Exempt Market Maker
An exempt market maker is a broker-dealer that qualifies for certain regulatory exemptions — most notably from short-sale locate and marking requirements under Regulation SHO — specifically because it is engaged in bona fide market-making activity in a security, standing ready to buy and sell at displayed prices on a continuous basis.
Regulation SHO, adopted by the SEC in 2005 and subsequently amended, governs short selling in U.S. equity markets. Under Regulation SHO, broker-dealers are generally required to locate and obtain a reasonable belief that a security can be borrowed before executing a short sale — the so-called 'locate' requirement. For registered market makers and other bona fide market-making participants, Regulation SHO provides an exemption from this locate requirement for short sales that result directly from market-making activity in the security.
The rationale for the exemption is that legitimate market makers provide a continuous two-sided quote and fulfill customer orders on both sides of the market throughout the trading day. A market maker that sells short to fill a customer buy order is performing a structural liquidity function — bridging a temporary imbalance between supply and demand — rather than speculating on a price decline. Requiring this market maker to locate borrow before completing a routine customer fill would impair liquidity and slow execution.
The exemption is available to bona fide market makers but is not available to all short sellers who claim market-making status. The SEC has been active in enforcement actions against firms that claimed the market-maker exemption for short sales that were not genuinely connected to market-making in the relevant security. Key factors in determining bona fide market-making status include whether the firm displays continuous two-sided quotes, whether its net position in the security is consistent with a market-making function, and whether its short sales occur in the normal course of filling customer orders.
For equity options market makers, a related exemption permits hedging short stock positions that arise from options market-making without satisfying the standard locate requirement, since options market makers routinely take short delta-hedging positions as a direct consequence of their options quoting activity rather than as speculative directional bets.
Investors and analysts should understand exempt market maker status primarily in the context of short interest data interpretation. Reported short interest figures in U.S. equity markets exclude short positions held by bona fide market makers that are exempt from Reg SHO, meaning that total disclosed short interest may understate aggregate short positioning in the market by a meaningful amount.