order-by-order basis is required, evidencing the customer's understanding of the terms and conditions of each net execution. For institutional customers — accounts qualifying as institutional accounts under Rule 4512(c) — three alternative consent methods are available: a negative consent letter covering future orders where silence constitutes consent, oral disclosure and order-by-order consent with documentation, or written order-by-order consent. For customers with discretionary fiduciary managers the consent may be obtained from the fiduciary — with institutional treatment available if the fiduciary itself qualifies as an institutional customer. Rule 2124 does not apply to non-market makers. All consent documentation must be retained in accordance with FINRA Rule 4511.