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Consider a low-volume exchange-traded security that sometimes sees no trading volume for days on end. Examples of such securities are some bonds, preferred shares, SPACs, and ETFs listed on the NYSE or Nasdaq. Suppose Alice happens to submit a buy limit order at $10 on stock exchange X while Bob submits a sell limit order at $10 on stock exchange Y. Alice and Bob submitted their orders at the same time, at the same price, but on different exchanges. This produces a locked market. Stock exchanges X and Y happen to give traders rebates for adding liquidity but charge fees for removing liquidity. Alice is unwilling to move her order to stock exchange Y because she will then have to pay fees for removing liquidity. Bob is thinking along similar lines.

From my understanding of Regulation NMS, locked markets are not allowed. Do both Alice and Bob have to remove their orders, and later resubmit them with Alice voluntarily decreasing her bid by $0.01 and/or Bob voluntarily increasing his offer by $0.01? What incentivizes them to prevent a locked market when they resubmit their orders?

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The market data systems generally prevent locks from happening simultaneously. No market data ticks in a single security are transmitted at the same time, they are always in some kind of order (though it could essentially be a function of which exchange is faster than the other or dependent on how the securities information processor (SIP) processed the market data during that particular instant). As a result, either Alices order will be before Bob's or vice versa but never both at the same time.

Most exchanges have "order protection" rules in their rule book, which prohibit their members from locking or crossing the market, as well as in some cases, algorithms that may adjust the price or hide the order until it is no longer locking.

In the event of a lock which is continuing to last for more than a few seconds, the exchange member being locked can call the operations center at the exchange doing the locking and ask them to address it. They in turn will contact the relevant participant who in turn may either take action or contact their customer.

Regulators also periodically review who has locked and crossed markets and investigate and fine the worst offenders. They are fined not only for the offense but also for not having sufficient procedures to prevent the offense from happening.

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